Response to consultation on RTS on minimum requirement for own funds and eligible liabilities (MREL)
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If there is a systemic failure, we are unconvinced that the bail-in of any amount of MREL would be able to deliver the stated objective of recapitalising the affected banks such that they are able to re-enter the public markets immediately after the restructuring. In this environment, we would anticipate: (i) a material loss of confidence in asset prices, (ii) significant doubts about the solvency of many, if not all, of the banks in the financial system, and (iii) considerable issues with the continued financing of banks from market sources, with the central bank needing to provide liquidity to avoid disorderly liquidation. In these circumstances, a bail-in of MREL across the market could make a contribution to recapitalisation and address some questions of moral hazard but we are uncertain that it would be possible for banks to hold MREL in sufficient quantities to restore confidence in a systemic crisis, stabilising asset prices and markets and restoring the private provision of funding to banks. Indeed, there may be much wider economic effects if there is a system-wide bail-in of MREL which may compound uncertainties.
This is an important consideration when reviewing historical loss experiences. In our view, there are certain events which should be excluded as they do not represent an idiosyncratic failure which could have been addressed with MREL but a systemic failure of bank managements and supervision which should have been addressed through proper macro prudential policies and ex ante supervision decisions.
In addition, we believe that regulators should pay close attention to the outcome of stress tests, in particular, the degree to which it is possible for an individual institution to be specially affected by events before this becomes a much broader economic crisis which will require different policy measures to address, rather than relying on private sector balance sheets to deliver the necessary repairs.
Furthermore, we are observing an increasing trend for regulation which over-rides risk sensitive analysis with simpler measures such as the leverage ratio and using standardised models as floors of Internal Risk-Based model outcomes. This has the effect of increasing overall capital levels for any given portfolio and, in our view, creating an increasing gap between the capital which might be allocated to address economic risks and the capital which banks are expected to hold for regulatory purposes.
There may be elements of the capital requirements as calculated before resolution which are not required post-resolution. As discussed under Question 1, there may be elements of the original capital calculation which are not subject to resolution. Pillar 2 requirements would need to be re-calibrated for the nature of the business post-resolution and may need to be adjusted. In addition, it may the case, particularly for a subsidiary within an MPE Group, that the institution is neither part of a G-SII or a G-SII in its own right post-resolution so these requirements would be inappropriate in these circumstances.
In our view, the level of recapitalisation should be simply driven by the capital requirements needed to meet the minimum thresholds for operations (as established by the supervisors) and the level of capital necessary to enable the firm to access funding, assuming the normal operation of central bank and other liquidity facilities. This assessment should be firm specific. If a firm no longer qualifies as a G-SII following resolution, either because of changes in the nature of its operations or because it ceases to be a member of a G-SII Group, no buffer should be applied.
While most capital instruments should qualify under their current terms, if new entities are required to introduce structural subordination, or as the result of structural reforms in some member states, this could further elongate the process of change as issuance cannot, in reality, start until those entities are in place and there remains an issuance capacity which needs to be addressed. The investor base to which these securities will be issued will have changed as a result of the different terms and risks and there will need to be a process of education, the adjustment of investment mandates, etc. With, potentially, a substantial debt re-issuance programme in a number of banks, it is difficult to believe that this could be completed within a two year window without imposing material financial costs on banks in respect of the terms for MREL issuance. In particular, they may be forced to:
• redeem and re-issue securities with revised terms or execute some form of exchange offer; or
• issue excess amounts of securities in order to meet the MREL requirements without redeeming existing, non-eligible instruments, with this burden diminishing as existing instruments run-off; or
• pay a premium to investors beyond what would be expected long term market price for these instruments in order to be able to meet the short deadline.
A more realistic timetable for implementation will need to be developed once the outcome of the TLAC QIS is available.
(i) it is important that the RTS follows the FSB’s TLAC proposal in providing clarity on the capital requirements for an MPE Group, notably that there should not be a consolidated TLAC requirement;
(ii) the level of MREL should fundamentally be determined by the range of factors set out in Article 45 of the Level 1 text. These include, notably in paragraph 6 (d), the size, business model, funding model and risk profile of the institution.
2. Should the resolution authority be allowed to adjust downwards? What are the specific circumstances under which resolution authorities should allow a smaller need to be able to absorb losses before entry into resolution and in the resolution process than indicated by the capital requirements?
There needs to be coordination between supervisors and resolution authorities to ensure that there is the right amount of total loss absorbency. However, allowing the resolution authority to impose changes in the amount of loss absorbency required before the point of resolution has the potential to create a ‘shadow’ supervisor operating without the full information available to the day-to-day supervisor. There is a danger that this could create confusion within firms. We believe it is more appropriate if the remit of the resolution authority is limited to determining loss absorbency in resolution.3. Should any additional benchmarks be used to assess the necessary degree of loss absorbency? If yes, how should these be defined and how should they be used in combination with the capital requirements benchmark? Should such benchmarks also allow for a decrease of the loss absorption amount compared to the institution’s capital requirements?
It is essential that there is clarity on the nature of the failure which MREL is seeking to address: it is to support the resolution in the event of the idiosyncratic failure of any individual bank rather than a systemic failure of multiple banks.If there is a systemic failure, we are unconvinced that the bail-in of any amount of MREL would be able to deliver the stated objective of recapitalising the affected banks such that they are able to re-enter the public markets immediately after the restructuring. In this environment, we would anticipate: (i) a material loss of confidence in asset prices, (ii) significant doubts about the solvency of many, if not all, of the banks in the financial system, and (iii) considerable issues with the continued financing of banks from market sources, with the central bank needing to provide liquidity to avoid disorderly liquidation. In these circumstances, a bail-in of MREL across the market could make a contribution to recapitalisation and address some questions of moral hazard but we are uncertain that it would be possible for banks to hold MREL in sufficient quantities to restore confidence in a systemic crisis, stabilising asset prices and markets and restoring the private provision of funding to banks. Indeed, there may be much wider economic effects if there is a system-wide bail-in of MREL which may compound uncertainties.
This is an important consideration when reviewing historical loss experiences. In our view, there are certain events which should be excluded as they do not represent an idiosyncratic failure which could have been addressed with MREL but a systemic failure of bank managements and supervision which should have been addressed through proper macro prudential policies and ex ante supervision decisions.
In addition, we believe that regulators should pay close attention to the outcome of stress tests, in particular, the degree to which it is possible for an individual institution to be specially affected by events before this becomes a much broader economic crisis which will require different policy measures to address, rather than relying on private sector balance sheets to deliver the necessary repairs.
Furthermore, we are observing an increasing trend for regulation which over-rides risk sensitive analysis with simpler measures such as the leverage ratio and using standardised models as floors of Internal Risk-Based model outcomes. This has the effect of increasing overall capital levels for any given portfolio and, in our view, creating an increasing gap between the capital which might be allocated to address economic risks and the capital which banks are expected to hold for regulatory purposes.
4. Do you consider that any of these components of the overall capital requirement are not appropriate indicators of the capital required after resolution, and if so why?
As an overarching principle, the level of requirements should be established in the context of the objectives of the resolution framework, ie. to ensure that there are minimum resources to facilitate the resolution plan (continuation of critical functions and orderly resolution), not resurrection of the entire group. For this reason we do not agree with the content or underlying rationale of point 7 of Article 3.There may be elements of the capital requirements as calculated before resolution which are not required post-resolution. As discussed under Question 1, there may be elements of the original capital calculation which are not subject to resolution. Pillar 2 requirements would need to be re-calibrated for the nature of the business post-resolution and may need to be adjusted. In addition, it may the case, particularly for a subsidiary within an MPE Group, that the institution is neither part of a G-SII or a G-SII in its own right post-resolution so these requirements would be inappropriate in these circumstances.
5. Is it appropriate to have a single peer group of G-SIIs, or should this be subdivided by the level of the G-SII capital buffer? Should the peer group approach be extended to Other Systemically Important Institutions (O-SIIs), at the option of resolution authorities? If yes, would the appropriate peer group be the group of O-SIIs established in the same jurisdiction? Should the peer group approach be further extended to other types of institution?
We do not see how such a peer group could be defined.In our view, the level of recapitalisation should be simply driven by the capital requirements needed to meet the minimum thresholds for operations (as established by the supervisors) and the level of capital necessary to enable the firm to access funding, assuming the normal operation of central bank and other liquidity facilities. This assessment should be firm specific. If a firm no longer qualifies as a G-SII following resolution, either because of changes in the nature of its operations or because it ceases to be a member of a G-SII Group, no buffer should be applied.
6. The approach outlined in Articles 2 and 3 will reflect differences between consolidated and subsidiary capital requirements. Are there additional ways in which specific features of subsidiaries within a banking group should be reflected?
It is important that the RTS follows the FSB’s TLAC proposal in providing clarity on the capital requirements for an MPE Group. For MPE Groups, there will be no consolidated TLAC requirement; instead, the requirements will be calculated for resolution groups and resolution entities. This is clarified in the instructions to the QIS on TLAC: “TLAC minimum requirements will be applied to each resolution entity within a G-SIB. For MPE, this may not necessarily include meeting TLAC at the G-SIB consolidated group level if this is not itself a resolution entity.”7. Do you agree that there should be a de minimis derogation from this provision for excluded liabilities which account for less than 10% of a given insolvency class?
De minimis derogations make common sense in many circumstances, for example, where putting in place bail-in requirements as set out under Article 55(3), although the EBA has declined to do so in this case. However, this should only be done where there is a genuine benefit in terms of administrative costs and complexity and there is no additional risk under a ‘No Creditor Worse Off’ provisions.8. Do you agree that resolution authorities should seek to ensure that systemic institutions have sufficient MREL to make it possible to access resolution funds for the full range of financing purposes specified in the BRRD?
The BRRD Level 1 text is clear that the test should be whether there is sufficient MREL available for an orderly resolution on the basis of an assessment of each individual firm taking into account a number of factors as specified in Article 45. This is the basis on which the assessment should be made, using proper assumptions for the potential level of losses to be absorbed and the scale of recapitalisation which may be required. We do not therefore see a need to include Article 7 in the RTS.9. Is this limit on the transition period appropriate?
We welcome the EBA’s recognition that there needs to be a substantial transposition period. In our view, it will be important that the implementation date and transition period is consistent with the final FSB proposal on TLAC – which we do not anticipate being in place before mid-2016 at the earliest – and the terms of eligible instruments are carried across, particularly in respect of subordination, either in legislation or regulation. European banking groups could require a considerable amount of time to adjust to these features, which were not envisaged in the original MREL proposals within the BRRD.While most capital instruments should qualify under their current terms, if new entities are required to introduce structural subordination, or as the result of structural reforms in some member states, this could further elongate the process of change as issuance cannot, in reality, start until those entities are in place and there remains an issuance capacity which needs to be addressed. The investor base to which these securities will be issued will have changed as a result of the different terms and risks and there will need to be a process of education, the adjustment of investment mandates, etc. With, potentially, a substantial debt re-issuance programme in a number of banks, it is difficult to believe that this could be completed within a two year window without imposing material financial costs on banks in respect of the terms for MREL issuance. In particular, they may be forced to:
• redeem and re-issue securities with revised terms or execute some form of exchange offer; or
• issue excess amounts of securities in order to meet the MREL requirements without redeeming existing, non-eligible instruments, with this burden diminishing as existing instruments run-off; or
• pay a premium to investors beyond what would be expected long term market price for these instruments in order to be able to meet the short deadline.
A more realistic timetable for implementation will need to be developed once the outcome of the TLAC QIS is available.
10. Should the resolution authority also set a transitional period for the MREL of banks which are undergoing or have undergone a resolution process?
Just a period would be required to rebuild capital conservation buffers after these have been used, so a transition period must be required for any entity which has been through a resolution process. This should be firm-specific, reflecting the nature of the institution post resolution and its ability to accumulate capital and loss absorbency.11. Overall, do you consider that the draft RTS strikes the appropriate balance between the need to adapt the MREL to the circumstances of individual institutions and promoting consistency in the setting of adequate levels of MREL across resolution authorities?
As stated above, we believe that:(i) it is important that the RTS follows the FSB’s TLAC proposal in providing clarity on the capital requirements for an MPE Group, notably that there should not be a consolidated TLAC requirement;
(ii) the level of MREL should fundamentally be determined by the range of factors set out in Article 45 of the Level 1 text. These include, notably in paragraph 6 (d), the size, business model, funding model and risk profile of the institution.