Fundamentally, HSBC considers it essential that the EU MREL definition under the BRRD is aligned with the final international framework for TLAC adopted by the FSB, both in substance and in the implementation timeframe. This means that the MREL requirement should be determined at the resolution group or entity level, as appropriate.
In particular, we are concerned that the EBA’s draft RTS does not differentiate between resolution strategies (Single Point of Entry vs Multiple Point of Entry). In line with the FSB’s approach, we would expect the level of application of the MREL requirements to be for example at the resolution entity (subsidiary) level for firms intending to pursue a Multiple Point of Entry resolution strategy and at the resolution group (consolidated) level for Single Point of Entry firms subject to distribution to material subsidiaries.
We support a framework whereby MREL continues to be determined on a firm-by-firm basis, although we have significant concerns with the way in which the EBA is proposing that this is achieved, as it does not seem to serve the objectives of the resolution tools. In particular, we would disagree with the proposal to make exclusions or adjustments to the capital requirements when assessing the baseline loss absorbency amount. This risks confusing the roles of the resolution authority and the competent authority (supervisor). References made to the need to make adjustments to take into account any firm specific obstacles to resolvability (which will vary according to business and funding model, impact on financial system, cross border activities, etc) would be better addressed through an additional Pillar 2 element of MREL, which should in our view be applied at the resolution entity level, rather than by imposing a higher general level of MREL. The specifics and quantum of any such requirement should be aligned with the resolution strategy and objectives, and agreed at the Crisis Management College for a particular banking group.
We also disagree with the methodology proposed for determining the amount of recapitalisation which would be required upon resolution. In our view, recapitalisation is not resurrection and therefore the amount of resources necessary should be the minimum necessary to meet conditions for authorisation and minimum level of going concern capital to enable the maintenance of critical activities and an orderly run down of activities. For this reason, it should not comprise a typical Pillar 2 capital requirement, or any capital buffers. In this regard, we would also note – as the EBA proposals appear to recognise, that the group emerging from the resolution process would be very different from that pre-resolution. We also do not understand why it should be necessary to recapitalise a banking group to the level of a peer group. We would nevertheless support an approach that correctly differentiates between resolvable and less resolvable groups and the recapitalisation amount should reflect these differences.
There should also be exclusions from a firm's loss absorbency requirement if the original capital requirements include (a) non-banking entities, such as insurance and asset management companies, (b) associated companies for which the Group would not be responsible in resolution, (c) entities which are separately listed and where the loss-absorbing capacity issues must be addressed at the entity level, and (d) special purpose entities which may be associated with the financing of specific asset pools where there is a clear ex-ante distribution of losses to the creditors without recourse to the parent.
We support the EBA’s decision not to impose a limit on CET1 to meet the requirements. However, we are concerned that banks which have genuinely low risk balance sheets may be prejudiced by the use of the non risk based metric to determine MREL. These banks are often mortgage or commercial banks operating within a wider group which (a) invest in lower risk assets such as low loan-to-value mortgages and/or (b) hold significant portfolios of high quality liquid assets to provide liquidity for their deposit portfolio and repository for surplus deposit funds. The ring-fenced retail bank which HSBC is being required to create in the UK is an example of this but a number of other banks within the Group have similar characteristics.
Often deposit-funded, such banks are required to raise capital and loss-absorbing capacity which they do not need for the underlying risks which they hold. In these cases, the proposed leverage ratio measure under MREL significantly increases any difficulties created by the leverage ratio for going-concern capital. And when these additional resources are deployed into liquid assets with negative spread, this exacerbates the leverage issue still further.
Given the potential amplification of the effects of the leverage ratio in this way, we believe that this should be specifically considered in any re-calibration of the leverage ratio.
Finally, we do not understand or support the use of a ‘SREP adjustment’. The SREP assessment relates to the going concern minimum level of capital and, consistent with our view above, should not be used to determine MREL.
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.
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.
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.
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.
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.”
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.
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.
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.
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.
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.
We strongly support the EBA’s intention to undertake a more detailed assessment of the quantitative impact on institutions. A comprehensive QIS will be critical in informing final design and calibration. While, as noted above, we would prefer to see the treatment of buffers and Pillar 2 capital requirements aligned with the TLAC proposals, if these aspects are retained, their impact, as well as that of Article 7, should be specifically considered. The impact on different business models (including MPE groups), markets and investors should also be considered.