Legal Aspects of Cross-Border Insolvencies

1. Legal Aspects of Cross-Border Insolvencies Panel on International Aspects of Financial Insolvency: Cross-Border Insolvencies and Financial Conglomerates 3rd Annual International Seminar on Critical Issues in Financial Stability: Preventing and Confronting Bank Insolvency June 4, 2003 Washington, D.C. -Thomas C. Baxter, Jr. -Joseph H. Sommer Federal Reserve Bank of New York

2. Topics • Territoriality v. Universality • The Goals of a Cross-Border Bank Insolvency • Timely Initiation • Maximum Recovery • Systemic Risk Control • Reducing Moral Hazard • Increasing Comity

3. Each jurisdiction has its own proceeding, based on local assets and liabilities. Host-state supervisors have many roles, e.g.: Asset maintenance requirements Local lender-of-last resort Asset recovery tools outside insolvency Home state distributes assets; host states collect assets for distribution. No active role for host-state supervisors, except: Entry standards Forced exit Universality v. Territoriality

4. The Goals of Cross-Border Insolvency • Timely initiation of insolvency. • Maximum recovery for creditors. • Minimum systemic risk. • Minimum moral hazard. • Banks • Supervisors • Minimum conflict and friction in proceeding.

5. Depends solely on home supervisor. If home supervisor is slow, host can do nothing. Depends on first supervisor to see a problem. Competitive initiation is unlikely, but host can pressure home w/increasing asset maintenance. Timely Initiation Universality Territoriality

6. Netting--a work in progress (EU). Good mechanical efficiency. Compatible with reorganization. Netting--a work in progress (NY 618-a). Comparable mechani-cal efficiency. Local authorities are better at collecting local assets. (This can be a major factor!) There are no reorganizations in modern bank insolvency law! Maximum Recovery Universality Territoriality

7. Why are Local Authorities so Significant? • Cross-border wrongdoing is common. • It often severely impairs capital. • It sometimes even leads to insolvency. • Effective asset recovery in these cases requires local enforcement authorities, working outside of insolvency proceedings. • This is facilitated by ring-fencing.

8. Cross-Border Wrongdoing is Common $700 MM • Allied Irish (AllFirst sub in Baltimore) • Barings (Singapore) • BCCI (Everywhere) • Crédit Lyonnais (California) • Daiwa (New York) • Republic-Princeton (Japan) • Standard Chartered (India) • Sumitomo Trading (New York) £ 830 MM To be discussed $1100 MM >$600 MM $2600 MM

9. Asset Recovery and Ring-Fencing: The Case of BCCI $ MM Total US Recovery ~1200 Recovery From BCCI Liquidation 367 Third-Party Recoveries ~833 Sale of First American ($480 MM x 61%) 293 Asset Recoveries From Culpable Individuals ~350 ~643 => ~190 million from other sources Source: US v. BCCI Holdings, 69 F. Supp.2d 36 (D.D.C. 1999)

10. In BCCI, almost 70 % of the US recovery came from outside the liquidation proceeding. • This additional recovery--relying on public law--would have been unavailable to any foreign receiver. • Insolvency law is very respectful of the corporate veil. • Insolvency claims against third-party property--unless formulated as voidable transfers--are likely to fail. • It is unlikely that US enforcement authorities would have been so diligent if they did not feel responsible for BCCI.

11. Netting law can work in universality. Host central bank has no control over timing of insolvency. Better information-sharing. Netting can work in territoriality. Greater palette of host liquidity tools Controlling timing Ability to operate branch More willingness to assume local lender of last resort role Systemic Risk Universality Territoriality

12. Host supervisors have no substantial role. Will tend to free-ride. Exception: entry requirements. Home supervisors feel no external pressure to timely initiate insolvency. Host supervisors have strong incentives to supervise. Local creditors Reputation Local recovery is the ultimate metric Energetic liquidation Asset maintenance Fast initiation Moral Hazard-Supervisors Universality Territoriality

13. Controlled only by home-country supervisor. Can be further reduced by host-country supervisor. Moral Hazard-Banks Universality Territoriality

14. Comity • Universality is certainly kinder and gentler, in terms of international supervisory relations. • No unseemly rush for assets. • No receiver versus receiver litigation. • But . . . is comity an end or a means? • The market uses comity to set the rules, but uses competition to play the game.

15. THE BEGINNING