Monthly Archives: May 2013

Firm Advice: Implementing Dodd-Frank

By Joseph Santiesteban, J.D. Candidate 2014 | Posted on

The comment period recently expired on the Federal Reserve’s proposal to require foreign banking organizations with at least $50 billion in global assets and $10 billion in U.S assets to form an intermediate holding company for most of their U.S. assets.  The proposal is part of the Board’s implementation of Sections 165 and 166 of the Dodd-Frank Act. In a recent Client Alert, Gibson Dunn advises that “the IHC requirement likely exceeds the Board’s legal authority in implementing Sections 165 and 166 of Dodd-Frank, has the tendency to increase, rather than reduce, financial instability in the United States and globally, threatens other adverse effects, and does not effectively respond to the developments that the Board perceives in the U.S. operations of FBOs and in international banking regulation generally.” Gibson Dunn explains why here.

On April 10th, the White House released its proposed budget, which contained significant new tax proposals. While often general, the budget laid out specific proposals for: 1) the Buffet Rule, 2) marking to market of derivatives, and 3) alternative treatment for debt purchased on the secondary market. Skadden’s recent Client Alert explains the various proposals and both their foreign and domestic tax implications.

Class Action Complaint Alleges Conspiracy to Fix CDS Market

By Joseph Santiesteban, J.D. Candidate 2014 | Posted on

A group of institutional investors recently filed a class action complaint against some of the world’s largest banks alleging a conspiracy fix prices and monopolize the market for Credit Default Swaps (“CDS”) in violation of the Sherman Act § 1.  Defendants include Bank of America, Barclays, Citibank, and Goldman Sachs.   The complaint also names the International Swaps and Derivatives Association (“ISDA”), a financial trade association, which the complaint alleges is controlled by the defendant banks.  The plaintiffs are claiming potentially billions of dollars in damages.

A credit default swap is a method of transferring the risk of default for a financial instrument.  The purchaser pays a fixed payment to the seller in exchange for the promise to pay off the underlying debt in the event of a default.  The complaint alleges that because of the CDS market structure is unregulated and over the counter, every transaction must be with one of the defendant banks.

The complaint characterizes the CDS market as “starkly divided” between the defendant banks “who control and distort the market” and the plaintiffs “who, in order to participate in the market, must abide their distortions.”  The complaint alleges that this is the result of an opaque trading environment in which the defendant banks manipulate the bid-ask spreads through their negotiations with individual traders.  These manipulations cost the plaintiffs billions of dollars, says the complaint.  Plaintiffs allege that several of their attempts to create and regulated exchange were rebuffed by defendants.

Both the DOJ and the European Commission have been conducting their own investigations into these activities.  In March, the EU indicated that “ISDA may have been involved in a coordinated effort of investment banks to delay or prevent exchanges from entering the credit derivatives business.”

Federal Reserve FBO Proposal: Will Comments on the Intermediate Holding Company Requirement Be Heeded?

By Gibson, Dunn & Crutcher LLP | Posted on

[Editor’s Note:  The following post is a Gibson, Dunn & Crutcher LLP Publication, authored by its Financial Institutions Practice Group.]

The comment period has now closed on the controversial proposed rule (FBO Proposal) of the Board of Governors of the Federal Reserve System (Board) implementing Sections 165 and 166 of the Dodd-Frank Act (Dodd-Frank) for foreign banking organizations (FBOs) and foreign nonbank financial companies supervised by the Board.  If the FBO Proposal becomes final in the manner proposed, it will mark a sea change in the regulation of the U.S. operations of FBOs, by requiring FBOs with $50 billion or more in total global consolidated assets and $10 billion or more in total U.S. nonbranch assets to form an intermediate holding company (IHC) for almost all of their U.S. subsidiaries.  In our view, the IHC requirement likely exceeds the Board’s legal authority in implementing Sections 165 and 166 of Dodd-Frank, has the tendency to increase, rather than reduce, financial instability in the United States and globally, threatens other adverse effects, and does not effectively respond to the developments that the Board perceives in the U.S. operations of FBOs and in international banking regulation generally.

(more…)

Professor Paulus Speaks on Sovereign Debt Restructuring

By John Muse-Fisher, J.D. Candidate 2014 | Posted on

On April 17, legal practitioners, bankers, scholars, and students met at the Federal Reserve Bank of San Francisco to discuss recent developments in sovereign debt restructuring.  Sovereign debt restructurings date to at least 300 B.C. and are a practical fact of life in today’s global economy.  Recent developments in the realm of sovereign debt restructurings include Greece’s recent restructuring, the Second Circuit’s potentially destabilizing decision in NML Capital v. Argentina, and the seemingly perpetual Eurozone debt crisis.

Professor Christoph Paulus, Director of the Institute for Interdisciplinary Restructuring (Berlin) and graduate of Berkeley School of Law (LLM ’84), presented his framework for creating a Eurozone sovereign debt restructuring mechanism (SDRM).  The IMF proposed an international SDRM in the early 2000s, but the plan lost out to market driven approaches.  Market driven approaches to sovereign debt restructuring include the use of Collective Action Clauses (CACs) in debt contracts, which allow a qualified majority of bondholders to change the terms of the contracts to effectuate a restructuring. 

Professor Paulus’s proposed Europe-centered SDRM envisions a “resolvency” proceeding for sovereigns – a more optimistic and palatable vision of restructuring than an “insolvency” proceeding.  The proposal includes three key requirements: (1) the inclusion of a resolvency clause in bond contracts that would trigger resolvency proceedings under certain circumstances; (2) the creation of a resolvency court overseen by a president who would in turn select 30–40 elder statespersons to serve as judges in potential resolvency proceedings, and; (3) the development of the resolvency court rules of procedure.  The envisioned resolvency process is roughly comparable to insolvency proceedings under most country’s corporate laws and would be intended to promote orderly negotiations between sovereigns and bondholders.

Following Professor Paulus’s presentation, Professor Barry Eichengreen facilitated a lively discussion detailing the limitations and virtues of an institutional approach as compared to market driven approaches, including CACs.  Professor Eichengreen described the moral hazard argument against the creation of an SDRM – that such an institution could make it too easy for sovereigns to write down their debt.  Nonetheless, Professor Eichengreen pointed out that the moral hazard argument now cuts the other way out of concerns that sovereigns borrow too much, and the market for sovereign debt requires greater discipline.  The group also considered Contingent Convertibles (CoCos), an additional market driven approach, as a means to facilitate smooth sovereign debt restructurings.  CoCos would convert sovereign debt to equity on the occurrence of certain measurable conditions, such as sustaining a particular GDP.

The ideas and issues raised at the Federal Reserve Bank provided a useful framework for understanding the potential of a Europe-centered SDRM to facilitate sovereign debt restructurings in the future.  Limitations and questions remain. There are hurdles to applying resolvency clauses in non-European jurisdictions. Certification is required for ensuring the legitimacy of the elder statespersons who would serve as judges. Methodological questions remain about calculating accurately the effect of an SDRM on liquidity in the bond market, and an account of the insufficiency of market-based solutions (especially CACs) to shore up the argument that an SDRM is in fact needed. Indeed, these ideas are still being developed and stakeholders are not in consensus about the best way forward.

Experience from the Anti-Monopoly Law Decision in China – Part II

By TC Tsui | Posted on

[Editor’s note:  This post continues yesterday’s article, found here.]

3.2. Methodology and Assumptions

This “legal discount” test provides how much Coca Cola may lose in the acquisition of Huiyuan Juice if the application were rejected because of improper enforcement of law.

The potential loss Coca Cola suffered was the potential net income of the Huiyuan Juice for fiscal year 2009, the first year of operation if the transaction were approved.

It was difficult to predict whether the profit of the new company would increase because it was a component of the Coca Cola (by economies of scale, for example) or decrease (as actually occurred with Huiyuan in year 2010). We assumed that the annual profit of the new company was stable.

It was not sufficient that we merely estimated the profit if Coca Cola successfully purchased Huiyuan, because Coca Cola’s funding does not exist in a vacuum, i.e., Coca Cola would not be required to pay for the costs of funding, whether dividends to shareholders or interest expense to creditors, if it did not spend the USD24 billion for the deal.

Thus, potential income should be divided by the weighted average cost of capital (WACC) of Coca Cola.

Because legal risk is variable case by case, the analysis only examines the highest level of loss caused by uncertainty in the rule of law in the Chinese legal environment. This assumption also matches the conservatism in accounting principle, which suggests that expenses should be over-estimated at their highest possibility when the amount is not certain.

To reflect the possibility of judicial intervention, the discount should be multiplied by 1/67, which reflects the highest legal risk.

The potential return on the project resulting from the assumptions made above is that made for USD24 billion in investment funds.

(more…)