International Insolvencies in the Financial Sector A Study Group Report Group of Thirty Group Group of Thirty, Washington, DC International Insolvencies in the Financial Sector A Study Group Report Published by Group of Thirty© Washington, DC 1998 1 For more information, contact: Group of Thirty 1990 M Street, N.W., Suite 450 Washington, DC 20036 Tel.: (202) 331-2472 · Fax: (202) 785-9423 E-mail - [email protected] · WWW - http://www.group30.org 2 Acknowledgements The Group of Thirty would like to thank INSOL International for its cooperation in conducting the study and conference described in this volume. Both were joint undertakings of the two organizations, but the original impetus for the study came from INSOL. Particular thanks in this regard is owed to Richard Gitlin for his initiative in proposing the project, and to Neil Cooper, Vice President of INSOL, for his continuing involvement and support. The project could not have been brought to a successful conclu- sion without the substantial effort and commitment of time by the participants in the original study group, by the many public offi- cials and private commentators who analyzed and commented on the Discussion Draft, and by the speakers at the London conference. All brought a wealth of experience and information to the process. It is equally clear that the London conference would not have been possible without the generous financial and logistical support of the Bank of England, Ernst & Young and Morgan Stanley. Finally, recognition is due to several individual contributors to the project: to Charles Taylor, for preparing the original Discussion Draft; to Christopher Oprison, for legal analysis and management of the international consultative process; and to Sheila Campbell and Jeffrey Humin for their efforts in editing and producing this document. Contents Page Introduction 1 Overview: Reducing The Threat of International Insolvency 3 Recommendations 7 Appendix I: Working Papers 21 Discussion Draft 23 List of Participants 25 Chairman‘s Foreword 27 Summary of Recommendations 29 Discussion 31 Recommendations 37 Notes to Discussion Draft 50 Summary of Comments on Discussion Draft 55 Respondents 65 Appendix II: Conference Proceedings 69 International Insolvency in the Financial Sector 71 Conference Panelists 159 Group of Thirty Members 165 Group of Thirty Publications since 1989 167 Introduction or the last two years, the Group of Thirty, in cooperation with the International Insolvency Practitioners Association (INSOL F International), has been examining the issues that could arise in the cross-border insolvency of a financial institution. While this project was originally triggered by the failure of Barings in 1995, the final report is being published amidst widespread insolvencies in the emerging markets of Asia, involving both financial institutions and large industrial conglomerates. Although the Asian crisis has affected a wide range of internationally active financial institutions and investors, it has not triggered the failure of any globally active financial institutions. Nonetheless, the insolvency issue has become a matter of greater importance now than when the project began. This volume contains the full sequence of work the Group of Thirty has pursued on the issue of international insolvency. This effort began with the creation of a study group in 1996 to examine the issues surrounding the insolvency of a global financial institution. Given the complexity of the issues and substantial variations in insolvency law and practice across countries, the group’s report and recommendations were presented in draft form to provide a basis for discussion. This text is included in original form in Appendix I. The draft report was widely distributed, and comments were requested from private and official experts in twenty jurisdictions 1 as well as international organizations and agencies. During the latter part of 1996 and early 1997, comments were received from 16 countries and three international organizations. This commentary follows the discussion draft in Appendix I. Both the draft report and commentary served as background for a conference on international insolvency in the financial sector held in London in May 1997. Roughly 100 experts from 19 countries were assembled for a wide ranging discussion of insolvency issues. The agenda, speakers and proceedings of the conference are presented in Appendix II. Out of this discussion has come an endorsement of the recommendations in the original report, modified to reflect mainly technical concerns, plus additional suggestions on how best to ensure that future insolvencies are pursued with speed and certainty. The overall conclusions of the study are provided in the overview section, “Reducing the Threat of International Insolvency,” along with the expanded list of recommendations and the agency or organization best suited to take the lead on them, where appropriate. Given the variety of national laws and the absence of an international framework for cooperation on insolvency, the proposals in this report must be considered only a first step in reducing the risks inherent in cross-border financial insolvencies. They place heavy reliance on voluntary action by supervisors, insolvency practitioners and the private sector, offering a way forward in the near term. The recommendations also propose changes in law and regulation, to ensure consistency of practice and legal authority for cross-border cooperation, which will clearly take longer to accomplish. The report does not even broach the subject of conforming national insolvency laws for financial institutions to a single international standard, since eliminating differences in national preferences and approaches is unlikely in the near term and may simply be unworkable. However, the present level of international attention to the problem of insolvency is such that it may be possible to develop a set of broadly applicable required elements for an effective insolvency regime as a basis for evaluating and improving upon current national laws. Until such time as broad international agreement on insolvency is reached, the recommendations in this report make a start at ensuring that if a global financial institution gets into serious difficulty, its insolvency can be handled with greater speed and certainty. 2 Overview: Reducing The Threat of International Insolvency fter an extended review of the issue of international financial insolvency, it is clear that supervisors, legislators, the financial A services industry and insolvency and legal professionals have a great deal of work to do. There is no international framework for dealing with the supervisory, legal and financial problems that would arise in a cross-border insolvency of any kind, and a major cross-border insolvency in the financial sector could therefore pose a substantial risk to the international financial system. In considering the nature of this problem, it is important to recognize that globally active financial institutions are increasingly complex financial groups, a development with implications for both risk management and supervision. Experience has shown that counterparties may be distressingly unaware of the actual party within a group with which they are contracting, and therefore of their true financial and legal position in insolvency. Supervisors, even where they strive to take a global view of a firm, inevitably focus on that part of the group that is within their jurisdiction. Yet the triggering event of an insolvency is likely to originate within the firm’s trading arm, where a collapse can happen literally overnight. Thus, both private and official observers must comprehend both the 3 general and particular conditions of the firms with which they are dealing. In considering how to address this problem, it is important to recognize that the first line of defense in dealing with a financial insolvency is the supervisor, whose approach to supervision will, in general, be consistent with the requirements of national bankruptcy laws. In the event of insolvency, and ideally in advance of balance- sheet insolvency, supervisors in the G-10 countries would undertake resolution procedures under the special legal authority available to supervisors and central banks, without recourse to general insolvency procedures in the courts. And certainly if supervisors had cause to believe that a financial insolvency could be a source of systemic risk, they would act quickly and directly to address the problem, avoiding the protective mechanisms built into insolvency laws that would be likely to slow emergency action. Yet while this supervisory imperative may be the same across countries, the legal authorities available to deal with a financial insolvency vary greatly from country to country, often based on quite different social preferences, with different priority assigned to protection of creditors, borrowers, employees and shareholders. Some are well tested and provide a fair and effective basis for sorting out competing claims within the national context; others much less so. In addition, virtually none were written with attention to the cross-border dimensions of an insolvency, offering no mechanism for dealing with matters outside of home jurisdiction or reconciliation of national differences. There is therefore substantial scope for conflict and miscalculation. On the other hand, the tradition of cross-border and now cross-sectoral supervisory cooperation that has developed because of the globalization