Banking and Finance Law Daily GSIBs now subject to TLAC and long-term debt requirements
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Thursday, December 15, 2016

GSIBs now subject to TLAC and long-term debt requirements

By John M. Pachkowski, J.D.

The Federal Reserve Board has issued a final rule that is intended to safeguard the financial stability of the United States by: enhancing the resolvability of covered bank holding companies (BHCs) under the U.S. Bankruptcy Code; enhancing the resolvability of covered BHCs under Title II of the Dodd-Frank Act; enhancing the resolvability of foreign global systemically important banking organization (GSIB) parents of covered intermediate holding companies (IHCs) under their home jurisdiction resolution regimes; and further increasing the resiliency of covered BHCs and covered IHCs. Specifically, the final rule will establish long-term debt (LTD) and total loss-absorbing capacity (TLAC) requirements, as well as restrictions on certain arrangements that could impede a resolution proceeding—clean holding company requirements—for covered BHCs and IHCs.

The final rule is based on a proposed rule that the Fed issued in 2015 (see Banking and Finance Law Daily, Nov. 2, 2015).

Covered BHCs and IHCs. For purposes of the final rule, a "covered BHC" is defined to mean a U.S. GSIB identified under the Fed’s GSIB surcharge rule. Currently, the following eight firms are subject to the GSIB surcharge rule: Citigroup Inc., JP Morgan Chase & Co., Bank of America Corporation, The Bank of New York Mellon Corporation, Goldman Sachs Group, Inc., Morgan Stanley, State Street Corporation, and Wells Fargo & Company.

A covered IHC is defined in the final rule to include any U.S. IHC that is: required to be formed under the Fed’s enhanced prudential standards rule, and controlled by a foreign banking organization that has been designated as a GSIB or would be designated as a GSIB under the Fed’s capital rules.

External LTD and TLAC. To meet the external TLAC requirement, covered BHCs would be required to maintain outstanding eligible external TLAC equal to the greater of: 18 percent of risk-weighted assets (RWAs) and 7.5 percent of total leverage exposure.

A covered BHC will also be subject to an external TLAC buffer that is equal the sum of 2.5 percent, any applicable countercyclical capital buffer, and the GSIB surcharge applicable under method 1 of the Fed’s GSIB surcharge rule and a leverage-related external TLAC buffer equal to 2 percent. The buffers operate like the capital buffers in the Fed’s capital rules for bank holding companies; and a breach of either buffer could result in restrictions on distributions and discretionary bonus payments.

A covered BHC meets the final rule’s external LTD requirement if it maintains outstanding eligible external LTD equal to the greater of: 6 percent of RWAs, plus the applicable GSIB capital surcharge, and 4.5 percent of total leverage exposure.

A debt instrument is considered to be eligible external LTD if it:

  • is issued directly by a covered BHC;
  • is unsecured;
  • is "plain vanilla" in that there are has no complex features that would interfere with its loss-absorbing capacity;
  • is governed by U.S. law, and
  • has a remaining maturity of more than one year.

In response to comments on the proposal, the final rule grandfathers LTD issued on or before Dec. 31, 2016, that has impermissible acceleration clauses or that is subject to foreign law.

In a memorandum to the Fed, the agency’s staff noted that four of the eight covered BHCs would currently have external TLAC shortfalls. The memorandum added that the aggregate external TLAC shortfall of the covered BHCs would be approximately $56 billion, the aggregate external LTD shortfall would be approximately $49 billion, and the aggregate shortfall for the external LTD and TLAC requirements together would be approximately $70 billion. The Fed staff estimated that the aggregate increased funding cost for the covered BHCs would range from approximately $680 million to $2 billion annually.

Covered IHCs’ LTD and TLAC. The LTD and TLAC requirements for a covered IHC in the final rule depend on the resolution strategy of the covered IHC. A non-resolution covered IHC will be expected to remain a going concern under its parent foreign banking organization’s single-point-of-entry resolution strategy. On the other hand, a resolution covered IHC will be expected to rely on resolution proceedings in the United States under its parent foreign banking organization’s multiple-point-of-entry resolution strategy.

A resolution covered IHC has the option to issue LTD externally to third parties in a manner similar to covered BHCs and consistent with the Covered IHCs resolution strategy. A non-resolution covered IHC will be required to issue internal LTD to its foreign GSIB parent or to a foreign wholly-owned subsidiary of its foreign GSIB parent.

A covered IHC will be required to maintain LTD in an amount equal to the greatest of: 6 percent of total RWA, 2.5 percent of total leverage exposure, if applicable, and 3.5 percent of average total consolidated assets, as computed for purposes of the tier 1 leverage ratio as calculated under the Fed’s capital rules.

Covered IHC TLAC is the combination of common equity tier 1 capital and additional tier 1 capital issued directly by a Covered IHC plus eligible LTD issued internally or externally, depending on the Covered IHC’s resolution strategy.

The amount of covered IHC TLAC will depend upon resolution strategy of the covered IHC:

  • A non-resolution covered IHC would be required to maintain TLAC in an amount not less than the greatest of 16 percent of RWA, 6 percent of total leverage exposure (if applicable), and 8 percent of average total consolidated assets, as computed for purposes of the U.S. tier 1 leverage ratio.
  • A resolution covered IHC would be required to maintain outstanding eligible TLAC in an amount not less than the greatest of 18 percent of the covered IHC’s RWA, 6.75 percent of the covered IHC’s total leverage exposure (if applicable), and 9 percent of the covered IHC’s average total consolidated assets, as computed for purposes of the U.S. tier 1 leverage ratio. The covered IHCs also would be subject to an RWA-related TLAC buffer equal to 2.5 percent that is similar to the capital conservation buffer in the Fed’s capital rules for bank holding companies.

Clean holding companies. The final rule’s clean holding company requirements will apply to both covered BHCs and IHCs and is intended to facilitate a single point of entry resolution by restricting the operations of those entities that could pose obstacles to orderly resolution.

In response to comments received on the proposal, covered BHCs and covered IHCs will be permitted to guarantee certain qualified financial contracts of their subsidiaries, to the extent such guarantees are in the future permitted by regulations governing stays on qualified financial contracts issued by the Fed or other federal banking agencies.

Effective date. All LTD and TLAC requirements would apply as of Jan. 1, 2019. The final rule does not retain the proposal’s extended phase-in through January of 2022 in recognition of the fact that observed shortfalls have declined substantially and a number of changes have been made to the final rule that will reduce the burden of complying with the requirements of the draft final rule.

Fed comments. At the Fed’s Dec. 15, 2016, open meeting, Fed Chair Janet L. Yellen stated, "This meeting marks an important moment, because today we are putting into place one of the last critical safeguards that make up the core of our post-financial crisis reform efforts." She added, "Today's rule and the many other reforms we have put in place help keep our financial system strong and stable—not for its own sake—but for the sake of the workers, families and businesses who determine the long-run success of our economy."

Fed Governor Daniel K. Tarullo called the final rule "another core component of a program to establish a viable resolution option." He added that although the final rule "is not intended to be a liquidity regulation as such, it does complement and reinforce requirements such as the Liquidity Coverage Ratio."

Finally, Fed Governor Lael Brainard stated, "Today's final rule helps to ensure that the largest and most complex banking institutions in America can be resolved without posing unacceptable risks to financial stability. The long-term debt requirement contained in the rule is a necessary counterpart to the Dodd-Frank Act requirement that firms construct credible plans to resolve themselves without endangering the stability of the financial system." She added, "Today's long-term debt requirement, together with rigorous resolution planning and preparedness, the GSIB surcharge, capital stress tests, and liquidity requirements, will decrease substantially the risk that a large financial institution's distress could pose to the broader financial system and help ensure that no banking institution is too large and too complex to fail. Today's rule moves us closer to our goal of a safer, more responsible, and more resilient financial system."

Limiting flexibility. Following release of the final rule, Rob Nichols, president and CEO of the American Bankers Association stated, "the final rule will inevitably limit the covered banks’ flexibility in managing their funding, and the markets’ reaction will be critically important, we will continue to examine how the existing regulatory framework, including the TLAC requirement, balances strong, effective regulation with the need to ensure that banks can effectively support economic growth and opportunity."

Companies: American Bankers Association; Bank of America Corporation; Citigroup Inc.; Goldman Sachs Group, Inc.; JP Morgan Chase & Co.; Morgan Stanley; State Street Corporation; The Bank of New York Mellon Corporation; Wells Fargo & Company

MainStory: TopStory BankHolding BankingOperations CapitalBaselAccords DoddFrankAct FederalReserveSystem FinancialStability Receiverships

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