Nigel Clarke | Resolution of non-viable financial institutions – Fixing the institutional gap that exists

While Stocks and Securities Limited (SSL) was a relatively small financial services firm, representing less than 0.7 per cent of total financial sector assets, its demise, the related investigations, and the public reaction hold disproportionately large lessons for Jamaica. For example, the experience has exposed gaps in the institutional framework for the resolution of non-viable financial institutions, and in particular, how such resolutions ought to be financed.

The Government of Jamaica (GOJ) has been unequivocally clear. The GOJ will not “bail out” clients or shareholders of SSL as occurred in some past financial-sector failures. Unfortunately for them, the financial losses experienced by clients and shareholders of SSL are theirs, and theirs only.

Where the Government has responsibility, however, through its regulatory and financial crime investigative bodies, is to (i) safely resolve the SSL quagmire; (ii) seamlessly unwind and return the approximately $30 billion in client funds across 8,000 client accounts; (iii) conduct a thorough and complete investigation into the alleged fraud at SSL, bring perpetrators and conspirators before the courts; and (iv) where criminal verdicts or civil settlements are reached, to recover any proceeds of crime that can be identified.

Fulfilment of these resolution and investigative responsibilities is in the public interest. However, under the current institutional framework, these responsibilities of the respective state agencies cannot be discharged without state financing. I have explained that the Financial Services Commission’s (FSC’s) short-term support of SSL employee costs and other expenses facilitates the GOJ’s fulfilment of its investigative and temporary management responsibilities, and this support will be financed by the FSC from its own resources and not from the Consolidated Fund.

I have also explained that the Financial Investigations Division (FID) is using the proceeds of assets confiscated under Jamaica’s proceeds of crime legislation to fund the extraordinary expenses it incurs in pursuing a complete and thorough investigation into the SSL fraud. These funds do not constitute tax revenue. Rather, these funds arise from the confiscation of ill-gotten gains. (These clarifications only became necessary in response to a well publicised media report that erroneously claimed that the source was tax revenues)

THOUGHT EXPERIMENT

But we are only dealing with a failure of SSL, a tiny firm in which a large fraud allegedly occurred. Let us engage in a thought experiment. Suppose, God forbid, it was a larger firm that became unviable, maybe for different reasons. With the current institutional arrangements, could the FSC and the FID discharge their responsibilities in such a scenario without recourse to taxpayers?

Taxpayer-funded financial crime investigations, inclusive of taxpayer-funded engagement of overseas specialists, are, in the normal course, completely justifiable. However, my views are fully aligned with public sentiment on the funding of the resolution of non-viable financial-services firms: resolution of non-viable financial institutions should be seamless, financial stability should be preserved but taxpayer funds should, ideally, not be touched in the pursuit of these objectives.

The challenge for Jamaica is that the institutional mechanisms to deliver resolution of non-viable financial sector entities on these terms do not exist. While we have a well-funded deposit insurance scheme in place to payout retail depositors to a maximum cap, the only resolution option currently available after taking control of a non-viable deposit-taking institution via temporary management is the acquisition (vesting) of the entity by the Government.

As such, the responsibility for the recapitalisation of a failed deposit-taking institution under the relevant legislation resides with the Government, which would expose the taxpayer to significant potential cost. There are other deficiencies. The current legislative framework is fragmented, which impedes timely intervention and resolution. Further, the conditions for intervention are also not clearly and comprehensively defined. Also, the ability to effect a merger or transfer of assets or other resolution tools is limited, given the overriding rights of shareholders. Finally, there is currently a loophole in the law regarding the winding-up of financial institutions as the insolvency provisions in the new Insolvency Act do not cover the winding-up of deposit taking institutions and insurance companies.

PUBLIC ITEREST

There is a public interest in financial system stability due to (i) the vital role that the financial sector plays in the functioning of an economy (e.g., facilitating payments, providing credit, transmitting monetary policy, etc); and (ii) the vulnerability of financial-sector businesses to public “loss of confidence” – even in otherwise healthy institutions. Indeed, experiences around the world in recent decades, including in Jamaica, have vividly demonstrated the direct linkage between a loss of financial system stability and economic ruin.

However, the resolution of non-viable financial institutions costs money. The services of accountants, lawyers, bankers, and other professionals are required. The non-viable entity needs to retain staff to service customers, maintain records and accounts, and support investigations. In addition, the failed entity will have other expenses that also have to be financed.

Due to the strong public interest in financial-system stability and early resolution, governments across the globe have, for several decades, through regulators or special resolution trusts, intervened directly and fiscally in the process of resolving insolvent or distressed financial institutions.

For example, in Jamaica, the Government’s intervention, with taxpayer funds, to resolve the financial-sector crisis of the 1990s cost 40 per cent of GDP, which is $1 trillion in today’s money. In the 2008-10 Global Financial Crisis, the US Government intervention, funded by US taxpayers, cost nine per cent of GDP, and there are many other examples.

Despite the intentions of governments, these types of interventions have often generated significant backlash. This makes perfect sense. The privatisation of profits in good times and socialisation of losses in bad times is unfair and can never be popular. In fact, the negative reaction to the numerous government interventions designed to rescue national financial systems during the Global Financial Crisis was so severe that in 2011, the G20 mandated the Financial Stability Board (FSB), an international body that monitors and makes recommendations on global financial stability, to develop robust alternatives to the common practice of publicly funded resolution of financial institutions.

In 2014, the FSB delivered on its G20 mandate through the publication of the Key Attributes of Effective Resolution Regimes for Financial Institutions, which are the international standard for financial sector resolution regimes. As the FSB says:

“The aim of the Key Attributes is to make it possible to resolve any financial institution in an orderly manner without severe systemic disruption or exposing taxpayers to the risk of loss, by protecting the firm’s functions that are critical to the financial market or the real economy and ensuring that losses are borne by shareholders and creditors of the failing firm, as they would be in insolvency.”

STRONG ALIGNMENT

The SSL experience has reaffirmed the strong alignment of Jamaican public sentiment with these global best-practice objectives.

The good news is that all members of the FSB, including Jamaica, are committed to pursuing the implementation of international financial standards in the resolution of non-viable financial services entities. As such, Jamaica has made an explicit high-level policy commitment, under the Precautionary Liquidity Line with the IMF, to submit a Special Resolution Regime (SRR) law to Parliament in early 2024 that would serve to strengthen the GOJ’s ability to resolve non-viable financial institutions while protecting financial stability and taxpayer funds.

The objective of Jamaica’s SRR will be consistent with FSB guidance as stated in the key attributes. The SRR will have a single, empowered, resolution authority (RA) for all financial institutions that will be vested with the requisite powers to ensure efficient and speedy resolutions which is not possible under the current incomplete and fragmented institution framework.

The SRR will also be explicitly structured such that the funding of any, god forbid, future resolution activities will not be borne by the taxpayer.

The work involved in delivering on this policy commitment is being collaboratively advanced by many agencies of Government working together.

We neither have the SRR nor the RA in place for the resolution of SSL, which makes this task much more challenging, time consuming and frustrating. But the lesson from the SSL case is that Jamaica’s Special Resolution Regime and its empowered resolution authority cannot come too soon.

Dr Nigel Clarke is minister of finance and the public service, and member of parliament for St Andrew North West. Send feedback to opedjamaica@gmail.com or columns@gleanerjm.com