Global systemically important banks (G-SIBs) will be required to meet a new prudential requirement – Total Loss-Absorbing Capacity (TLAC) – by 2019, in line with a new global standard published by the Financial Stability Board (FSB).

TLAC is the focal point for resolution authorities in their drive to make the ‘bail-in’ of creditors a credible means of absorbing losses and recapitalising failing banks, thereby eliminating the need for public funds. TLAC will essentially require G-SIBs to hold a layer of long-term unsecured debt over and above their minimum regulatory capital requirements – debt which will be made unambiguously loss-absorbing through bail-in.

TLAC is simple in concept but fiendishly complicated in the detail. And while the FSB’s publication creates an international standard, its implementation into national laws and rules will create challenges, including in terms of global consistency. The document may well set out the ‘final’ standard, but there is a lot of technical work to do to make the regime a practical reality.

Where did the FSB land?

The FSB’s initial TLAC consultation was published in late 2014, and after more than a year of debate and assessment the FSB has set out its stall ahead of the G20 Leaders’ Summit in Antalya, Turkey, which takes place this weekend.

The main questions in relation to TLAC have always been:

  • Eligibility – which liabilities should count?
  • Location – where in the group should those liabilities be issued from and held?
  • Amount – what quantities of these liabilities should banks be required to have?

The FSB has provided answers to all three questions, but in a way that has left issues open. National resolution authorities will need to determine the answers on a bank-by-bank basis over the next few years.

Eligibility: a bank’s TLAC will be made up of its regulatory capital, including CET1, Tier 1 and Tier 2 instruments, as well as various non-capital instruments which are deemed ‘eligible’ for inclusion in the buffer (in virtue of their being perceived to be readily bail-in-able). But determining which specific instruments this should include has not been straightforward. Among those excluded are structured notes, on account of their having derivative-linked features, which some resolution authorities argue complicate their bail-in.

There was brief discussion earlier this summer about whether structured notes might be made conditionally eligible for TLAC, but the FSB has come out against this in its final version. The most significant eligibility grey area relates to a requirement that TLAC instruments should be subordinated to non-TLAC instruments.

This requirement poses a challenge for banks which issue debt out of banking entities (as opposed to holding companies) which have large volumes of excluded liabilities (such as deposits). Inclusion or exclusion of existing unsubordinated debt which would otherwise be eligible for TLAC makes a difference of several hundred billion Euros, according to the FSB’s impact assessment.

Location: the FSB has defined two concepts to determine where TLAC should be held within a group. First, a ‘resolution entity’ – a legal entity to which the resolution plan envisages resolution tools being applied; second, a ‘material subgroup’ – a group of overseas legal entities (likely within the same country) which are not resolution entities but which together constitute a material part of the group.

The distinction matters because of a further distinction made by the FSB, between ‘external’ and ‘internal’ TLAC: resolution entities must meet a minimum external TLAC requirement, to be determined by the home authority, whereas material subgroups will need to meet internal TLAC, to be determined by host authorities. The notion of a material subgroup, however, grants host authorities discretion to define the makeup of those subgroups, as well as to determine the distribution of internal TLAC, which must be ‘pre-positioned’ on-balance sheet – this is sure to be a matter of intense negotiation within banks’ cross-border crisis management groups.

Amount: TLAC will be firm-specific, and is therefore likely to vary between institutions. The FSB’s principles only set a minimum figure for external TLAC at resolution entities, which resolution authorities can require a bank to exceed in line with the specificities of the group.

The minimum requirement will be phased-in, starting at the higher of 16% of risk-weighted assets or 6% of a bank’s leverage exposure measure by January 2019, and rising to the higher of 18% of RWAs and 6.75% of the leverage exposure measure by 2022. But the actual TLAC requirement for each bank essentially remains unknown – some authorities (such as those in the US) will have more conservative views than others, and individual banks may be more or less resolvable, with implications for the firm-specific ‘finish’ their resolution authorities will apply.

There remains in the final standard very little guidance as to how such firm-specific issues should be factored into the final analysis. Moreover, these figures are exclusive of regulatory capital buffers, which will sit on top of the TLAC requirement.

Further, with respect to internal TLAC, the FSB suggests that host authorities should impose on material subgroups an internal TLAC requirement of between 75% and 90% of the external TLAC requirement the subgroup would have faced if it were a resolution group.

Host authorities will be responsible for calculating a sub-consolidated balance sheet for the material subgroups in their jurisdiction against which to calculate the internal TLAC requirement. Again, this leaves discretion to host authorities to determine the eventual requirement for entities in their jurisdictions, and indeed, there is little the FSB can do to prevent hosts exceeding the 75%-90% range, or simply to impose external TLAC requirements on their entities. We can expect more guidance from the FSB on internal TLAC by the end of 2016.

Finally, there is an ‘expectation’ (but not a firm requirement) that at least one third of the total TLAC requirement should be met with debt instruments (either Tier 1 or Tier 2 regulatory capital debt instruments, or non-regulatory capital debt instruments).

Implementation in the European Union

National authorities will now have to study the TLAC rules and implement them in their own jurisdictions. In the EU this will take place through the ‘MREL’ requirement which is due to be phased in from the start of 2016. MREL will apply to all banks in the EU, not just the G-SIBs, but will be applied proportionately, based on their size and business model, providing EU resolution authorities with the discretion to impose higher MREL requirements on larger, more complex institutions.

TLAC and MREL are similar in broad terms, but there are important differences between them. MREL does not mandate subordination of liabilities, and does not explicitly rule out structured notes, for instance. It is also in general a more discretion-based framework. EU headquartered G-SIBs and non-EU G-SIBs with significant EU operations will be watching closely to see how MREL may be amended in order to bring it more in line with the TLAC standard – an EU review of MREL is due by the end of 2016, but as with much EU legislation, negotiating changes could potentially take some time.

Implications for banks

TLAC will, alongside the development of resolution regimes more broadly, have implications for banks’ funding costs. But this is intended– it is part and parcel of the elimination of the ‘too big to fail’ subsidy.

At first blush, the headline-grabbing figure of a €1.1 trillion TLAC ‘shortfall’ might suggest that we can expect a flood of new issuance into the market as banks hurry to meet the new requirements. But this figure is the upper end – essentially the worst case scenario – of a range of estimated shortfalls, and the bulk of it is accounted for by G-SIBs in emerging market which have an additional six years to comply. Individual banks need not be so hasty as to immediately issue large quantities of new debt – the first task will be to analyse existing debt instruments which are potentially eligible as TLAC against the FSB’s term sheet – where such instruments sit within the group, in what quantities, at what maturities, and where in the creditor hierarchy. For some banks, it may be a case of allowing existing ineligible debt to mature, and replacing it with TLAC-eligible instruments in time for 2019. For others, there may be contractual or legislative fixes which render currently ineligible unsubordinated instruments eligible for inclusion in their final figure. Each bank has a very different climb to the summit, depending on how high up the mountain it starts.

Less frequently remarked upon are the implications of the requirements for banks’ data and management information systems. G-SIBs will be required to disclose details of their TLAC at a legal-entity level, although it falls to the Basel Committee to define the disclosure requirements over the course of 2016. As investors become more familiar with resolution planning in general and the bail-in tool in particular, there may well be pressure from the market from creditors wanting to know their relative position in the creditor hierarchy, and banks may be pushed to publish various details relating to their intra-group funding arrangements. This is to say nothing of the expectation that they should be in a position to provide extensive detail to resolution authorities in relation to their liability structures at short notice, and outside normal reporting cycles, as part of resolution planning more generally – a point reiterated by the FSB in a separate document on resolvability.

As that other new document makes clear, there is still a long way to go before the authorities will be able to proclaim with confidence that G-SIBs are resolvable. Operationalising bail-in through the implementation of TLAC is just one, albeit very important, component of this still-evolving picture.

David Strachan blog photo

David Strachan - Partner & Co-Head, EMEA Centre for Regulatory Strategy

David is Head of Deloitte’s EMEA Centre for Regulatory Strategy. He focuses on the impact of regulatory changes - both individual and in aggregate - on the strategies and business/operating models of financial services firms. David joined Deloitte after 12 years at the FSA, where in his last role, Director of Financial Stability, he worked on the division of the FSA into the PRA and the FCA.

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John Andrews

John Andrews - Manager, EMEA Centre for Regulatory Strategy

John is a Manager in the EMEA Centre for Regulatory Strategy, with a focus on EU and UK banking regulatory initiatives. He joined Deloitte in early 2013 from the International Centre for Financial Regulation, where he followed the global development of financial regulatory reform after the financial crisis.

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