FSB announces TLAC floor ahead of G20 Summit

FSB announces TLAC floor ahead of G20 Summit

FSB issued its proposals for a common international standard on TLAC.

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KPMG in China

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The Financial Stability Board (FSB) has issued proposals (PDF 419 KB) for a common international standard on total loss absorbing capacity (TLAC). The consultation period runs to 2 February, and the FSB will also undertake a quantitative impact study and a market survey of investors early next year. Any increase in debt funding of this type will drive up costs. Quite pointedly the paper notes that these costs will need to be absorbed by clients, investors, or staff – but assume this will fall to investors and staff as there will be a “shift of banking activities to other (non-G-SIB) banks” by clients.

These standards are intended to apply to global systemically important banks (G-SIBs) from January 2019, although initially at least it will not apply to G-SIBs headquartered in emerging markets (which we take to mean the three Chinese G-SIBs).

The calculation of the minimum standards is complicated, but in essence a G-SIB with a 1 percent G-SIB surcharge would need to maintain overall Pillar 1 TLAC of 16 percent to 20 percent of RWA. After adjusting to include combined capital buffers this adjusts to at least 19.5 percent to 23.5 percent of its risk-weighted assets (RWAs); and a G-SIB with a 2.5 percent surcharge would need to maintain TLAC, including combined capital buffers, of at least 21 percent to 25 percent of RWAs. Any counter cyclical capital buffer or other country-specific buffer would be additional to this 1.

G-SIBs will also be required to meet a TLAC leverage ratio of at least twice the minimum Tier 1 leverage ratio – so at least 6 percent of your total assets (rather than RWA) must be held as TLAC.

The EU will issue proposals for its own minimum requirements (MREL) under the Bank Recovery and Resolution Directive immediately after the G20 Brisbane summit. The EU proposals will potentially apply to all credit institutions. This is significant, by any measure; of course when we get the BCBS proposals on revision to the RWA framework this could change again.

Clearly there is some considerable time before the consultation period ends, the QIS is undertaken by the Basel Committee and any proposals are coded into law in each jurisdiction, or region in the case of the EU. However now is the time to start to plan for how this may impact the strategy and business model – albeit that the implementation plan can wait until the proposals are turned in specific rules in each country.

Implications

G-SIBs subject to these requirements – which some national authorities may extend to D-SIBs as well – will need to raise additional debt that qualifies for inclusion in TLAC, and/or convert some existing long term debt into TLAC debt instruments. This may be expensive, depending on the coupons demanded by investors, who know what they will be among the first liabilities to be bailed-in in the event that a G-SIB is put into resolution. This will worsen the competitive position of G-SIBs relative to other banks not subject to these requirements. There may, however, be some offset in the form of reduced costs of other types of debt that might otherwise have been subject to earlier bail-in without the TLAC buffer.

This will be particularly expensive for banks that are funded predominantly by retail and corporate customer deposits, who will have to replace these deposits with TLAC qualifying debt.

Although the proposals cover various types of group structure, they will not remove entirely the pressures on host jurisdictions to impose local requirements for TLAC for bank subsidiaries in individual jurisdictions, just as they have set local requirements for capital, liquidity, funding and corporate governance. The paper does anticipate that even if the bonds are issued at Head office level, formal intra-group proposals will be required to provide local jurisdictional.

As these proposals are digested by the senior management in the banks – notably the Executive and the capital management and Treasury functions – we believe that the following key topics will emerge for debate:

  • Strategic considerations. Negative impact on G-SIB competitive advantage through additional funding costs relative to smaller competitors may accelerate G-SIBs closing of sub-scale and unprofitable businesses.
  • Importance of managing cross-border regulatory relationship. G-SIBs will need to work effectively with their Crisis Management Group (CMG) of regulators if they are to manage additional Pillar 2 minimum TLAC requirements.
  • Risk management. Liquidity risk appetite will need to reflect our view that a breach of minimum TLAC will be treated by regulators as severely as a breach of minimum capital requirements, limiting strategic flexibility.
  • Legal entity structure and booking model. Booking model may now need to be revised to reflect that minimum amounts of funding will be held by resolution entities and the material entities that hold internal TLAC.
  • Treasury and funding strategy. The Treasurer will likely have to expand the issuance of TLAC eligible instruments, perhaps doing so from an entity(s) that is not the current issuer of eligible instruments. The funds transfer pricing policy may also need to be revised to allocate these costs effectively. Furthermore, the legal counsel will need to confirm the eligibility of TLAC instruments.

Further insight

Find the detailed analysis (PDF 1.1 MB) here.

For further reading on what the FSB may bring to the Brisbane G20 Summit, please read our report (PDF 1.06 MB).

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