Playing the long game on MREL
The minimum requirement for own funds and eligible liabilities (MREL) is due to become effective in January but its final determination could still be years away.
Just 14 weeks remains before the implementation of MREL in Europe. The requirement, which comes into effect in January 2016 and has a maximum four year implementation period, is the final piece of the bank recovery and resolution directive (BRRD), which was itself launched in January last year.
Like the FSB’s total loss- absorbing capacity (TLAC) initiative for global systemic banks, MREL has one very clear aim: to enable banks to internalize the cost of failure.
While the market is braced for the final TLAC rules, which were due to be announced prior to the G20 meeting in November, the implementation of MREL remains worryingly vague. It is still far from clear how each European authority will implement MREL for each bank.
There are specific differences between the two requirements: MREL is set idiosyncratically for each of the 6,000-odd European banks to which it will apply while TLAC will be set at a universal level for the 60 G-Sibs it is designed for – expected to be between 16% to 18% of total assets initially, rising to 18% to 20% after a period of initial phase-in. MREL is expected to be no higher than the CRD 4 capital requirement for non-systemic banks and between 21% and 26% of RWAs for G-Sibs.
While MREL is based on a bank’s total assets TLAC is determined on the basis of total bank assets plus leverage. For MREL the single resolution board (SRB) will identify instruments for bail-in at each bank but under TLAC all senior debt is subordinated to ineligible liabilities.
Both requirements present significant challenges for the banks in terms of how the loss-absorbing capacity that they demand will actually mop up those losses in practice. Their imminent introduction will trigger a huge recycling of bank debt from non-bailinable senior liabilities to new, tier 3-style senior subordinated debt. This will be an expensive and time-consuming exercise for issuers.
According to CreditSights the shortfall of MREL eligible liabilities in Europe is more than €13 billion if senior debt and deposits of more than one year are included but rises to €674 billion if only subordinated debt and equity are eligible.
It is also an exercise fraught with uncertainty: not only in terms of regulatory treatment of bail-in capital itself but also because the final quantum required is, even now, still far from clear. Even though MREL is due to be implemented in January it remains joined at the hip with TLAC, which does not become effective until 2019.
Because of this there is the provision within MREL for each bank’s final requirement to be altered should the final TLAC requirements in 2019 be significantly different than anticipated.
Thus, determination of the final bill for each bank of internalizing its cost of failure remains years away as the mechanisms designed to achieve it are supposedly being set in stone.