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
The statements and opinions expressed in this article are solely the views of the author and do not necessarily represent the views of The Royal
Bank of Scotland plc, The Royal Bank of Scotland N.V. and/or their affiliates (“RBS”).
This article is for the use of intended recipients only and the contents may not be reproduced, redistributed, or copied in whole or in part for any
purpose without RBS’s prior express consent. No representation, warranty, or assurance of any kind, express or implied, is made as to the accuracy
or completeness of the information contained in this article and no member of RBS accepts any obligation to any recipient to update or correct any
information contained herein. This article is published for information purposes only and does not constitute an analysis of all potentially material
issues. Views expressed herein are not intended to be and should not be viewed as advice or as a recommendation. You should take independent
advice in respect of issues that are of concern to you.
This article does not constitute an offer to buy or sell, or a solicitation of an offer to buy or sell any investment, nor does it constitute an offer to
provide any products or services that are capable of acceptance to form a contract. RBS accepts no liability whatsoever for any direct, indirect or
consequential losses (in contract, tort or otherwise) arising in any way from the information contained in this article.
In the U.S., this document is intended for distribution only to major institutional investors as defined in Rule 15a-6(a)(2) of the U.S. Securities Act 1934
(excluding documents produced by our affiliates within the U.S.). Any U.S. recipient wanting further information or to effect any transaction related to
this communication must contact RBS Securities Inc., 600 Washington Boulevard, Stamford, CT, USA. Telephone: +1 203 897 2700.
The Royal Bank of Scotlandplc.Registered in Scotland No 90312.Registered Office: 36 St Andrew Square, Edinburgh EH2 2YB.Authorised by the
Prudential Regulation Authority and regulated by the Financial Conduct Authority and Prudential Regulation Authority. The Royal Bank of Scotland
N.V. is authorised and regulated by the De Nederlandsche Bank and has its seat at Amsterdam, the Netherlands, and is registered in the
Commercial Register under number 33002587. Registered Office: Gustav Mahlerlaan 350, Amsterdam, TheNetherlands. The Royal Bank of Scotland
plc is, in certain jurisdictions, an authorised agent of The Royal Bank of Scotland N.V. and The Royal Bank of Scotland N.V. is, in certain jurisdictions,
an authorised agent of The Royal Bank of Scotland plc.
RBS NV is authorised and regulated in Hong Kong by the Hong Kong Monetary Authority, in Singapore by the Monetary Authority of Singapore, in
Japan by the Financial Services Agency of Japan, in Australia by the Australian Securities and Investments Commission and the Australian
Prudential Regulation Authority ABN 30 101 464 528 (AFS Licence No. 241114) and in the US by the New York Department of Financial Services, the
State of Connecticut Department of Banking, the Federal Reserve Bank of Boston and the Board of Governors of the Federal Reserve System. In the
United States, securities activities are undertaken by RBS Securities Inc., which is a FINRA/SIPC member and a subsidiary of The Royal Bank of
Scotland Group plc.
Copyright © 2015 The Royal Bank of Scotland plc. All rights reserved.
APRIL 2015 | RBS62145