Resolving Large Complex Financial Organizations
The resolution of a large complex financial organization (LCFO) presents numerous problems, including organizational complexity, opacity of positions, and conflicting legal jurisdictions. Of particular concern is the potential impact of large derivatives books. Widespread adoption of laws permitting close-out of derivatives contracts exempts these contracts from the usual stays that provide time for the orderly resolution of claims by the courts. Thus, a potentially significant part of the LCFO’s assets and liabilities are exempted from normal bankruptcy procedures, creating the potential for a disorderly dismemberment of an insolvent LCFO. Nonetheless, however inconvenient they may be for bankruptcy administrators, the closeout netting privileges enjoyed by derivatives are essential to reducing legal uncertainty, increasing liquidity, and minimizing the systemic impact of large failures. The solution advocated in this paper is for regulators to provide “facilitated private resolution” for dealing with systemically important financial institutions, along the lines of the Long-Term Capital Management workout and the “London Approach” practiced in the last century. To make this early intervention effective, consolidated supervision is needed to ensure that comprehensive information is available and intervention takes place while the firm is still solvent.