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Preparing for resolution

Preparing for resolution

The Bank of England has published two important documents on resolution – an updated version of its approach to resolution and a consultation paper on setting internal MREL (minimum requirement for own funds and eligible liabilities).

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The Bank of England has published two important documents on resolution – an updated version of its approach (PDF 729 KB) to resolution and a consultation paper (PDF 524 KB) on setting internal MREL (minimum required own funds and eligible liabilities).

Implications for banks

Internal MREL requirements may be costly for banks to meet because in many cases this will involve some combination of (a) a legal entity restructuring to establish resolution entities (including in some cases a non-operational holding company); (b) a re-positioning of existing equity and debt issuance and intra-group down-streaming to align this with resolution entities and their material subsidiaries; (c) the conversion of existing intra-group debt into MREL-eligible instruments; and (d) putting additional intra-group equity and MREL-eligible debt down-streaming in place in order to meet internal MREL requirements.

Moreover, although the Bank’s proposals on internal MREL requirements are broadly in line with the EU Commission’s proposals to revise the Bank Recovery and Resolution Directive (‘BRRD2’), there are areas where the Bank’s proposals may differ from the EU-wide proposals, in terms of both substance and the timetable for implementation. These areas include what the Bank will publish on major UK banks’ resolution plans and the Bank’s assessment of their effectiveness; on what major UK banks will be encouraged to publish on their MREL resources; the basis on which internal MREL requirements will be set within the 75-90 percent range, in particular for ring fenced banks; and the timetable under which major UK banks will be expected to meet MREL requirements. However, any such divergences may be narrowed as the Bank and the EU finalise their positions and as the Basel Committee finalises its Pillar 3 disclosure standards.

Summary

Approach to resolution

The new version of the Bank’s approach to resolution document updates the 2014 version, not least to take into account the development of the Bank’s policy in areas such as operational continuity, valuation preparedness and the setting of (external) MREL for major UK banking groups.

The document contains one new policy announcement – that from 2019 the Bank will publish summaries of major UK firms’ resolution plans and the Bank’s assessment of their effectiveness. The Bank believes that greater transparency over the progress being made towards removing barriers to resolvability will incentivise firms to prioritise those actions.

Otherwise the document provides a useful reminder of:

  • The scope, objectives and main features of the UK’s resolution regime
  • The main resolution powers and tools
  • How the Bank is establishing overall resolution strategies depending on the size of a bank
  • The procedures for putting a firm into resolution, including the roles of the resolution authority, the supervisors, HM Treasury and the Financial Services Compensation Scheme
  • The conditions for triggering resolution
  • The current state of play on resolution planning for central counterparties and the continuing discussions on resolution planning for insurers
  • The Bank’s view of the most important barriers to resolution, including banks’ valuation capabilities
  • The steps that would have to be taken over a ‘resolution weekend’ 
  • The mechanics of exchanging debt for (new) equity using the bail-in tool.

Internal MREL

In order to support the potential use of the bail-in tool, banks that might potentially be put into resolution are required to hold MREL - a minimum required amount of own funds and eligible liabilities (in essence, equity and subordinated debt). The Bank has already set out its approach to setting (‘external’) MREL for a ‘resolution entity’ (the entity that would be subject to the use of resolution powers under the preferred resolution strategy), and has published indicative group-level MREL targets for major UK banks to reach by 2019 and by 2022.

Internal MREL instruments are issued from legal entities (that are not themselves resolution entities) in a group to the parent resolution entity in their group. These instruments can be in the form of equity or debt, and are designed to be written down to absorb losses or converted into equity to recapitalise the entity that issues them without triggering the resolution of the issuing entity. Losses within a group would therefore be met by the shareholders and creditors of the resolution entity, as a result of putting the resolution entity into resolution.

The Bank’s consultation paper on internal MREL sets out proposals for:

  • Setting internal MREL requirements in excess of capital requirements for the material subsidiaries (representing at least 5 percent of a group’s risk-weighted assets, operating income or leverage exposures) of major UK-headquartered banking groups and major UK subsidiaries of overseas banking groups.
  • Where internal MREL is required, setting this in the range of 75-90 percent of the amount of (external) MREL that the material subsidiary would have been required to hold if it was a stand-alone UK resolution entity.
  • For groups with UK resolution entities, any surplus MREL — the difference in requirements between group consolidated external MREL and the sum of what must be issued to the resolution entity as internal MREL or equivalent instruments in other jurisdictions — should be readily available to recapitalise any subsidiary to support the execution of the resolution strategy.
  • In deciding where to set the internal MREL requirement within this 75-90 percent range, the Bank will take into account the credibility of the resolution plan, the availability of other resources in the group that could be readily deployed to support the material subsidiary, and the scaling of internal loss-absorbing resources applied by overseas authorities to material subsidiaries located in their jurisdiction.
  • Where a ring-fenced retail bank is part of a material sub-group, the Bank proposes to scale the internal MREL for the top entity of the material sub-group at 90 percent, as a starting point, unless the Bank is satisfied that the wider group has sufficient readily-deployable resources to justify moving to a lower calibration in the range.
  • Internal MREL eligible liabilities will need to meet the same criteria as apply to external MREL.
  • An MREL-eligible liability should not be called or redeemed without the Bank’s approval, if that would cause the group to breach its external or internal MREL requirement, or if the group was already in breach of this requirement.
  • Critical service providers supporting the delivery of a group’s critical functions must maintain loss-absorbing capacity for operational continuity in resolution equivalent to at least 25 percent of the annual operating costs of providing services. 
  • Applying the same timetable for transition to meeting internal MREL requirements as for external MREL. Interim internal MRELs will apply from 1 January 2019 for material subsidiaries of G-SIBs, and from 1 January 2020 for other firms. End-state internal MRELs will apply from 1 January 2022.
  • Until EU legislation is finalised, the Bank will explore the scope for voluntary disclosure of MREL resources by UK G-SIBs and D-SIBs in line with the Basel Committee Pillar 3 standard from January 2019.

For more information, please contact Clive Briault (mailto:clive.briault@kpmg.co.uk) or Fiona Fry (mailto:fiona.fry@kpmg.co.uk).

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