The last few weeks have seen a flurry of activity on the resolvability front. Lest anyone think momentum was seeping out of the decade-long push to make banks resolvable – and thereby end “too big to fail” – these developments suggest a redoubling of regulatory efforts to demonstrate that the framework will work. Each of the initiatives is important in its own right, but taken together they amount to a raising of the bar in terms of resolution preparedness, particularly identifying and dealing with impediments to resolution. Major banks in the UK and the Banking Union can expect greater focus on resolution authorities’ assessment of their resolvability – and in the UK, the prospect of this assessment being made public. We have also had a very clear signal from the Bank of England (BoE) of what it expects of major UK banks' valuation capabilities for resolution purposes, and are approaching some key milestones for the Single Resolution Board (SRB)’s multi-year work programme. There continues to be progress on targets for MREL (the minimum requirement for own funds and eligible liabilities), albeit with some potential obstacles on the way there. We take the UK, Banking Union, and MREL developments in turn below.

The UK: aiming for the finish line

We start with the BoE, which has been at the forefront of the resolvability agenda over the last decade. The BoE has set itself a deadline by which to make UK banks “fully resolvable”: 2022. This target, variously described as “ambitious” and “demanding”, will clearly serve to concentrate minds – especially those thinking of applying for the vacancy as head of the BoE’s Resolution Directorate. The Independent Evaluation Office’s report into the BoE’s resolution framework provides clues as to what we can expect, which include that the BoE should introduce intermediate project milestones which should be reflected in banks’ resolution plans (see our blog for a summary)

Given the public commitment to full resolvability by 2022, the BoE will be looking to verify that resolvability work is proceeding within banks at the necessary pace, which implies an increase in transparency and assurance. A centrepiece of this will be a new requirement for banks to conduct resolvability self-assessments – elements of which may even be made public. What is certain to be made public is the BoE’s own assessment of the resolvability of the major banks. This, then, creates a further dimension to resolvability work: not only do banks need to progress the work itself, some of which is undoubtedly complex and demanding, but they also need to be able to demonstrate that everything is in order – the systems, controls, documentation – to support resolvability. Industry can expect a consultation on a framework for this by the end of this year.

The BoE has also recently finalised its valuation policy. Valuation capabilities have been consistently raised by resolution authorities as a generalised, industry-wide impediment to resolvability. A resolution necessarily involves valuation – especially when bail-in is being contemplated – in order to determine the extent of losses and, thereafter, the recapitalisation resources needed to restore a bank to a going concern. The BoE is the first major resolution authority to publish a policy in this area, and it has set a January 2021 deadline for banks to bring their capabilities up to the expected level. This is no simple task – some of the valuation challenges are significant, particularly in terms of data, and banks will need to document and demonstrate their capabilities in respect of how data will be assembled and used in a prospective resolution scenario. And in resolution-related matters it is often true that where the BoE leads, others will soon follow. Indeed, the SRB continues to work on its own valuation framework, although it remains unclear whether it will publish guidance or adopt a similar approach to the BoE.

The other major pieces of the BoE’s work programme to address impediments to resolvability in the run-up to 2022 are not new, but a good deal of implementation work remains. These include the implementation of loss-absorbing capacity rules (MREL and TLAC (Total Loss-Absorbing Capacity), on which more below), funding and liquidity in resolution (where banks and the authorities need to reflect the Financial Stability Board (FSB)’s work in this area), and operational continuity – including access to financial market infrastructures (FMIs) – in resolution. The first major milestone here is the start of 2019, when UK banks need to meet the BoE’s rules on operational continuity – while much work has been done here, for example on the revision of SLAs and the implementation of ServCos, remediation and optimisation will carry on past that date.

The Banking Union: looking to close the gap

On the continent, the SRB has previously indicated that work to identify substantive impediments to resolvability would begin in 2018. Identification of impediments will trigger legal requirements for banks to act to address them. The SRB now faces increasing pressure from several directions to complete this work.

In their Meseberg Declaration, France and Germany noted the possibility of the European Stability Mechanism becoming the backstop for the Single Resolution Fund before 2024 (the currently scheduled date), provided that there is sufficient risk reduction before then. It is clear from the text that “risk reduction” includes the building up of subordinated bail-in buffers. Progress will be assessed on the basis of a report from the European Commission, Single Supervisory Mechanism and SRB in 2020.

A recent mediation decision from the European Banking Authority (EBA) adds legal pressure to the mix. The EBA’s (first) binding mediation decision between the SRB and the National Bank of Romania is, at first sight, a dry inter-institutional procedural matter, but it has some significant implications which go beyond the scope of the individual decision. In short, the EBA determined that identifying “potential” impediments to resolvability in a resolution plan does not satisfy legislative requirements under the Bank Recovery and Resolution Directive (BRRD) to assess resolvability. This adds to the pressure on resolution authorities including the SRB to identify substantive impediments to resolvability more concretely, which will trigger the BRRD process requiring banks to make proposals on how to address them. Indeed, the SRB’s work on resolvability assessments has begun, and it intends to finalise its policy for identifying substantive impediments by the middle of 2018, with a view to having detailed assessments for each bank by Q1 2019. Brexit may also affect the SRB’s work, if a new group of more capital-markets focused subsidiaries of global banks is brought within its remit.

More generally, the SRB has identified a similar set of priorities for resolution planning: as well as progress on loss absorbing capacity (covered below), this includes legal and funding structures, valuation and other information, operational continuity (especially the management of SLAs and other contracts), liquidity and funding, and communication planning.

MREL: still the key

In the UK, the BoE recently updated its individual indicative MREL targets for the six largest UK banking groups and Nationwide (whose target is measured on a leverage ratio basis rather than a risk-weighted basis), together with an indicative average target for a group comprising nine medium-sized, predominantly retail banks and building societies. Relative to last year, most of the banks’ individual MREL targets have risen slightly, in the order of 50-100bps, with total MREL targets sitting in the range of 25.7% to 30.4% of RWAs (of which the recapitalisation amounts are between 11.1% and 13.5%). HSBC was alone in seeing its MREL target decline slightly (for its European resolution entity only).

At the same time, the BoE finalised its policy on internal MREL/TLAC, sticking by and large to the FSB’s preferred approach, with internal MREL to be scaled at 75%-90% of the full amount of external MREL that a material subsidiary would be required to hold if it were itself a resolution entity. This scaling will take into account the group resolution strategy, the availability of additional uncommitted resources, and the scaling of loss-absorbing resources applied by overseas authorities. For ring-fenced banks which operate within wider groups, there will be a presumption of scaling at 90%, “unless the Bank is satisfied that the wider group has sufficient readily-deployable resources” to justify a lower calibration. There were few changes from the consultation proposals, but one is that the final policy does not require critical service providers delivering the group’s critical functions to maintain financial resources equivalent to at least 25% of annual operating costs. Instead the BoE has promised to clarify its approach to loss-absorbing capacity for operational continuity at a later date.

The SRB is proceeding at a similar pace, although so far with less transparency as to the results of any of its bank-specific decision-making on MREL targets. The SRB has, however, said that MREL targets are on average around 26% of RWAs, and that half of the banks it has looked at so far already meet their targets. In terms of the focus for 2018 and 2019, the SRB intends to define MREL targets for major banking groups, with an increasing focus on the quality and the internal location of MREL to ensure there are sufficient subordinated instruments to implement banks’ preferred resolution strategies. Binding MREL targets will be set at a consolidated level, and a first identification of MREL targets at a material entity level will be conducted. The SRB has set itself a 2020 deadline for determining binding MREL targets at consolidated and material entity levels for all the banks within its remit.

The fact that targets are being set inevitably brings a focus on how much MREL banks will have to raise. The SRB expects that banks will need to issue €125 billion of additional debt to meet the current shortfall.

MREL gets complicated

The setting of targets represents clear progress. But MREL has never been a simple issue, and several recent developments look set to complicate matters – potential spanners in the works just as the targets are otherwise becoming clearer and potentially closer. First is Brexit: the EBA has asked banks and resolution authorities to satisfy themselves that MREL-eligible instruments issued by EU27 banks under English law will continue to be eligible once the UK leaves the EU (and the same question arises for MREL-eligible instruments issued by UK banks under EU27 laws). If they are not, this would trigger either a renegotiation of the terms of existing debt instruments or the issuance of new eligible debt.

The second spanner has been thrown by the EBA and the European Securities and Markets Authority (ESMA) which have flagged the stock of bail-in-able debt held by retail investors as a risk to banks’ resolvability. Strictly speaking, having retail investors holding bail-in-able debt is not in and of itself an impediment to resolvability, but in practice large quantities of such holdings are problematic. The SRB has publicly acknowledged as much, pointing out that it “makes banks difficult to resolve for various reasons”. In Italy retail investors hold well over €100 billion of bail-in-able debt – more than half of all such retail-held debt in the euro area. Banks for which this is a problem will clearly need to devise a strategy to fix it. In some cases, there may be no better solution than simply issuing new debt subordinated to the existing stock of retail-held instruments. If, in future, banks are unable to sell MREL-eligible debt to retail investors and/or have to issue more MREL-eligible debt which ranks junior to existing debt held by retail investors, this could add materially to their cost of funding.

Third, the BRRD is being revised by the EU legislators, with amendments to MREL a key component of the revisions. These revisions have proven somewhat contentious in the negotiations, and it remains unclear where the legislators will come out. Some outcomes would constrain the discretion of resolution authorities to tailor MREL targets towards individual institutions – to which the SRB has been vocally opposed. And as Elke König said recently, “let us all hope that the new rules will not be overly complex.”

A significant forward agenda

These related initiatives add up to a significant forward agenda for resolvability, with further guidance from the BoE and SRB likely on other substantive impediments to resolvability, such as continuity of access to FMIs, with the SRB expected to develop its policy by the end of this year. While we have deliberately limited our focus to the EU, there are linkages to the FSB’s ongoing work on resolvability; to developments in the US, Canada, and Japan; and of course to Brexit.

We expect resolution authorities in the EU to demand that banks progress rapidly towards making themselves resolvable, spurred by the knowledge that, ten years on from the collapse of Lehman Brothers, society at large has little appetite for public funds being used to support failing banks. This also implies a need for some critical reflection by resolution authorities on their own levels of preparedness – particularly the adequacy of their approaches to and practices for resolution planning, and the operational efficiency of their crisis management and related cross-border arrangements, including the lessons learned from implementation work to date and recent resolution cases.


David Strachan blog photo

David Strachan - Partner, 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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Vishal Vedi - Partner, EMEA Leader for Risk and Capital Management

Vishal is a Partner in Deloitte’s Risk Advisory Practice in London. He leads Deloitte’s Brexit Financial Service proposition and has more than 18 years’ experience in the financial services sector. Vishal is Deloitte’s EMEA leader for its Risk and Capital Management service line and he sits on the steering group of the Deloitte Centre for Regulatory Strategy. Vishal has in depth experience of dealing with complex risk, regulatory and governance issues both in the UK and internationally and has worked with many of the world’s most significant financial institutions.

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Alastair Morley - Partner, Banking and Capital Markets Prudential Regulation

Alastair is a Partner within Deloitte’s Banking & Capital Markets practice in London with over 13 years experience in the retail and investment banking industry. He is also a member of our Regulatory Assurance and Structural Reform leadership teams, and leads a number of our financial rules and regulatory assurance engagements.

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Mark Adams - Senior Manager, Risk Advisory

Mark has led a number of Brexit projects at G-SIBs and tier 1 firms, and is a key regulatory advisor across Deloitte’s Brexit work, as well as advising on resolution issues. Prior to joining Deloitte he helped to establish the resolution functions of both the Bank of England and European Banking Authority and led the EBA’s policy development work on topics including TLAC/MREL.

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