Everything you wanted to know about TLAC, but were afraid to ask

November 10, 2015

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The FSB has confirmed the final levels and timeline for the Total Loss-Absorbing Capacity (TLAC) standard for global systemically important banks (G-SIBs), a central element in the Basel III TBTF diet. TLAC sets a minimum requirement for instruments and liabilities that will be available to bail-in a G-SIB undergoing resolution; it acts to set a floor to the bail-in-able total, but does not bind resolution authorities to the upside. The final standard is accompanied by the results of impact assessment studies and a further BCBS TLAC Holdings consultative document.

G-SIBs will be obliged to meet a minimum TLAC of at least 16% of the group’s risk-weighted assets (RWA) as from 1 January 2019, rising to at least 18% as from 1 January 2022. Those G-SIBs which are headquartered in emerging market economies (EME) must meet minimum TLAC requirements of at least 16% RWA from 1 January 2025 and 18% RWA no later than 1 January 2028. This longer conformance period will be accelerated if, during the next five years, corporate debt issuance equates to 55% of the emerging market economy’s GDP. The same split conformance period will apply to the TLAC Leverage Ratio Exposure (LRE) Minimum initially 6% of the Basel III leverage ratio denominator, leading to a final 6.75%. Non-EME firms newly-designated as G-SIBs between 2016 and 2018 must conform to the 18%/6.75 % by 1 January 2022; those that are G-SIB designated after 2018 will have 36 months to comply.

The FSB has also issued a revision summary and term sheet (TS) which clarifies a number of questions raised during the consultation:

Minimum External TLAC for multiple point of entry G-SIBs. To ensure a level resolution playing field between group and single entities, adjustments may be made to ensure that minimum MPE TLAC does not exceed the hypothetical SPE TLAC for the same group. Subject to these adjustments, subsidiary entities with an MPE group will be treated on a pro-rata basis, the TLAC attributable from a subsidiary to a parent will be in a proportion equal to the regulatory capital issued by the parent to the subsidiary.
Relationship with Capital Requirements. Buffers will not apply to the leverage ratio exposure requirement, except where they are added by G-SIB home authorities. Minimum TLAC is an explicitly additional requirement to minimum regulatory capital; however, the two requirements may be satisfied by the same instrument, subject to its being in conformance with the TLAC TS. For those regulatory capital instruments that do not meet TLAC eligibility criteria (subject to certain exemptions), a phase-out period will apply until 31 December 2021.
Instruments and debt liabilities eligible for external TLAC. The “expectation” that 33% of TLAC be in the form of long-term debt will not become mandatory at a supra-national level, but may be imposed or exceeded by home authorities.
Phase-out of the issuance of external TLAC by entities other than resolution entities. Those jurisdictions that do not permit the issuing of TLAC out of the resolution entity may issue indirectly via a wholly and directly owned funding entity, subject to its assets meeting or exceeding the TLAC eligibility criteria. The window for “indirectly-issued” TLAC will close on 31 December 2021.
TLAC eligibility and excluded liabilities. Eligible TLAC must be: paid in, may be perpetual, and must not be redeemable by the holder prior to maturity. Excluded liabilities will, in principle, rank senior to TLAC. Liabilities which are neither excluded, nor meet the eligibility criteria, may rank pari passu with TLAC. Structured notes remain excluded.
Priority. A de minimis exemption to the subordination requirement is applicable, allowing a limited amount of excluded liabilities to rank pari passu with TLAC e.g. utilities, rent, salaries etc. subject to certain conditions eg. total does not exceed 5% of TLAC, does not impair resolvability, the exemption cannot be used to exclude liabilities from bail-in. For those liabilities which would otherwise count as external TLAC but rank pari passu with excluded liabilities, they may contribute to TLAC up to an equivalent of 2.5% RWA. This allowance rises to 3.5% RWA equivalent when the TLAC RWA Minimum is 18%.
Governing Law. TLAC eligible liabilities may be issued under other jurisdictions, provided that they are subject to effective and enforceable resolution.
Internal TLAC. The TS introduces the concept of a “material sub-group”- one or subsidiaries carrying out critical functions, which may be consolidated under an intermediate holding company. As determined by the host authority, material sub-groups will be subject to an internal TLAC requirement in the 75-90% range of the external. Public disclosure requirements have been modified to include material sub-groups.

The impact assessment studies estimate that the costs of TLAC translate to a 2.2-3.2 basis point increase in the lending rate to an average borrower, itself equating to 2-2.8 basis point annual cost to GDP. Perhaps unsurprisingly, TLAC’s estimated benefits in the form of reduced systemic risks are estimated to be far larger than its costs, benefits are estimated to amount to 15-20 basis points of annual GDP. The TLAC principles and TS will be submitted to the G20 leaders for their endorsement at the Antalya summit on 15 November 2015. The FSB expects to complete a review of the TLAC standards technical implementation by December 2019.

In conjunction with the above, the BCBS has issued a consultation paper on the treatment of banks’ investments in TLAC-qualifying instruments (BCBS342). The BCBS proposes that internationally active banks, both G-SIBs and non-G-SIBs, should deduct their net TLAC holdings from their tier 2 capital. The paper goes on to detail what the BCBS classifies as a TLAC holding. The deadline for response is 12 February 2016, the BCBS expects the final revisions to take effect with the beginning of the TLAC regime on 1 January 2019.