In November 2014, the Financial Stability Board (“FSB”) proposed international standards for total loss absorbing capacity (“TLAC”) that a global systemically important bank (“G-SIB”) would be required to maintain to facilitate its orderly resolution should it fail. Key aspects of the TLAC proposal include:

• External TLAC Requirement – the consolidated amount of loss absorbing capacity required of each G-SIB, which the FSB proposes to be 16 to 20% of the entity’s risk-weighted assets (“RWA”).  However, the FSB’s figure does not include a 2.5% capital conservation buffer and the G-SIB surcharge. If these additional requirements are included, the true loss absorbency range for G-SIBs under the proposal increases to 19.5 to 21% of RWAs – and possibly even higher depending on the Federal Reserve’s final G-SIB surcharge rule.
• Internal TLAC Requirement – the loss-absorbing capacity required to be ‘pre-positioned’ at each material foreign subsidiary of an entity in resolution, the purpose of which is to assure the confidence and cooperation of host countries during the resolution process.
• Public Disclosure – to maximize credibility and strengthen market discipline, the proposal requires the public disclosure of the amount, maturity, and pre-positioning of TLAC liabilities.
• Investors in TLAC – to ensure that the use of TLAC in resolution does not cause harm to systemically-important investors and broader economic contagion, the proposal regulates the holding of TLAC by other G-SIBs. 

Concerns

The banking industry is strongly supportive of the SPOE resolution strategy and TLAC. Together, SPOE and TLAC mark a profound and effective change to how G-SIBs will be resolved and ensures that creditors and shareholders, and not taxpayers, bear losses in the event of default without government support, the disruption of financial stability, or ring-fencing by foreign jurisdictions. However, requiring TLAC in excess of what is necessary to support the orderly resolution of a G-SIB, or structuring or defining TLAC in an unnecessarily restrictive way, would unnecessarily constrain G-SIBs in managing their balance sheets, with the consequence not only being economic inefficiency but possibly even impairment, instead of the promotion, of the safety and soundness of these institutions. To help avoid negative consequences, it is critically important that the calibration of TLAC be credibly supported by studies and that opportunity be given for interested parties to provide comment in view of these studies’ results.    

Next Steps

The Federal Reserve is expected in 2015 to propose a regulation imposing an external TLAC requirement on U.S.-headquartered G-SIBs, as well as an internal TLAC requirement on the U.S. intermediate holding companies of foreign banking organizations that are G-SIBs.  

Further Reading

• Financial Stability Board, Adequacy of loss-absorbing capacity of global systemically important banks in resolution, November 2014, www.financialstabilityboard.org.
• Mark Carney, Statement by Mr. Mark Carney, Chairman of the Financial Stability Board, October 2014, www.financialstabilityboard.org.
• Cleary Gottlieb, Financial Stability Board Proposes TLAC Requirements for G-SIBs, January 2015, www.cgsh.com.
• PwC, First Take: Ten key points from the FSB’s TLAC ratio, November 2014, www.pwc.com.

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