What is an Orderly Liquidation Authority?

Published by Thomas Herold in Banking, Laws & Regulations

'Orderly Liquidation Authority' is explained in detail and with examples in the Banking edition of the Herold Financial Dictionary, which you can get from Amazon in Ebook or Paperback edition.

As part of the Dodd-Frank Act that Congress passed following the Financial Crisis and Great Recession of 2008, they accepted that there are financial firms that will ultimately fail. This is despite the fact that the new regulatory and supervisory framework scrutinizes banks and non banking financial entities more carefully than ever before now.

In the crisis and the years that followed, many policymakers decided that the U.S. Bankruptcy code and process did not quickly and effectively wind down institutions which were systemically important as they became insolvent.

The FDIC had the role of seizing such failing banks in order to resolve them. Their method for doing this has been seen as the best way to stop runs on banks and eliminate financial panics in the process. The FDIC maintains full discretion on which claims that are not deposits to pay and according to the priority that it sees fit. The FDIC generally subordinates debtors and creditors to the U.S. government and its interests.

Congress decided that a new way of winding down these failing institutions was in order to help regulators mitigate risks to the system. Because of this increasingly prevalent view in Washington, D.C. the Dodd-Frank Act set up a new mechanism mostly following the FDIC’s existing process for resolving failing institutions. This new Orderly Liquidation Authority is designed to help liquidate financial firms that are systemically important and fail.

All entities that fall under the new regulation provided by the Financial Stability Oversight Council and the Federal Reserve will be resolved under this new mechanism. This includes not only companies who pose a systemic risk. It also covers financial entities whose failure can lead to negative consequences for the remainder of the United States’ financial system. The Orderly Liquidation Authority is also known as simply the Liquidation Authority.

For the remainder of financial companies, the standard United States’ Bankruptcy Code and judicial process continues to apply. Only in the cases where financial company failure threatens risk to the entire system as determined by the judgment of the Financial Stability Oversight Council will the Orderly Liquidation Authority mechanism supersede the traditional bankruptcy process.

Where the new Liquidation Authority takes precedence over the traditional bankruptcy rules and process, the FDIC is able to utilize this mechanism in order to seize a failing financial entity and move forward to liquidate it. This way, the company and its various creditors will not ponderously and slowly engage in typical restructuring agreements that the U.S. Bankruptcy Code envisions.

Because of these provisions contained in the Dodd-Frank legislation and now enforced by the Financial Stability Oversight Council, financial firms that may fail and threaten the system as a whole will be treated differently than other non-systemically important financial firms. This means that rating agencies, lenders, and various counterparties to financial firms should remember that there will be different results from companies wound down under the mechanism of the Liquidation Authority versus that of the standard United States’ Bankruptcy Code.

In order for financial firms to be handled by the Orderly Liquidation Authority, the Treasury Secretary as head of the Financial Stability Oversight Council must intentionally designate these companies to be “covered financial companies.” The secretary must first decide that the company will default or be at a substantial risk of default and that it also presents a risk to the financial system as a whole.

This authority gives the federal government the ability to put any financial entity under the auspices of the Liquidation Authority as they deem fit. Insurance companies that become insolvent will continue to fall under the authority of state regulators. Insured thrifts and banks will still be dealt with by the FDIC and its present system for winding down failed institutions.

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The term 'Orderly Liquidation Authority' is included in the Banking edition of the Herold Financial Dictionary, which you can get from Amazon in Ebook or Paperback edition.