Financial institutions that are too big, too complex or too strongly bound up with other market participants cannot, however, quit the market via the insolvency route without causing great problems. For resolution to succeed in an emergency without disrupting the equilibrium of the market, precautionary measures must be taken in good time.

That is why the authorities are currently working hard both internationally and nationally on commensurate rules for banks and also for insurers and central counterparties. These rules are also intended to counter misguided incentives: G-SIFIs should no longer be able to rely on support from the State in the event of imminent insolvency. For this may tempt them into taking on high risks. BaFin President Dr Elke König explains what progress the international efforts to arrive at efficient resolution rules have made and what she thinks still remains to be done.

Dr König, in the opinion of the US banking supervisor, the Fed, and the US deposit insurer, the FDIC, the eleven biggest banks in the United States, which also include Deutsche Bank, are still quite a long way from being able to resolved in an orderly fashion. Do you share this assessment?

There is, in fact, still quite a lot to be done. We are talking here of global systemically important banks, for which orderly resolution is anything but easy, if only because of their size alone. These banks are globally interconnected and have partners in all major financial centres. Sometimes their organisational structure is complex, too; for their part, their local units are often systemically important for their particular financial market. The biggest challenge lies in identifying and eliminating impediments to resolution, one of the main causes of which is the cross-border activities of the banks.

What particular impediments are these?

We will only make headway on the resolution of international banks if the countries in question mutually recognise each other’s legislation. For example, how will a US judge react to resolution measures taken by a European resolution authority? Can we suspend contractual call rights, for a limited period at least? Here we need legal clarity – as we also do, incidentally, on how the supervisory and resolution authorities involved will act in a crisis. Ring-fencing of local units can be avoided only if we agree internationally on binding rules and trust each other. I think that in this respect we are on the right path – a path that we must rigorously stick to.

In addition, we must seek to ensure that the banks have adequate loss-bearing potential, generally known in English as “gone concern loss-absorbing capacity” (or GLAC for short), of the necessary quality. The same applies for the liquidity required to be able to maintain critical functions in a crisis.

How is this to be achieved?

Close and trusting international cooperation is absolutely essential here. That is why BaFin has been working for years together with the main supervisory and resolution authorities of other countries on these and other complex subjects. In addition to the usual crisis management groups, there are informal working meetings. These have been a great success: the exchange of ideas outside the fixed framework has helped to build mutual trust and led to a better understanding of the respective culture. You can hardly overestimate how important this is in a crisis situation: when the right decisions have to be taken quickly, success depends crucially on being able to rely on one another and all pulling together. Incidentally, the international meetings have a further advantage: by bringing the knowledge that we gain in them into our work with the banks, we can apply practical and internationally tried and tested approaches there.

How far have we in Germany and Europe gone down the road to a functioning resolution regime?

With the Bank Restructuring Act (Restrukturierungsgesetz) of 2011 Germany created a framework for orderly resolution before the rest of Europe did. This was followed here last year by the Ringfencing Act (Abschirmungsgesetz), which in addition to the rules governing ringfencing also laid down requirements for recovery and resolution planning. In May 2014 the European Union finally adopted the Bank Recovery and Resolution Directive (BRRD). It tallies in many respects with the German rules and brings additional advances, especially in the clear regulation of creditor participation and cross-border issues. Member States have until the end of the year to transpose the Directive into national law. In Germany this is being done through the BRRD Implementation Act (BRRD-Umsetzungsgesetz), which is currently going through the consultation phase, and in particular through the Recovery and Resolution Act (Sanierungs- und Abwicklungsgesetz). The resolution authority is to be the FMSA, or Financial Market Stabilisation Agency (Bundesanstalt für Finanzmarktstabilisierung), which in a second step is to be incorporated into BaFin as an agency within an agency. The FMSA and BaFin are even now working closely together in order to structure the numerous interfaces between banking supervision and the resolution unit in the best possible way and also to ensure a smooth transition into the European resolution regime.

In Europe we are at present also building the second pillar of the Banking Union, the Single Resolution Mechanism. In addition to a central banking supervision authority, the Single Supervisory Mechanism (SSM), which will be housed in the European Central Bank, from 2016 there will also be a central resolution authority, the Single Resolution Board, thereby creating the main regulatory framework at the European level. Nevertheless, this is a project that is still a long way from completion.

What remains to be done?

Firstly, issues relating to cross-border matters must be resolved. I have already mentioned that. Within Europe, we also need to put the flesh on the bones of the Recovery and Resolution Directive. The European Banking Authority (EBA) intends to issue around 40 Technical Regulation Standards and Recommendations for this. BaFin is supporting it in this and is providing its expertise in the relevant working groups.

That sounds like a lot of work and complicated negotiations. Will Germany be able to assert its own interests properly?

I think so. BaFin represents the German position in numerous working groups in both the FSB and the EBA. Thanks to our many years’ collaboration we enjoy the trust of our partners there. In the FSB we chair the all-important committee on resolution issues. So we can play a crucial part in shaping the regulations. We are a member of a group of countries that set the tempo – be it in the international initiative to suspend call rights in the Master Agreements of the International Swaps and Derivatives Association or in the regulations governing gone concern loss-absorbing capacity, to mention but two very topical subjects. And of course, our national work on recovery and resolution plans also benefits from this.

So the German banking industry need not fear anything from the new resolution and recovery rules?

For me, this is not a matter of fear but of good sense. What we want is a binding and effective resolution regime that also provides for suitable rules for the orderly resolution of systemically important institutions or institutions that pose a potential systemic risk. These rules must obviously be practicable – i.e. not just rules for rules’ sake. For this reason, it has for years been the custom to discuss important regulatory initiatives with representatives of institutions and associations as well as accountants in BaFin’s Crisis Management Committee. And also, when it comes to the application of the rules, I think it is important not to blindly follow the letter of the law, but to ensure that effective action is taken with a due sense of proportion.

Will the “too big to fail” problem have been solved once all the planned regulations, statutory instruments and standards have been adopted?

Statutory instruments alone will not suffice. They provide a binding regulatory framework and authorise us to act with sovereign powers. But that will not be of much use to us if we do not also flesh out the rules into something of more practical application. Let me explain what that means by way of the example of recovery planning. First of all, we drafted a recovery planning Circular. On the basis of this we asked the systemically important institutions in Germany to draft a recovery plan and to implement it in their business organisation. We monitored the banks closely in this, in order to support them and at the same time gain knowledge that we could take into account in the final draft of the Circular. The result of this procedure was that we were largely able to get the German Circular accepted by the EBA as a regulatory standard.

We are currently adopting a similar approach for resolution planning. We have identified the main impediments to resolution and are working with pilot banks to find ways of eliminating them. As a result, every day we are becoming a little better informed and are able to make our voice heard at the international level because of this expertise.

What challenges do you see for the near future?

With the European Central Bank taking over banking supervision, quite a lot will change for us – and not just in supervision. With regard to the current analysis of European banks’ balance sheets and stress-testing as well, we need a functioning resolution mechanism in Europe and quick-on-their-feet national units to apply this mechanism in practice, if necessary. I think Germany is best prepared in this respect: we can call on the expertise of experienced members of staff who are well-known and respected by their international partners and the banks. Trust, credibility and continuity are, as we know, the foundation of successful cooperation.

But a regime for the resolution of systemically important banks will not be enough on its own. We also need a rulebook for the infrastructures of the financial market – i.e. trade repositories, central securities depositories, payment and securities settlement systems, but also, and especially, for Central Counterparties (CCPs).

Why is that necessary?

The resolution rules for banks cannot be transferred to financial market infrastructures (FMIs) on a one-for-one basis. Systemic importance is virtually an inherent feature of them: they themselves are the system, the nodes in the network of market participants. We therefore need a rulebook that takes account of the special importance of the services they provide for the financial market as a whole.

What might that look like?

The big challenge is that certain FMI functions are essential for the financial markets – i.e. without them the markets would not function. They include the network connections between individual market participants, access to securities and the safe execution of trades – derivative trades in particular often extend over long periods. Even when all attempts to turn a business around have failed, these functions must be maintained. The functions, mind you. This does not mean that the businesses that provide these functions with their services cannot themselves be resolved. One possibility would be to transfer their systemically important functions to a bridging institution. A resolution regime must be created that maintains the systemically important functions and at the same time rules out as far as possible the use of public funds.

You said earlier that a rulebook for Central Counterparties was especially important. Why?

EMIR, the European Market Infrastructure Regulation, has introduced a clearing requirement for over-the-counter derivatives. This will, of course, lead to more deals being cleared overall, thereby increasing the importance of Central Counterparties for the financial market. We must be careful that this does not create new too-big-to-fail problems and risk concentrations. The future rulebook must also enable the resolution of very large and closely interconnected undertakings and at the same time do justice to the importance of CCPs for the financial market.

How far have we got with the regulation of the resolution planning of financial market infrastructures?

Still not as far as we have with the banks, but we are making progress. The Financial Stability Board (FSB) is currently working on international standards for a resolution regime for financial market infrastructures and their members and users, while the EU Commission is working on corresponding draft legislation. Many points are still in dispute. For instance, when has a recovery plan failed, so that the undertaking must enter the resolution process? What resolution instruments are needed? What form should resolution plans take? All these are questions that still have to be resolved. But all in all, we are on the right path.

Is there also a corresponding resolution regime for insurers?

The resolution rules that the Financial Stability Board (FSB) drew up in late 2011 in its “Key Attributes of Effective Resolution Regimes for Financial Institutions” also apply as a matter of principle for systemically important insurers. Who these are was laid down by the FSB for the first time in July of last year. The list is to be updated in November 2014 and on an annual basis thereafter. Now the FSB is developing guidelines on how the Key Attributes should be applied to insurers – for many of the rules cannot simply be transferred to them either. The business models of insurers and banks differ too greatly.

Do we know already what the basic outlines of the regime will look like?

Yes, the implementation has in fact already begun. The FSB had given national supervisory authorities until July 2014 to set up a crisis management group for each systemically important insurer. These groups are building on the structures of the international colleges that have existed for insurance groups for some time already. Each systemically important insurance undertaking must now draw up a recovery plan, similar to those of the banks, by the end of the year. For their part, the crisis management groups have to draw up resolution plans for these insurers, also by end 2014. But all this is on the basis of the FSB’s requirements – no corresponding legislation is currently being planned at the European level. And to a large extent, there are no national rules either. Nevertheless, national supervisory authorities and the insurance groups that have been classified as systemically important are already implementing the FSB requirements as far as is possible.

So the resolution question will keep BaFin busy for quite some time yet.

Indeed. After all, resolution is closely linked to supervision: with its preventive measures BaFin is not only seeking to ensure that financial market undertakings become more resilient but is also helping to actually make them resolvable. So we won’t run out of work all that quickly.