UK Treasury: "vital" to expand resolution powers for investment banks

Although the Treasury denied "misconceived" reports that the US insolvency system had responded better than the UK system to the Lehman Bros collapse, it pointed out that the UK could still benefit from change.

The report focuses on possible changes in three areas: resolving trading, clearing and settlement issues after an insolvency; returning client assets; and the insolvency process itself. With the rest of the year already set aside for consultation, any legislation is unlikely to be published before next year. 

Although the Treasury denied "misconceived" reports that the US insolvency system had responded better than the UK system to Lehman's collapse, it pointed out the UK could still benefit from change.

The report focuses on possible changes in three areas: resolving trading, clearing and settlement issues after an insolvency; returning client assets; and the insolvency process itself. With the rest of the year already set aside for consultation, any legislation is unlikely to be published before next year.

Over-the-counter trades after the insolvency of one of the counterparties are identified as the main settlement problem –greater transparency would help investors to "more accurately quantify and manage the risk they assume when dealing with an investment bank", the Treasury said.

The collapse of Lehman Brothers also revealed problems in returning client assets, especially if the assets had been rehypothecated. "The practical implications of returning client assets and monies in the event of the failure of a firm with such a complex arrangement of client assets and monies as Lehman Brothers were not fully considered in any jurisdiction," the Treasury commented.

One of the roots of the problem might have been investors' unwillingness or inability to look into the details of their brokerage arrangements – assuming the institutions were essentially interchangeable and too big to fail, investors were unaware of the "variable cost and risk exposures" involved. If clients agree to let the bank use their assets as security for its own lending, the complexity involved slows down insolvency proceedings, the Treasury said. Better record-keeping would help, but the UK alone would be unable to enforce it across all the operations of an international bank. It might also be useful to limit the use of third-party asset custodians and to make it possible for banks to segregate client assets by client type to cater for different risk appetites.

Potentially, the Treasury added, it could use existing powers to create a new insolvency regime for investment banks, including a separate officer responsible for the safety and return of client assets.

The report follows similar calls for expanded powers from the US Federal Deposit Insurance Corporation, whose chairman, Sheila Bair, said last month she needed resolution powers to cover non-bank financial institutions as well as banks, to deal with the possible collapse of a large multinational financial company.

See also: Bair: FDIC needs power to take over non-bank institutions 
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