8.1 Going-concern versus gone-concern regulation

300. Going-concern prudential regulation is aimed at mitigating (financial) risks for an institution in order to prevent a bankruptcy. Regulation is, therefore, aimed at ensuring robust provisioning for expected losses (this mainly addresses credit risk) and measuring and capitalizing the unexpected losses of an institution. Gone-concern regulation is defined by the BCBS1 as “a situation where the bank is made subject to insolvency or liquidation proceedings”.2 According to the BCBS, “one [of] the main reasons the economic and financial crisis which began in 2007, became so severe was that the banking sectors of many countries had built up excessive on- and off-balance sheet leverage. […] The weaknesses in the banking sector were rapidly transmitted to the rest of the financial system and the real economy, resulting in a massive contraction of liquidity and credit availability. Ultimately the public sector had to step in with unprecedented injections of liquidity, capital support and guarantees, exposing taxpayers to large losses”.3 The regulatory response that introduced a gone-concern principle in prudential regulation was therefore mainly intended to prevent a public sector bail-out. Furthermore, the BCBS seems to address the concern about disorderly winding up of banking institutions.4

301. The difference between going- and gone-concern regulation can thus be qualified as follows: going-concern regulation is aimed at preventing the failure of an institution and making sure that specific risks within an institution are adequately measured, mitigated and capitalised,5 whereas gone-concern regulation is intended to prevent institutions from undergoing a disorderly wind down and to prevent public sector involvement in such a disorderly wind-down of the institution itself.6

302. Going-concern regulation therefore has the consequence that it is a form of protection for all ordinary creditors of an institution. An institution that complies with a going-concern prudential regime7 would signal to its creditors that it is required to have a robust system of risk management and that it can withstand an unexpected loss event. Coupled with a deposit guarantee scheme,8 this going- concern approach can thus also be seen as a means to stabilize the deposits held by the bank, as the assurances following from this regime purport to manage (sudden) liquidity outflows. If depositors are convinced the bank complies with going-concern regulation and they are further comforted by a deposit guarantee scheme, they are less likely to withdraw their deposits at the first sight of adverse circumstances. From the perspective of the bank, this means that the risk of a bank-run is reduced, which would reduce the likelihood of a bank facing financial difficulties because of a withdrawal of deposits exceeding its holdings of liquid assets. A going-concern regulatory approach for a bank is thus an intended layer of protection for depositors, as their deposits are comingled with the assets of the bank.9

303. After the financial crisis, gone-concern regulation was added to the prudential regime for banks to prevent the large-scale public sector interventions and disorderly wind-downs of banks. The gone-concern regulations have been “used to describe a situation where banks are not necessarily being made subject to an insolvency or liquidation proceeding, but where investors in regulatory instruments are nevertheless required to participate in loss absorbency”.10 By interposing a regulatory gone-concern mechanism before the insolvency or liquidation procedures, regulators have sought to create a situation which facilitates an orderly wind-down of an institution. For banks, this orderly wind- down phase is intended to prevent a public sector intervention, and instead “holders of subordinated debt positions in [that] bank […] should be forced to participate in sharing the burden of this rescue operation”.11

304. When looking at the gone- versus going-concern principles from the perspective of an investment firm, one has to assess the need for protection for certain creditors of an investment firm.12 As discussed in Chapter 3 and 4, investment firms differ from banks in a significant manner in that they are not allowed to hold funds or securities belonging to their clients. Consequently, assuming the asset segregation requirements are applied correctly by the investment firm, the funds or securities of an investment firm’s client will not be part of the bankruptcy estate. This asset segregation should prevent an investment firm from being exposed to a bank run. As the funds and securities of a client are segregated, and the investment firm should at all times have an administration detailing which securities belong to which client,13 it should be possible for the investment firm to transfer all the funds and securities of all its clients to those clients, without the investment firm getting into financial difficulties.14 The need for investment firm prudential regulation to fully assess all unexpected losses and capitalise these is thus less than it is for a bank. The EBA report15 on investment firms of December 2014 also raises the question of whether investment firm prudential regulation should be more focused on gone-concern principles versus going-concern principles. The EBA report highlighted that several requirements of the CRD 2006 and the CAD 2006, such as the fixed overhead requirement,16 do seem to consider a gone-concern principle without this being made explicit by the European legislator.

305. Given that clients’ assets should be segregated from the assets of the investment firm, prudential regulation of investment firms should be focused on achieving an orderly wind-down, and thus a gone-concern principle. The business of investment firms does not require prudential regulation aimed at preventing insolvency of investment firms.17

306. One could argue that certain investment firms that have large trading portfolios and that create a risk for the financial system, a systemic risk, should be treated in the same way as a bank. This would mean that the prudential response for a bank, i.e. having going-concern regulation supplemented with gone-concern principles to prevent public sector bail-outs, would also suffice. The question, however, is whether the starting point of going-concern regulation, and thus capitalizing the unexpected losses, is indeed needed for an investment firm with a large trading book. Since the assets of its clients (if such a firm has clients) should be fully segregated, a regime that provides for an orderly wind- down should be enough to prevent systemic risk. By having an orderly wind- down, the financial markets and the counterparties of the investment firm should be able to adjust to the situation where the investment firm has failed. If the wind-down procedure, i.e. the gone-concern regulations, are adequate, it should provide financial markets and counterparties with enough time to close any transactions they have with the investment firm and seek a new counterparty.

307. Given the asset segregation requirements for investment firms, going-concern regulation is not necessary or useful for investment firms. The focus should be fully on gone-concern regulation and making sure that the investment firm has enough loss absorbing capabilities and liquid assets for supervisory authorities to wind-down the business in an orderly fashion. What an orderly wind-down is, and what time this would take, is all dependent on the business model of the investment firm, the risks incurred by that investment firm and the size of those risks. A large and systemic investment firm with a large trading portfolio would require a longer timeframe for an orderly wind-down than a small and non-interconnected asset manager.