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2. bank

INSIGHT: April 2015
Corporate costs under threat
from new bank rules
BY PHIL PEARCE, DIRECTOR, HYBRID CAPITAL & BALANCE SHEET
SOLUTIONS, RBS
The Financial Stability
Board’s recent
proposals to increase
the loss absorbing
capacity for global
systemically important banks are
likely to have far-reaching
implications for their corporate
clients as they seek to pass on
additional costs.
The total loss-absorbing capacity requirement –
TLAC – could also affect corporates’ ability to
tap capital markets because of the pressure it
places on banks.
TLAC was proposed last year as part of the
post-crisis global bank reform package to end
the idea of financial institutions being “too big
to fail”. It is conceptually similar to the primary
loss absorbing recommendations of the UK’s
Vickers Report.
“ The reality is likely to translate into
increased cost of capital and more
complicated decisions for banks,
which in turn would mean higher
margins and potentially less access
to capital for corporates.”
Banks will be required to hold a certain amount
of capital available to absorb losses – in
addition to their regulatory solvency capital – in
case of failure, so that critical functions of the
bank can continue if a bank is placed
‘in resolution’.
These proposals have been widely
acknowledged as an important and positive
step, but unfortunately it isn’t that simple.
The reality is likely to translate into increased
cost of capital and more complicated decisions
for banks, which in turn would mean higher
margins and potentially less access to capital
for corporates.
TLAC is likely to be introduced by national
governments in 2019 and in most jurisdictions
may need to be harmonised with existing
resolution and insolvency frameworks. There
are important questions over how TLAC will
reconcile with the framework of the European
Union Bank Recovery and Resolution Directive
(BRRD), which applies to all credit institutions
across Europe and has its own loss absorbing
capacity requirement, the minimum requirement
for eligible liabilities (MREL).
There is a subtle but important difference
between the two approaches: subordination.
In a resolution context, subordination can be
viewed as the most straightforward way to
ensure certain liabilities, for example SME
deposits would rank senior to unsecured debt.
The TLAC subordination requirement can be
applied either on a statutory, structural or
contractual basis. However, MREL treats all
creditors at the same level of subordination
equally but regulators retain the capacity to
exclude certain liabilities. This is broadly in the
interests of protecting critical functions and to
avoid widespread contagion.
Banks with non-operating holding companies,
such as many of the big UK institutions, could
count their existing holding company-issued
senior unsecured debt towards TLAC. However,
those with operating parent companies – of
which there are many in Europe – would have to
issue potentially more expensive subordinated
debt in order to meet these requirements.
Summary
New rules on total
loss absorbing
capacity for banks
are a positive step
But the requirements
could translate into
higher costs which
banks may pass on
to corporates
How the new rules
will be implemented
remains to be seen
April 2015
Creating a bank holding company structure is
another option but this could be expensive,
time consuming and in some jurisdictions
highly complex and is not thought to be a
practical solution for most large institutions.
In an MREL context, regulators appear to
remain nervous that the BRRD’s ‘no creditor
worse off’ safeguard could be subject to legal
challenge from bailed-in senior bondholders,
who may be required to assume a greater
burden of losses if certain liabilities are
exempted.
However, authorities in Germany have tabled a
domestic proposal which could be applied in
jurisdictions where banks do not operate
holding company group structures. The crux of
this proposal is a change to the order in which
creditors are dealt with if a bank enters
resolution or becomes insolvent, effectively
exposing senior unsecured bonds to a greater
proportion of loss absorption.
The German proposal offers an innovative and
workable solution that neatly side-steps the
problem, simultaneously aligning TLAC and
MREL in a bank’s capital structure.
Estimates on the potential volume of new
TLAC-eligible debt to be issued vary, in part
due to the new proposals from Germany and
whether they will be adopted across Europe. It
now looks as if the volume of issuance may well
be modest, and nowhere near some of the hefty
early estimates.
However, the challenge of implementing TLAC
in Europe is made more difficult by the myriad
of insolvency regimes in different countries.
While banks based in emerging markets will be
exempt from the TLAC regime, European and
US regulators have the capacity to exempt
certain liabilities with equal ranking. Banks in
different jurisdictions are struggling to make
sense of how the global regulatory patchwork
will apply to their circumstances and structure.
Meanwhile global regulators have work to do to
coordinate their approaches.
Questions around the timing and precise
design of the TLAC proposal remain, but
market participants should start preparing now.
Find out what we think.
rbs.com/insight
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APRIL 2015 | RBS62145