Earlier this week, we filed our views on the single-point-of-entry (SPOE) resolution construct with the FDIC http://www.fedfin.com/images/stories/client_reports/FedFin%20Comment%20to%20FDIC%20re%20SPOE%20Notice.pdf. In short, we said nice try, but work fast because so much is being decided so soon as effectively to side-swipe SPOE as a credible anti-bailout solution. Indeed, the same day we filed our comment, the FRB essentially said that it doesn’t care what the FDIC is negotiating on comfy cross-border resolutions. When it comes to foreign banks doing business here, the Fed wants them to be islands of safety and soundness the home country can’t touch in a storm. Both the FDIC and FRB stand by their commitment to seamless cross-border finance, but the talk is increasingly belied by the walk they are taking farther and farther down the “our-way-is-the-highway” path. And, judging by the EU’s response to the FRB, at least one other major jurisdiction will trot down the road it likes, taking it farther and farther from not just the U.S., but also the global framework for which so much hope swelled in the wake of the financial crisis.

First, what is SPOE? For those with their minds on happier topics, SPOE is a construct the FDIC has developed in concert with the U.K. to take over a failing SIFI without taxpayer money when ordinary insolvency law won’t work. The idea is for the top-tier holding company in a big banking organization to have so much capital and long-term unsecured debt that, in the event of a disaster, the FDIC can step in, seize the parent, take the money, and then run the subsidiaries in an orderly fashion for as long as it takes to prevent a panic. The FedFin comment letter addresses a lot of questions that need to be answered before we can be confident that each SPOE step will work as desired, but this is the construct and in broad form, it’s a great way to prevent bailouts unless or until the Bankruptcy Code can take on a SIFI in extremis.

The challenge the FRB posed to SPOE is its requirement that foreign banking organizations (FBOs) form intermediate holding companies (IHCs) if their non-branch U.S. assets exceed $50 billion. Commenters – including some very vocal foreign governments – protested this for many reasons, one of which is that isolating these U.S. assets and their capital and funding supports means that what’s in the U.S. stays in the U.S. when they might otherwise safeguard other parts of the FBO. The FRB readily acknowledges this, saying in the preamble to the new rule that:

While the proposed requirements could incrementally increase costs and reduce flexibility of internationally active banks that primarily manage their capital and liquidity on a centralized basis, they would increase the resiliency of the U.S. operations of a foreign banking organization, the ability of the U.S. operations to respond to stresses in the United States, and the stability of the U.S. financial system. A firm that relies significantly on centralized resources may not be able to provide support to all parts of its organization. The Board believes that the final rule reduces the need for a foreign banking organization to contribute additional capital and liquidity to its U.S. operations during times of home-country or other international stresses, thereby reducing the likelihood that a banking organization that comes under stress in multiple jurisdictions will be required to choose which of its operations to support.

Aware of this tough stand, FRB Gov. Jeremy Stein asked staff at the February 18 board meeting if the IHC is compatible with SPOE or if it instead forces another resolution option: the multiple-point-of-entry (MPOE) approach proposed by the Financial Stability Board. The FSB isn’t opposed to SPOE, but it also likes MPOE because a lot of countries don’t house all their banking assets in lead banks – the traditional U.S. approach – and many universal banks outside the U.S. also do all sorts of non-banking things in lots of ways ill-suited to SPOE.

When lots of risk is housed in branches of a single subsidiary, SPOE is G2G. When the risk is in all sorts of places in all sorts of ways, not so much.

At the board meeting, the FRB’s staff assured Mr. Stein that IHCs and SPOE are compatible. This is right – at least in the U. S. — if the IHC forms a top-tier entity through which the FDIC could implement SPOE when the IHC is structured much like traditional U.S. BHC, with one very large lead insured depository institution and a few other itty-bitty things the FDIC thinks it can handle. But, what of an FBO with multiple IHCs in the U.S. – an option the FRB expressly permits in its final rule? This would allow FBOs with several large U.S. banking operations to house them in separate IHCs reflecting existing retail-banking operations in various states. If the parent back home hit the wall, which IHC would the FDIC use for SPOE or would it need instead to deploy MPOE through each of the IHCs to rescue the subsidiary banking operations?

How would the U.K. use SPOE if its own big banks are forced – as they will be – to establish IHCs? The construct in the memorandum of understanding between the U.S. and U.K. in 2012 was that each home country would deploy SPOE and determine how branch activities in the other nation can best be resolved once the home-country banking organization is stabilized. But, if the U.S. operations are walled off in an IHC, can the U.K. act as desired when U.S. resources are, as the FRB intends, walled off from the parent? SPOE handles branches well because the home-country regulator can protect them tidily if all of the top-tier parent’s resources are as robust as hoped. But, what if branches aren’t there because some or all of them are forced into IHCs?

Maybe this will work as planned and I truly hope it does. But, once the U.S. walls off operations here from home-country regulators, expect other nations to do the same. Indeed, the EU has already threatened as much. As a result, forced subsidiarization could well occur across the globe, putting each bank’s prize assets into safes in each nation secure from repatriation when a parent back home comes calling. As the FRB says, this ring-fenced approach makes it far easier for each host country to protect itself, but – and this the Fed doesn’t say – it does great damage to the concept of cross-border finance in which capital and liquidity flow freely as markets demand. Saying SPOE still works doesn’t make it so, raising challenges to a critical plank of the U.S. reform effort even as the FRB’s new rule drives nails into the coffin of cross-border financial reform.