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San Diego Law Review

Document Type

Article

Abstract

Contingent capital has great potential to help make systemically important financial institutions (SIFIs) safer, minimize systemic risk, and help avoid another financial crisis. United States policymakers may not have fully utilized the potential of contingent capital. A draft by the European Union (EU) Commission already suggests the mandatory issuance of contingent capital securities in the resolution phase of systemically important banks in Europe. The Dodd-Frank Wall Street Reform and Consumer Protection Act mandates a study on the feasibility of contingent capital. This Article proposes the use of contingent capital with a sequential trigger as an early preventative tool and as a reorganization tool before liquidation, independent of protection under bankruptcy proceedings. The first preventative trigger, in a going concern conversion, would convert a fixed amount of debt to equity at a stage when the institution is still sound on a micro prudential basis but shows early signs of substantial weakening. The first trigger in this proposal would help prevent an externality on taxpayers. The second reorganization trigger would increase voting rights for holders of contingent capital after conversion to equity at the reorganization stage. Sequential triggers could incentivize corrective action by SIFI management. The second trigger, gone concern conversion, introduces a quasi-preparation stage for bankruptcy, independent of management decisions or corrective action by regulators. The second trigger would only be utilized if evidence proves that the first conversion did not internalize the costs of bank failure through the equity conversion induced capital increase. The second trigger could be used either to prevent a SIFI resolution or to assist in a SIFI?s resolution or bankruptcy. The proposal would work seamlessly with the regulatory framework proposed by the EU Commission and could provide U.S. policymakers with a new perspective on the multiple uses of contingent capital in the context of bank restructuring.

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