Bank capital: Banks brace for TLAC terms, clarity still needed

Louise Bowman
Published on:

Tier-3 debt faces contractual hurdles; FSB accedes on structure disparities.

A series of leaked documents throughout the summer have provided limited clarity on the Financial Stability Board’s final thoughts on total loss-absorbing capacity (TLAC), which are set to be revealed imminently.

"We could have agreement on TLAC within the next week or so," says one official close to the negotiations. "There has been huge progress over the last month."

Etay Katz-160x186
  Not all countries are
at the same place in
terms of what you can
do in resolution

Etay Katz,
Allen & Overy

Publicly, however, following its plenary meeting on September 25, the FSB has merely said that "good progress was made in agreeing key remaining policies to help end too-big-to-fail".

It is sometimes forgotten that while TLAC applies to roughly 60 G-Sibs, the minimum requirement for own funds and eligible liabilities (MREL) in Europe applies to around 6,000 banks and is due for implementation in January 2016. Unsurprisingly, resolution strategy has been top of the agenda for most European banks in recent months. 

Prospects of a TLAC announcement coincided with many European banks rushing to fund at the end of September, eager to get ahead of any developments. In the last week of the month, UBS issued $4.3 billion in its first holding company issuance, BNP Paribas issued $1 billion tier-2 notes and Société Générale issued its first AT1 trade.

"People want to get on with this," says Chris Bates, partner at Clifford Chance. "There is no lack of desire by issuers to get to the endgame. They want to say to the market – we are done, we are resolvable. But uncertainty could run on for two more years after the proposal." 

Far away

And that could still be a long way away. "This is the end of the beginning in achieving bail-in," warns one EC official. "We might have the rules but we don’t know what their impact will be – the jury is still out."

Banks are undeniably under pressure to be seen to be on top of what is an extremely fluid situation. "There has been constructive alertness," according to Gerald Podobnik, global head of capital solutions at Deutsche Bank. "Whenever there is a big new concept there is pressure to immediately disclose the estimated effect of the framework." Podobnik, speaking at the Brussels meeting, adds: "Large banks are under substantial pressure to comply as soon as possible."

That can be tough to do when the implications of bail-in are still so unclear. At the core of any bank’s resolution strategy is loss-absorbing capital. The requirement for this has been evident since 2010 but even now banks are still struggling with the mechanics of exactly how bail-in can be achieved. It is a legal minefield. 

There are effectively three routes to subordination for banks needing to issue bail-inable debt. The first is structural subordination, whereby debt is issued through a bank holding company and is subordinated to debt held at the operating company level. The second is statutory subordination, where debt is subordinated to excluded liabilities by statute.

The third is contractual subordination, whereby senior subordinated, or tier-3, debt is issued that is bail-inable but ranks above pre-existing tier-2 debt in the waterfall. 

Of the three routes, contractual subordination is by far the trickiest to pursue. The path of least resistance is the one that Germany and Italy have taken. In Germany, draft legislation has been introduced to subordinate bank bonds in insolvency and in Italy the legislature has proposed to make deposits that are not covered by deposit protection super senior. The two opposing routes essentially achieve the same aim. This makes life easy for the banks, but it is not clear the extent to which other European jurisdictions might follow their lead.

Wait and see

Many might take a wait-and-see approach. "If countries decide to do things on their own, other countries will look at this and wonder what the impact will be," says one observer. "There are always first movers. People are watching to see whether this will be an advantage or disadvantage."

Issuing debt out of a holding company is an easy solution for banks in certain jurisdictions, such as the UK or US, but is a very tough challenge for those elsewhere.

"To move towards a holding company model in a jurisdiction that has never had one is a complex and difficult undertaking. This is not an easy thing to do. It is not an easy route," says Podobnik. Swiss banks Credit Suisse and UBS have now both issued at holdco level this year.


This leaves contractual subordination, which sounds simple but could be very difficult.

"For bail in to work, it has to be workable in practice," says one official. "You need contractual consent and the consent of the home regulator to bail in. This raises issues we are aware of and it is important to find a way out if we can’t find contractual agreement."

That might well turn out to be the case for some banks. Ever since bail-in was proposed in 2010 banks have realized the need for an extra cushion of loss absorbency below senior debt and many have issued large volumes of tier-2 bonds as a result.

"Bail-in has changed the way we look at tier-2 completely," says Podobnik. "Investors want to see an additional cushion of loss absorbing capital below senior debt." But what tier-2 investors probably don’t want is for a new layer of loss-absorbing debt to be inserted between them and senior bondholders. 

"The contractual subordination route is a problem for many banks with legacy tier 2 issues," says Tom Grant, partner at Allen & Overy in London. "In order to achieve tier 3 we need the existing tier 2 to be capable of being subordinated to a new layer of debt sitting immediately below senior debt. Most of the time tier 2 ranks directly below senior so there is no room to squeeze in any new tier 3." The Spanish regulator has already introduced legislation to subordinate tier-2 creditors in the statutory hierarchy.