A. The nature and timing of communications should be considered when closing a bank

The home supervisor could find that its actions trigger automatic effects under the laws of host countries, which could have unintended consequences. For example, it might be undesirable if local law required a host supervisor to liquidate the bank's branch in its jurisdiction even in the case of a conservatorship in the home country. In the process of deciding what measures should be adopted when closing a multinational bank, bank supervisors may wish to consider whether adopting measures could give rise to automatic effects under the laws of certain overseas jurisdictions in which the bank has branches. They also may wish to consider whether their domestic laws are sufficiently flexible so as to permit the temporary closure of a foreign bank's operations in their jurisdictions if that is what is being done in the home country. The home supervisor's decisions regarding consultation and the communication of information could be affected by several additional factors. The home supervisor might have existing cooperation arrangements with some supervisors, which could facilitate communications, but not with others. In general, the supervisor might have concerns about confidentiality because of the possibility that some parties connected with the failing bank could gain an unfair advantage if they receive information which others do not. The size of the bank's operations could pose practical problems which complicate the assessment further.

Parties who have entered financial contracts with a multinational bank could be subject to uncertainty by the timing of the bank's closure. This can give rise to the temporal Herstatt risk, which was observed in the BCCI S.A. case. The potential for temporal settlement risk suggests there might be some times which are better than others for supervisors to act jointly to close a multinational bank. Although it might be desirable to close a bank at a time that minimises Herstatt risk, it should be recognised that the imperative of the situation or constraints of local laws could make achieving the goal less desirable or impossible. Supervisors may wish to consider whether they have adequate procedures available to effect the closure of a bank outside of normal business hours so as to minimise Herstatt risk.

The uncertainty and confusion associated with the insolvency liquidation of a multinational bank, particularly one that has a significant number of retail depositors, emphasise a need for the supervisors involved to have open and reliable channels of communication. In the initial period after the closure, a home supervisor might expect to receive inquiries from creditors and users of the bank's services worldwide. Similarly, host supervisors might need to have information available for local creditors and bank customers. Given the possibility that there could be many liquidation proceedings related to the multinational bank, as the bankruptcy progresses, it would be desirable for host supervisors to report to the home supervisor about developments in their jurisdictions, and for the home supervisor to keep other interested supervisors informed on overall developments to the extent possible.

B. Liquidation rules may be relevant to the supervision of multinational banks

1. General

Moreover, the study group has found in the case of BCCI S.A.'s liquidation that the interaction of different liquidation regimes and other relevant laws can introduce many complexities and uncertainties with respect to the disposition of a failed multinational bank's assets and the payment of claims against it. In essence, it is extraordinarily difficult for supervisors - and for banks - to identify and manage all the potential risks posed by the intricacies of laws which might be relevant in the failure of a multinational bank. Thus, pursuing policies based on the expectation of certain outcomes in a liquidation may not be appropriate.

The complexities and uncertainties that can result from the liquidation of a multinational bank's operations confirm that effective consolidated supervision performed by home-country supervisors remains paramount in protecting depositors and other creditors. Further, these complexities and uncertainties reinforce the need for host-country supervisors to be satisfied that banks seeking to enter their markets are supervised by home-country authorities that perform consolidated supervision, consistent with the Minimum Standards for the Supervision of International Banking Groups and their Cross-Border Establishments.

2. Location of capital

In order to determine the location of a bank's capital, capital may be thought of either as being represented by the assets of the bank or as the surplus of the bank's assets over its general or current liabilities. It is difficult to determine where the capital of a multinational bank is located. If capital refers to the surplus of a bank's assets over its general liabilities, in the case of a bank which, if it failed, would have all its branches and assets liquidated under the single-entity doctrine, the starting point, in theory, would be that its capital is not located in any particular branch. Rather, the capital is located either at the centre, i.e. in its country of incorporation, or is spread over every location in which the bank does business; in either case, it is available for all the bank's worldwide creditors. However, if a multinational bank has a branch in a separate-entity jurisdiction and there is a surplus of assets over the general liabilities of that branch, it is possible to think of the bank as having capital located at that branch. (The amount of the capital located at that branch would depend upon the realisable value of the branch assets.)

But the issue is more complicated than this. It may be more accurate to think of the capital of a multinational bank as being "located" where the assets of the bank are located (rather than the jurisdiction in which the assets are booked). For example, if a bank incorporated in country A (a single-entity jurisdiction) has a branch in country B (a separate-entity jurisdiction) and that branch has assets on its books located in country C, it is the law of country C that may determine whether the relevant assets would go to the liquidator appointed under the law of country A or country B, if these liquidators make competing claims for the assets, or to an attaching creditor from country D. The location of an asset itself is a complex legal question beyond the scope of this paper.

A consequence of the separate-entity doctrine may be that assets of the bank located at a branch in such a jurisdiction would not be available for the worldwide creditors of the bank if the bank were liquidated. This may mean that, in certain circumstances, home-country supervisors may wish to make an adjustment when assessing capital adequacy in respect of capital or assets located at such a branch.

3. The function of a branch

The treatment of inter-branch claims in an insolvency liquidation can raise issues for supervisors regarding the appropriate function of a branch. Consistent with the theme that supervisory policies should not necessarily follow liquidation regimes, it would seem inappropriate - and uneconomical - to prevent branches in all circumstances from funding other branches. However, a host supervisor might not want a branch of a foreign bank whose creditworthiness is seriously in question to act as a funding vehicle for other branches of the bank. Host supervisors may wish to limit the amount of funding a branch may provide in these circumstances.

4. Supervisory ring-fencing

A supervisor could require a bank to limit its exposures to other members of its corporate group. Similarly, a supervisor may attempt to place limits on the degree to which the bank has exposures to certain categories of country risk. These forms of ring-fencing can be effective whether a branch or a bank would be wound-up under the single-entity or the separate-entity doctrines. Supervisors also may seek to protect the assets of a branch or to limit the exposure of a branch to the rest of the bank.

In single-entity jurisdictions, all the worldwide creditors of a bank can prove in the liquidation. Therefore, attempts by supervisors to ring-fence a branch in such a jurisdiction would not enhance the return to creditors of the local branch as it might in a separate-entity jurisdiction. However, such ring-fencing might result in a greater pool of assets being available for distribution to the worldwide creditors of the bank.

Where the creditworthiness of a multinational bank is in doubt, difficult issues may arise between the home supervisor and a host supervisor in a separate-entity jurisdiction. The host supervisor may require the transfer of assets to the branch (from the home country or elsewhere) to protect the interests of creditors of that branch. The home supervisor may be reluctant to permit this to take place because it could mean that fewer assets are available to support the liabilities of the bank as a whole and that there might be a lower return to the worldwide creditors of the bank if the bank were liquidated. Overly protective measures by the host supervisor could bring about the insolvency of the bank. Such problems are best resolved through supervisory cooperation and coordination, as stated in the Concordat.

C. Liquidation rules can affect returns to creditors and the operations of deposit protection schemes

1. General

2. Insolvency set-off

Thus, there are differences between systems of law which provide for insolvency set-off and those which do not. There also are differences between insolvency set-off regimes which treat a multinational bank as a single legal entity and those which regard a branch of a multinational bank as having a separate legal identity. The detailed provisions of the insolvency set-off regimes also may differ, e.g. the treatment of foreign exchange contracts.

The complexities arising from the differences between insolvency set-off regimes are exacerbated by the fact that there do not appear to be clear, generally accepted principles of private international law. Moreover, there is no international convention regarding cross-border insolvency which provides for set-offs in one jurisdiction to be recognised overseas or which specifies the system of law governing the parties' rights. This means, for example, that if a Luxembourg-incorporated bank in liquidation there has branches in England and New York:

1. it is not clear whether a set-off effected in the New York branch liquidation would be recognised in Luxembourg;
2. if the English winding-up is ancillary to the Luxembourg liquidation, it is not clear whether the Luxembourg liquidator can sue a customer of an English branch for the full amount of a loan even though the loan could have been set-off against the customer's deposits under the English law of set-off; and
3. it is not clear whether the New York superintendent of banks, liquidating the New York branch as a separate entity, could sue a customer for the full amount of a loan appearing on the New York branch's books when the customer has a deposit with the English branch that would be available for set-off against the loan under English law.

One factor potentially affecting the return to creditors is how set-off relates to the assets involved in the liquidation. The liquidators of foreign branches in the United States marshal all the assets of the foreign bank in their jurisdictions, even if those assets are not assets of the US branch. Thus, there seems to be some imbalance in that set-off may only be asserted against a branch when the asset and liability are on that branch's books, but set-off may not be asserted against a correspondent balance that is an asset of another branch. For example, if bank A in the United States has a deposit with the New York branch of failed bank B and holds a correspondent balance for a non-US branch of failed bank B, it would have to turn over the correspondent balance to the New York liquidator and prove in the New York liquidation for the amount of its deposit with the New York branch. Bank A would not be able to set-off the correspondent balance against its claim on the New York branch of bank B. Similar issues may arise in the case of cross-border collateralisation arrangements.

The lack of an international convention providing for mutual recognition of insolvency set-off or of generally applicable choice of law rules can mean that the expectations of parties at the time contracts are entered into may not be fulfilled if the contract is entered into in a jurisdiction which has one type of insolvency set-off regime but the customer has to prove his claim in a liquidation taking place in a country with a different insolvency set-off regime.

The different approaches to set-off in the jurisdictions studied reinforce the conclusions of the Lamfalussy Committee on Interbank Netting Schemes that netting schemes should have a well-founded legal basis under the laws of all relevant jurisdictions. The greater the number of branches and the degree of complexity of such arrangements, the greater is the risk that they will not take legal effect in accordance with their terms. In the light of this, a supervisor may wish to examine how its banks measure and control counterparty risk.

3. Deposit protection schemes

In structuring a deposit protection scheme or in calculating the amount of compensation which should be payable to depositors at a failed bank, it may be relevant to consider whether set-off in an insolvency is permitted or required in the relevant jurisdiction. It may be appropriate for deposit protection schemes to pay deposit protection on a gross basis in jurisdictions which do not permit insolvency set-off and on a net basis in jurisdictions which do. Another issue is whether the deposit protection scheme, in making protection payments, should take into account any right of set-off a depositor might have in another jurisdiction.

In all three countries studied, deposit protection schemes are subrogated to the rights of depositors against a failed bank when protection payments have been made. The differences between insolvency set-off regimes may affect the amounts recovered by deposit protection schemes. A deposit protection scheme in country A (which does not permit insolvency set-off and pays deposit protection on the gross amount of the deposit) may have difficulty in enforcing its subrogation rights if it has to prove its claim in the principal liquidation of the failed bank in country B (which requires insolvency set-off). These problems might be overcome by an international convention regarding the treatment of deposit protection schemes' subrogation rights in liquidation proceedings in different countries.

In both Luxembourg and the United Kingdom, the deposit protection schemes (when subrogated to a depositor's rights) obtain a priority over the depositor in respect of protection payments made in relation to his deposit until such time as the scheme has been fully reimbursed. This priority is granted by statute in the United Kingdom, whereas in Luxembourg the depositor executes an agreement subordinating his rights against the insolvent bank to those of the scheme. It is not clear whether the priority rights granted to a host-country deposit protection scheme under its local law will be given effect if it has to prove in the liquidation of the insolvent bank in its country of incorporation. It may be that specific subordination agreements have a greater chance of being given effect overseas than statutory rights of priority. In such circumstances, it may be necessary for arrangements to be entered into or for steps to be taken by the courts of the host country if it is desired to preserve the priority the host country scheme would have under its local law.

When a bank fails, it may be subject to certain insolvency procedures which do not involve the formal commencement of a liquidation, e.g. the appointment of provisional liquidators in the United Kingdom or the respite from payment procedure in Luxembourg. In such circumstances, depositors may be adversely affected if, for example, their ability to enforce their contractual right to repayment is frozen and they are not entitled to receive payments from deposit protection schemes. This raises the question of whether a deposit protection scheme is intended to insure timely repayment of a deposit or ultimate repayment of a deposit.

D. Coordination and cooperation between liquidators can affect creditors and can be affected by the role of supervisors in a liquidation

Differences in the insolvency regimes which may apply and the fact that there may be multiple liquidators give rise to the potential for conflicts between the interests of the different liquidators. This can adversely affect the interests of creditors. The liquidators could make competing claims to assets or they may fail to exchange information and documents, which could inhibit the prosecution of third-party claims and reduce the amount distributable to creditors.

The affairs of a multinational bank involve a level of complexity that requires a significant amount of sharing of information and documents by liquidators for the effective winding-up of the company, e.g. to assess the value of creditors claims, to realise assets and, where criminal activity has occurred, to cooperate in enforcement and supervisory proceedings. The inability or unwillingness to share information and documents can delay the winding-up process. The failure to share information or documents may be due to (a) certain liquidators being required by law to pursue interests of creditors of a branch, for example, to the exclusion of other creditors, (b) bank secrecy laws, e.g. where the law of a country recognises only the local liquidator as the bank and would not permit customer information to be provided to a liquidator of the bank in another country because he is regarded as a third party or (c) other constraints of local law. In addition, liquidators may not be able to share information with liquidators appointed in other countries because they are engaged in confidential negotiations with a third party, e.g. to settle litigation claims.

There are a number of means by which insolvency proceedings in different jurisdictions may be harmonised in order to achieve a coordinated liquidation of a multinational bank in the interest of achieving fair treatment of, and maximum return to, all creditors. These include recognition of the home liquidator in overseas jurisdictions and ancillary insolvency proceedings. Certain jurisdictions also have rules to prevent creditors obtaining an unfair advantage by proving in more than one liquidation such as the hotchpot rule in the United Kingdom. However, where a multinational bank has branches in a large number of countries, it is unlikely that a coordinated liquidation of the bank can be achieved merely by relying on mutual recognition rules. Moreover, certain jurisdictions may have laws which preclude participation in coordination arrangements or make such participation unnecessary because they require the local branch to be dealt with on a discrete basis.

Given the difficulties discussed above, other measures may be necessary if it is desired to promote a coordinated liquidation of a multinational bank. Supervisors may attempt to secure the appointment of the same liquidator in each of the countries where the bank has branches. This may streamline communications, simplify the process of the realisation of assets and facilitate negotiations with third parties. However, the local laws of certain countries or conflicts of duties may prevent a common liquidator from being appointed. Contractual cooperation arrangements could be entered into among the different liquidators, e.g. contractual pooling of assets and claims. An international convention or regime covering cross-border insolvencies of multinational banks could provide for such banks to be liquidated on a coordinated basis.

The role of the supervisor in the liquidation of a bank can vary across jurisdictions. In some jurisdictions, the supervisor is the liquidator of the bank. Other supervisors may have the role of advising the court regarding the possible modes of liquidation. Others may not have a formal role in the liquidation but retain certain information-seeking or supervisory powers over a failed bank. The role of the supervisor in the liquidation can affect its ability to influence the conduct of the liquidation, the disposition of the failed bank's assets and the payment of creditors' claims.