16. Bank Resolution Procedures, Contingent Capital (CoCos), and Bail-Ins

If capital and liquidity are the wings to address contagion, better insolvency resolution procedures for banking organizations and other financial institutions are the prayer. Effective resolution procedures are primarily designed to address the TBTF problem by allowing banking organizations or other covered financial institutions to be resolved without public support. Those designing these procedures have recognized, however, that such resolutions must be conducted in a manner to avoid contagion. They seek to achieve this result by assuring all short-term creditors of subsidiaries that they will not lose any money, even if their institution goes into resolution, because resolution will only take place at the holding company or because all longer term creditors are subordinated to short-term creditors if resolution takes place within operating subsidiaries.

For contagion to be prevented by resolution, short-term creditors of an institution that may go into resolution must believe they have no risk of losing their money. If they do not believe this, then it is rational for them to run. Better safe than sorry. Moreover short-term creditors in other institutions, fearing resolution, will run as well. I believe that shortcomings in the design of the resolution procedures, as discussed below, will not provide such assurances. In any event, prudence dictates that we have strong measures in place if there is a run despite the resolution procedures. It is also important to realize that fear of initiating contagion, particularly if one has poor weapons to fight it, could deter use of resolution in the first place. And if that happens, the primary objective of better resolution procedures, avoiding TBTF, will not be achieved.

In this chapter we turn to the principal components of the new resolution system, CoCos and bail-ins.

16.1  Contingent Convertible Capital Instruments (CoCos)

The term “contingent capital” is the generic name given to a group of long-term hybrid debt instruments. The distinguishing characteristic of all contingent capital instruments is an embedded equity mandatory conversion provision, triggered automatically after the issuer’s financial profile deteriorates below a defined threshold.1 These instruments are thus designed to provide more capital when needed so as to avoid formal resolution. Contingent capital instruments incorporate long-term maturities that enhance the total loss-absorbing capital available to issuers, thus protecting all nonconvertible liabilities (including, indirectly, shorter term debt) against losses large enough to overwhelm common equity.2 Like bail-in proposals, examined next, contingent capital instruments generally focus on the holding company level because generally only holding companies issue these instruments, not bank subsidiaries. Like bail-ins under the single point of entry (SPOE) approach, use of contingent capital at the holding company does not in and of itself recapitalize banking subsidiaries or other operating subsidiaries.

Since contingent capital is long-term debt,3 it is arguably more economical to issue than equity given tax regimes permitting the deduction of interest on debt but not dividends on equity. Further, since contingent capital instruments convert automatically, they can absorb losses outside of a formal resolution process. In effect, they streamline loss absorption and internalization of costs beyond the common equity layer. For this reason, and owing to its substantive similarity to creditor bail-ins, contingent capital may be viewed as a form of resolution procedure rather than simply as an exotic variant of capital.

Analogous instruments predate the financial crisis in concept and practice. Reinsurance companies use contingent capital to manage risk from large, discrete loss exposures.4 As one example, in 1997 LaSalle Re Holdings Ltd. issued $100 million of contingent capital structured as convertible preferred shares to cover “a major catastrophe or series of large catastrophes that cause[d] substantial losses” in the future.5 The adoption of contingent capital by the banking industry is a more recent development that remains at a more conceptual stage.6 Variations of contingent capital instruments customized for bank and nonbank financial institutions have, however, gained traction with some policy makers. Between 2009 and February 2015, $288 billion of CoCos were issued.7 Significantly, $174 billion of these issuances occurred in 2014, demonstrating the growth of their popularity.8 Chinese banks accounted for approximately one-third of these 2014 issuances, while European banks were responsible for slightly more than half of the amount.9 As of April 2015, there have not yet been any United States issuances.10

US regulators and the Basel Committee have not permitted CoCos to satisfy capital requirements. Thus, in July 2011, the Basel Committee announced that the capital buffer for systemically important banks would be composed only of tier I common equity, rejecting the use of contingent capital to satisfy a SIFI surcharge.11 Similarly the Federal Reserve’s June 2013 final rules implementing Basel III in the United States require that the paid-in amount of any instrument be classified as equity under GAAP to qualify as tier I capital, which effectively prevents contingent convertible debt from qualifying prior to conversion.12 Regulators have, however, acknowledged certain potential benefits of CoCos: FSOC determined that contingent convertible instruments can help financial institutions withstand losses at a cost cheaper than common equity13 and Federal Reserve Board Governor Tarullo has stated that requirements for long-term convertible debt would “strengthen our domestic resolution mechanisms and be consistent with emerging international practice.”14

With the so-called Swiss finish, Swiss policy makers have offered the most significant endorsement of contingent capital. Under the new Swiss regime, in addition to the Basel III tier I common ratio of 4.5 percent, the two systemically important Swiss banks are required to maintain an 8.5 percent capital conservation buffer, up to 3 percent of which may consist of contingent capital that converts to equity if tier I common falls below 7 percent of RWA (“high trigger CoCos”).15 The remaining 6 percent of RWA progressive surcharge may consist of contingent capital that converts when the tier I common ratio falls below 5 percent (“low trigger CoCos”).16

Contingent capital is an attractive complement to common equity and nonconvertible long-term debt and offers several benefits. It minimizes the public externalities and market disruption of putting a SIFI through conservatorship or receivership.17 Automating the restructuring motivates bondholders and equity holders to monitor risk-taking by issuers.18 The current yield on contingent capital instruments serves as an objective leading indicator of the market’s judgment of an issuer’s financial strength. Contingent capital is cost-effective for issuers relative to permanent equity,19 but more expensive than nonconvertible debt, supplying an ex ante source of market discipline.20 The loss absorbency of contingent capital can shield short-term debt holders along with other creditors supplying credit not subject to conversion from impairment.21 Finally, contingent capital has an established record of performance in the insurance industry. Nevertheless, two serious practical obstacles must be overcome before these potential benefits can be realized and before regulators will be willing to count these instruments as capital: (1) relative lack of investor demand and (2) design of an effective conversion trigger. In addition recent studies indicate that CoCo bonds may increase equity holders’ risk taking.22

16.1.1  Demand for CoCos

Strong demand for contingent capital is essential to realizing the cost savings that these instruments offer relative to equity. Recent contingent convertible issuances show that investor demand is heavily dependent on the particular structure of the contingent capital instruments, while the structure itself generally hinges on the constraints imposed by regulators and ratings agencies.23 Bert Bruggink, chief financial officer of Rabobank, reported ambivalence on the part of buyers about pricing the SCNs: “We met people who argued the pricing was completely wrong—overpriced—and others surprised we were even willing to pay a premium to our senior debt.”24 Similarly a disappointing UBS issuance in February 2012 shows that in some cases there is weak demand for the particular contingent convertible structures that banks are able to offer.25

Weak demand for contingent convertibles is partially explained by the fact that many current institutional investors participating in the market for nonconvertible subordinated debt instruments (classified as tier II debt under the existing Basel framework)26 face statutory restrictions on owning common stock or convertible instruments.27 Other investors might be reluctant to manage the tail-risk associated with conversion as a matter of investment policy.28 Excluding these buyers from the marketplace could narrow the prospective investor base for contingent capital to pure fixed income funds and hedge funds with investment mandates that extend affirmatively to hybrid, convertible debt, and equity instruments.29

16.1.2  Conversion Triggers

One model, favored by the Basel Committee, assigns this decision to the discretion of the issuer’s primary regulator. While the convertibility of the capital instruments is still subject to contract, the conditions triggering the convertibility are determined under the contract by regulators upon a finding that the issuer’s financial condition is unsatisfactory, for example due to a negative stress-test result.30 This flavor of a CoCo is really a bail-in, discussed below. A second model bases conversion on the adequacy of the issuer’s capital ratios.31 The Association for Financial Markets in Europe favors this model, and both the Lloyds and Rabaobank securities are patterned on it.32 A third model employs market-based variables to determine when to convert,33 such as an issuer’s share price, credit spreads, or the CDS pricing on an issuer’s long-term subordinated debt.34 To ensure that a market-based trigger is activated only during a genuine market-wide downturn, some have suggested pairing any of these market measures of an issuer’s individual riskiness with a secondary variable measuring overall market risk, for instance the level of an index of financial firms. Using an index-based component theoretically would help ensure that conversion of contingent capital instruments occurs only during a financial crisis, when all firms are faring poorly for systemic reasons, while restricting convertibility and leaving scope for resolutions through normal bankruptcy channels otherwise.

The market trigger model, unlike the regulatory- or some capital-based alternatives, is independent of regulatory discretion and observable in real time. Critics of a market trigger worry that it will expose conversion to arbitrary market volatility and possible manipulation by speculators35 Risk of manipulation may be overstated, however. It is doubtful if even wide-scale manipulation by “speculators” or short-sellers could exercise enough influence on security prices to trigger a conversion event. This risk could easily be addressed, in any case, by adding an index-based conversion provision of the type described above, which would require a downturn in the performance of all of the financial institutions in the financial system before mandating conversion of any individual issuer’s contingent capital.

Reliance on index-based triggering might, however, increase overall correlation risk among contingent capital issuers during a market-wide crisis. If a conversion event at one financial institution caused the securities prices of peer institutions to decline, for example, because investors become fearful of a more generalized crisis, this could inadvertently prompt conversion of contingent capital securities issued by other institutions. By linking the behavior of individual convertible instruments to the performance of financial institutions other than the issuer itself, an index trigger might introduce an additional source of correlation and connectedness, increasing systemic risk as a result.36 Additionally both the index-based and the single-issuer market triggers, either separately or in conjunction, should incorporate a type of market variable that is impervious to the effects of market noise. If CDS prices, credit spreads, or share prices prove to be too easily distorted during a crisis, then use of a market trigger will have to be reevaluated. Indeed an FRBNY study has found that “trade frequency in single-name reference entities [is] relatively low.”37 This thin trading may suggest that CDS prices do not function as a high-quality proxy for the market’s perception of a reference entity’s likelihood of default and therefore might not provide a reliable conversion trigger.

Assuming these practical considerations may be resolved, contingent capital instruments may improve the existing framework for internalizing the costs of financial distress and might lessen the probability of failure by adding to the amount of capital on which financial institutions may draw. In this sense automatic resolution operating at the holding company level, may protect short-term creditors of banks and other operating subsidiaries, making contagious runs less likely. However, a conversion event might well intensify contagion as existing creditors and new potential investors might interpret the signal transmitted by the conversion of contingent capital into equity in one institution as a sign of fatal distress for their own institutions or for the financial system more generally.

Since contingent capital does not satisfy the systemic demand for liquidity created during a run, it can never serve as a useful tool for rescuing financial institutions affected by contagion. Proponents of contingent capital instruments who appreciate this limitation acknowledge the necessity of interim liquidity facilities, organized privately or in all likelihood by a public lender of last resort to steward issuers through a period of systemic crisis.38

16.2  Creditor Bail-ins by Regulators

Creditor bail-in transforms the basic loss absorbing functionality of contingent capital instruments into a more general and noncontractual method for restructuring a financial institution’s liabilities without going through an extended resolution process. The bail-in procedure is generally patterned on a prepackaged restructuring that is intended to enable a struggling bank to recapitalize swiftly and free from the institutional value destruction or market disruption typical in a judicial or administrative reorganization.39 We later discuss the use of bail-in techniques inside of resolution through the new Dodd–Frank Orderly Liquidation Authority but this section is addressed to bail-in outside of resolution. Nonetheless, many of the problems we identify with the use of bail-in outside of resolution are also present within resolution.

Bail-in refers to a set of related techniques that aim at forcing the creditors of a financial institution that is deemed by regulators to be in danger of failing to absorb the losses that it has incurred by swapping certain of their liability claims for new equity issued for the purpose of recapitalizing the financial institution’s balance sheet. Bail-in uses debt-to-equity conversion to increase a troubled financial institution’s total pool of available capital and to reduce its leverage in a period of stress.40 Unlike contingent capital, bail-in is a stand-alone strategy for resolving distressed or failed institutions.41 It is a systematic restructuring procedure, not a class of capital instruments, which is intended to automate the conversion and write-down of a designated portion of a financial institution’s debt capital structure in response to a preceding regulatory determination or trigger event.42 Conversion through a process of bail-in is not governed by contract and, as such, can embrace any or all parts of an institution’s debt, including instruments that may not have been specified as convertible at the time of issuance. This is sharply different from contingent capital instruments, which are designated in advance to convert only under a defined set of contractual conditions.

Under most approaches envisioned by its sponsors, to institute a creditor bail-in regulators simply would require that designated liabilities (those that regulators have selected, whether or not they incorporate a preexisting contractual conversion feature) undergo a form of mandatory write-off or convert to equity.43 One important consequence of this difference is that contingent capital is naturally limited in the amount of support it can provide to an ailing firm to the value of contingent capital instruments that are actually issued and outstanding. By contrast, creditor bail-in would potentially provide the same firm access to a much larger implied capital cushion, theoretically equal to the firm’s entire financial indebtedness. This would enable bail-in to serve the role of a more comprehensive restructuring system during a crisis, rather than just supplying a novel form of supplementary capital.

16.2.1  Shortcomings of Bail-in outside Formal Resolution

One major shortcoming common to all forms of creditor bail-in is the legal uncertainty associated with implementing it. It would not appear that the FDIC or other US regulators currently possess bailout powers outside of a formal resolution procedure. It is true that the Federal Reserve can use the “source-of-strength” doctrine to force holding company parents to inject capital into their bank subsidiaries.44 However, if that capital injection and any absorption of subsidiary losses put the holding company at risk of failure, then use of a formal resolution procedure to restructure the holding company (e.g., OLA) would be necessary.

Since the process of bail-in is designed to bypass ordinary bankruptcy channels (including chapters 7 and 11 of the Bankruptcy Code and the various forms of FDIC resolution) the automatic stay normally instituted against withdrawals by creditors in bankruptcy might not be available to prevent a mass exit,45 though this shortcoming could be addressed in principle by extending the application of such a stay to cover debts subject to the bail-in. This seemingly would require new legislation. For example, §362 of the Bankruptcy Code automatically prohibits the creditors of an entity entering bankruptcy from enforcing financial claims against the debtor—apart from so-called qualified financial contracts (QFCs), such as repos and OTC derivatives, that they are entitled to terminate—a stay not available outside formal resolution.46 Even if such a stay could be adapted to bail-in, however, it would not deter runs by anxious short-term creditors on institutions that had not yet become subject to bail-in.

Anticipatory runs by short-term creditors on institutions that have not yet, but could soon be, bailed-in thus present a major problem for the implementation of a bail-in regime, and this concern would be present whether we are dealing with bail-in in or outside of a formal resolution procedure. The main alternative—generally exempting short-term creditors from bail-in, for example by announcing an express carve-out of short-term debt or confining its reach to a financial institution’s regulatory capital instruments only—could restrict its effectiveness in situations where severe losses overwhelm an institution’s capital buffers. If the bail-in of non–short-term debt was insufficient to cover losses, short-term debt could still be at risk. Explicitly carving short-term debt out from the coverage of a bail-in regime might also promote a shift of institutional funding from unprotected longer term capital instruments into shorter maturity investments, increasing overall systemic dependency on short-term debt. This would increase the overall risk of contagion in the financial system rather than contain it.

16.2.2  Bailable Instruments and the Amount of Losses

Common to all forms of creditor bail-in, whether it occurs outside or within a formal bankruptcy procedure, is the question of which classes of debt instruments are eligible for impairment or conversion. Absent a special exemption from normal priority rules, applying debt-to-equity conversion across the entirety of a financial institution’s capital structure will expose short-term unsecured debt holders to the risk of impairment, encouraging them to exit preemptively from an institution that is perceived to be in distress, considerably increasing the risk of a run. Shielding short-term debt holders (in particular, uninsured deposits including foreign deposits, nondeposit short-term debt, plus all the other systemically important liabilities that are likely to exit instead of accepting impairment) from the imposition of losses will, however, override ordinary rules of contractual priority controlling inter-creditor relationships outside of bankruptcy, altering the pricing of longer term bailable instruments that beforehand may have ranked equivalently with (or senior to) shorter term debt in order of recovery but now will in effect have been demoted.

At the least, the power of regulators conducting bail-in to unsettle existing inter-creditor contracts for the purpose of favoring systemically relevant debt is likely to raise the cost of unfavored bailable instruments proportionately. Further, short-term creditors that harbor doubt about whether exemptions will actually be given or the strength of the legal footing for a regulatory carve-out will rationally prefer to withdraw from a distressed institution rather than remain invested during a bail-in and, taking their chances in court. The FDIC’s SPOE proposal, pursuant to OLA, discussed below, seeks to avoid these problems by limiting bail-in to the holding company, which is generally funded by only longer term debt. This in turn creates the necessity to downstream new capital from the restructured holding company to the banks and other operating subsidiaries, a matter we examine in our discussion of OLA.

The Basel Committee proposal on bail-ins limits bail-in conversion to noncommon tier I and tier II capital instruments only. Under this formulation, short-term debt presumably will be excluded from conversion, since it is not a capital instrument. This will reduce the danger of setting off a run or spreading contagion, since short-term debt would be protected. Limiting the selection of bailable instruments to tier I and tier II capital only, however, could restrict the total amount of capital potentially available to absorb losses, narrowing the usefulness of bail-ins to situations in which institutional losses are no greater than total existing capital. Short-term investors who suspect that their issuer’s long-term debt and common equity are insufficient to facilitate the recapitalization will expect to be impaired too despite ex ante assurances of a carve-out, and may run anyway. This concern is even more acute in the case of an Institute of International Finance (IIF) proposal, which ordinarily reserves only subordinated debt, but not senior debt, for bail-in conversion, and thus increases the chance that a severely impaired firm will be unable to marshal the financial resources necessary to support a successful bail-in. Although the IIF proposal does permit bail-in of senior indebtedness in extraordinary circumstances, it would require a separate decision by regulators.47 If short-term creditors had any doubt that this decision would be timely and forthcoming, they might panic and run.

Provided in table 16.1 is an illustrative bail-in based on Citigroup’s consolidated balance sheet as of December 31, 2008. It depicts a bail-in at the holding company level.

Table 16.1

Illustrative bail-in of Citigroup balance sheet as of December 31, 2008 (USD millions)

As the table suggests, the firm possessed enough senior and subordinated long-term debt, about $1.9 billion, to support losses of 20 percent, or about $260 million, to its trading, investment, and loan portfolios through bail-in, without impairing guaranteed, short-term, and otherwise ineligible instruments. Losses greater than approximately 30 percent of the carrying value of these assets, however, would have exhausted the amount of long-term debt eligible for bail-in, requiring public support to fully restore the pre–bail-in leverage ratio without converting shorter term instruments. The issue of sufficient bailable instruments at the holding company level is a concern inside formal resolution like OLA, as well as outside formal resolution.

Table 16.2

Illustrative bail-in of Citigroup under IIF proposal with subordinated debt only (USD millions)

Under the IIF proposal, however, in which bail-in is confined (at least initially) to subordinated and junior subordinated debt instruments only, losses of 20 percent or more would exhaust bailable capital and subordinated debt, requiring public support or the conversion of senior indebtedness (via separate regulatory approval) to effectuate the bail-in. As of December 31, 2008, subordinated debt held at Citigroup’s parent and subsidiaries levels totaled no more than $57.7 billion, or just 16 percent of Citi’s cumulative long-term debt maturities recorded on balance sheet (the remaining $301.6 billion represented senior long-term instruments) (see table 16.2). A bail-in of Citigroup assuming even modest balance sheet losses would thus have overwhelmed the total amount of liability claims the IIF proposal would make available to regulators. The current solution to this problem for bail-ins within resolution is to impose minimum requirements of unsecured debt that would be available for potential bail-in, through TLAC, or total loss absorption capacity requirements, discussed below under OLA.48

16.2.3  Other Potential Obstacles to Bail-In

Regulators also face an array of practical obstacles similar to those confronted in the case of contingent capital. First, the impact on investor appetite of subjecting the debt of financial institutions to the risk of automatic conversion at the discretion of regulators is unknown, but it could be significant. The Financial Times reported the results of a customer survey by JPMorgan showing that one quarter of senior bondholders have indicated they would refuse to purchase instruments subject to bail-in risk.49 This could raise average bank borrowing costs by 0.87 percent.50 European banks’ issuance of senior debt that can be subject to a bail-in is at its lowest in a decade as of mid-2013.51 During September and October of 2014, European banks issued 14.5 billion euros of senior debt, down from 27 billion issued over that same period in 2013.52

Bail-in eligibility is also likely to impact the ratings and capital treatment of implicated instruments. In 2011, Moody’s Investors Service cautioned that it would consider downgrades of junior bank debt subject to bail-in;53 in February 2014, S&P issued a similar warning.54 S&P followed through on its threat in August 2014, when the rating agency downgraded three Austrian banks, specifically citing new bail-in legislation that “indicates reduced predictability of extraordinary government support for systematically important banks, and for banks’ hybrid capital instruments and grandfathered debt, than we previously envisaged.”55

Second, the mechanics governing conversion must be designed and articulated.56 If the “trigger” controlling when bail-in takes place is a pure function of regulatory discretion (rather than premising it on capital- or market-based variables), then at the very least regulators must define prospectively under what circumstances bail-in will occur (and which liabilities will be included or exempted from its sweep). This is the subject of considerable disagreement among advocates for the solution.57 Many of the putative advantages of bail-in, for example, automating resolution, minimizing regulatory intervention, and promoting uniformity in reorganizational outcomes, all in a nondisruptive manner,58 require investors to know ex ante which claims will bear these costs and under what circumstances, but many market participants echo doubts that certainty in this connection can be achieved.59

Third, bail-in may entail replacing the failed institution’s old management with new management that commands the confidence of the market place following reorganization. This means that new managers may have to be found and installed before a bail-in can be completed, delaying the process. Completing a bail-in would furthermore involve a change of control that placed former debt holders into equity ownership of the failed institution. These debt holders may, however, be disqualified by regulators from the ownership of banking institutions under US law, for example, hedge funds or private equity firms.

The fourth major practical shortcoming of creditor bail-in is jurisdictional. To encompass a meaningful portion of the international financial system, a bail-in regime will need to be coordinated with insolvency laws and resolution procedures applicable in multiple national jurisdictions so that bail-ins can take place on a cross-border basis without violating or otherwise interfering with local laws.60 This is crucial when large financial institutions with multinational operations are subjected to bail-ins during a crisis. These institutions—arguably the most complex in the financial system—are widely regarded as most in need of an efficient alternative to current resolution regimes. Cross-border resolution through bail-in is likely to be much more difficult outside of formal resolution—developing cross-border cooperation is primarily focused today on resolution within bankruptcy. Given the major obstacles to achieving coordinated bail-in policies in the near future, one could require new debt instruments issued by financial institutions to incorporate private contract terms authorizing conversion to equity upon a trigger signal from regulators of a specified country, as the Basel Committee and others such as Bates and Gleeson (2011) have suggested.61 Under this alternative creditors would contract to apply the law of the bail-in jurisdiction in advance, so that conflicts of law and among local regulators would be minimized. In the variant of this approach outlined by Bates and Gleeson, a financial institution incorporated in a bail-in regime would be required by the law of that jurisdiction to contract ex ante with any creditors whose claims could potentially arise in a non–bail-in jurisdiction to submit to the effect of a bail-in if one were to occur.62

However appealing it may be in principle, “contracting” for cross-border bail-in presents daunting challenges in practice. Success depends, among other things, on where the long-term debt of large, complex financial institutions is issued and held, and at what level of the corporate structure. The paradigmatic case imagined by Bates and Gleeson contemplates one-company institutions where all subsidiaries are of a parent bank (though potentially with creditors in different jurisdictions) governed by bail-in rules applicable to all creditors. If all bailable debt were indeed issued at and held at the parent bank holding company level in a single jurisdiction, it might be relatively straightforward to require the institution to contract for uniform bail-in terms from all creditors. However, most large institutions hold debt at dozens or even hundreds of local subsidiaries in multiple jurisdictions (even if originally it was issued at the holding company level but then transferred downstream to those subsidiaries). Under these conditions, the contractual solution is unlikely to work. Lehman Brothers, for example, operated 433 subsidiaries in 20 different countries prior to its failure.63 Many subsidiaries were subject to local regulation including capital. Local regulators responsible for managing the capital levels of local bank subsidiaries are unlikely to allow conversion of subsidiary-level debt for the purpose of restoring the consolidated capital ratio at the holding company-level in a different jurisdiction, or to uphold or even permit contract terms to require that such local debt be subject to the control of foreign regulators.

Even for regulators bailing-in a financial institution that is organizationally confined to a single jurisdiction, the challenge of coordinating the conversion of debt instruments outstanding across many different bank subsidiaries so that all of these subsidiaries, in addition to the parent holding company, are adequately (but not over-) capitalized after the bail-in, will be formidable. Contracting for bail-in of complex multinational financial institutions thus presents both a “vertical” problem (coordinating bail-in between the holding company and its bank subsidiaries) and a “horizontal” one (coordinating bail-in of debt in different jurisdictions). Furthermore relying on contract to streamline bail-in would transform it into a form of contingent capital, sacrificing its functionality as a substitute for formal resolution procedures by requiring that the major terms controlling conversion be stipulated in advance if it were to be acceptable in multiple jurisdictions.64

Bail-ins outside of resolution have significant problems, some of which can be addressed in a more formal resolution procedure. We now turn to the new Orderly Liquidation Authority, the new formal US framework for dealing with certain nonbank SIFIs including bank holding companies.