WASHINGTON — Seeking to rebut concerns the Federal Deposit Insurance Corp. would use its new resolution powers over large firms to play favorites with creditors, the agency released a proposal Tuesday designed to severely limit who could receive extra relief in a failure.
Under the Dodd-Frank regulatory reform law, the agency was given latitude to treat similar creditors differently when handling the resolution of a systemically risky firm.
But FDIC officials said they want to use such power as sparingly as possible, and its proposal specifically locks out some creditors from any favorable treatment, including shareholders, subordinated debtholders and long-term holders of senior debt.
They said the FDIC would still be extremely cautious with those classes of creditors that could qualify.
"We do want to reassure creditors it will be rarely used, and that we do believe that narrowing it is consistent with the overarching objective of Dodd-Frank to end bailouts and to restore market discipline and to impose losses," FDIC Chairman Sheila Bair said in a conference call with reporters.
Dodd-Frank gave the government unprecedented powers to seize failing behemoths — similar to the FDIC's resolution powers for banks — that would otherwise cause systemic fallout if resolved through the bankruptcy process.
Under the law, the FDIC can pay certain creditors extra — even if other similar creditors receive less — to maintain essential services at a failed firm and maximize asset recoveries.
With heightened interest over who exactly would apply for such relief, the FDIC found it necessary to craft the limited rule, which has a 30-day comment period.
The agency also asked a series of questions — with a 90-day comment period — designed to help in the formation of a broader proposal launching the resolution system, which is expected early next year.
Observers said it was crucial for regulators to minimize the appearance that they will pick favorites.
"It's important that the FDIC and everyone else involved in the resolution process make clear as early as possible and as firmly as possible that nobody is going to get any special treatment in the resolution of any of these entities," said Wayne Abernathy, the executive director of financial institutions policy and regulatory affairs at the American Bankers Association. "If they don't, they still will not have eliminated 'too big to fail,' at least in the perceptions of the market."
The FDIC's proposal Tuesday, Abernathy added, "doesn't do that by itself but it's an important step in that direction."
The agency had expected to release the proposal at a Sept. 27 board meeting, but held back to give members of the new Financial Stability Oversight Council — who are required under the law to weigh in on the resolution plan — time to provide consultation.
Bair told reporters Tuesday that the agency's ability to provide extra discretion had caused some "angst" in the market, in part because nonbank creditors are not as familiar as bank creditors with FDIC resolutions.
She said the Dodd-Frank language is similar to the FDIC's current processes for resolving commercial banks, in which extra coverage is provided in extremely rare cases.
The extra coverage is mainly intended to "keep the lights on," she added.
"If an institution goes into receivership, you want to keep the essential operations running as it's wound down and sold off," Bair said. "The people who provide IT, the people who provide payments-processing, the people who provide building maintenance — those are all general creditors under the statute. And if you strictly apply the claims priority, you would be imposing losses on those essential service providers, which would be ultimately self-defeating."
The proposal also makes clear that all creditors would face the risk of losses in a liquidation, sets the ground rules for the agency's compensation for employees whose services to the company would continue in a bridge institution and clarifies the level of damages for creditors stemming from contingent claims.
Officials stressed that even those who qualify for additional payments should not assume a big payday.
"We're simply saying that the three categories — sub debt, shareholders and long-term term debt — are out of the question, but that all other creditors, including unsecured derivatives counterparties, have to assume that … they're at risk and very likely to get a haircut because of very high standards for making payments to any creditors, short-term or long-term," said Michael Krimminger, the deputy to the FDIC chairman for policy.
Despite its move Tuesday, the agency still has a long way to go before it completely outlines its new resolution powers. Both Bair and Krimminger reiterated that the proposal is only a preliminary step in the process.
The agency's release included 13 questions for comment about implementing the broader plan to be used in crafting a subsequent proposal.
The FDIC asked commenters to identify other areas of Dodd-Frank relevant to the resolution power that need rulemaking, including which sections of the new law require rules to harmonize them with other insolvency laws.
The agency also asked for input on the procedures for chartering bridge companies, and whether the agency should better clarify its definition of "long-term senior debt."
The resolution plan is just one area of Dodd-Frank that requires rules from the FDIC.
The agency is also required to implement new provisions related to assessment rates, including using assets instead of domestic deposits to calculate a bank's premium and raising the minimum ratio of reserves to insured deposits, to 1.35%.
The FDIC announced Tuesday it will hold a board meeting Oct. 19 to consider a proposal on assessments and its target reserve ratio.
The FDIC must also jointly implement with the Federal Reserve Board provisions requiring living wills from systemically important companies.