Nomura FIG Conference
This year saw Nomura hold its 7th annual Asia FIG Conference, in Hong Kong. Historically the Conference has been a great venue to introduce European and Asian FIG issuers of debt, to Asian investors. Given the vast changes going on in the bank capital regulatory landscape, we altered the emphasis of this year’s Conference – and made good use of the global knowledge of our FIG Solutions team in London – by focusing more on educating investors. With regulatory changes progressing at different places across jurisdictions, and in an area be speckled with acronyms and technical definitions, the Solutions team were able to improve investors’ understanding of capital regimes and developments, via a large group luncheon presentation, and then a series of customized one-on-one and small group meetings.
An introduction to TLAC / MREL:
TLAC (Total Loss Absorbing Capacity) / MREL (Minimum Requirement for Own Funds and Eligible Liabilities) instruments constitute a new layer in the bank capital structure, put in place to ensure that banks can be resolved in credible and feasible fashion. With this in mind, one of the key tenets of the TLAC requirements is that globally systemically important banks must have sufficient long term debt at the point of resolution which ranks subordinated to operational liabilities. The subordination requirement provides clarity to investors and avoids bail-in being inhibited by legal risks, such as bailed in holders claiming compensation if they were treated worse than in insolvency. While the TLAC term sheet, published by the Financial Stability Board provided for three methods (structural, contractual or statutory) to meet the subordination requirement, efforts to implement a partial harmonization of this in Europe are under way for European banks subject to MREL (a European requirement broadly similar to the international TLAC standard). However in the meantime, different jurisdictions have opted for different methods, e.g. structural in the UK, with the issuance of holding company senior debt, contractual / statutory in France with the creation of the senior non preferred layer of debt, and statutory in Germany, where the status of certain senior unsecured debt in the insolvency framework has been amended).
Benefits of TLAC and MREL:
The introduction of additional loss absorbency requirements is one of the consequences of the 2008 financial crisis and the realization that most banks are “too big to fail”. Bank capital requirements have increased significantly since 2008, thereby reducing the probability of unexpected losses causing a bank failure. At the same time, a whole new system has been developed to recapitalize failing banks without direct recourse to the taxpayer. Think of it as a second spare tire in the boot. As part of this system, systemically important banks are required to have loss absorbing liabilities that can easily be converted into capital if and when a bank is deemed to be failing and becomes subject to “resolution”.
Investor considerations in the market place:
As with all other bank funding and capital instruments, investors will want to make sure that they are receiving a fair compensation for the risks they are taking. A common misconception is that TLAC/MREL instruments are “bail-in-able” whereas non-TLAC/MREL eligible liabilities are not. Unfortunately, the reality is more complicated than this. The scope of the “bail in tool” extends beyond TLAC/MREL eligible liabilities but TLAC/MREL qualifying liabilities are deemed by the resolution authorities to be easier to bail in than other “bail-in-able” liabilities where the use of the “bail in tool” could give rise to so called NCWO (No Creditor Worse Off) issues. In brief, investors will need to gain a better understanding of the bank creditor hierarchy; both from a strictly legal as well as from a practical perspective (i.e. what a resolution authority might actually decide to do with a specific bank). The good news is that, in many cases, TLAC/MREL eligible liabilities simply replace old-style senior debt (which is statutorily “bail-in-able” in the EU) meaning that their exposure to losses is very similar. The distinction between TLAC/MREL eligible liabilities and bank capital is also very clear – the latter absorbs losses automatically at the so called Point of Non-Viability (PONV) and does not benefit from NCWO protection, whereas TLAC/MREL eligible liabilities only absorb losses in resolution. Given that resolution is “the new liquidation”, the parallel with old-style senior debt makes even more sense. In a way, this is “the new senior” debt more explicitly structured to absorb losses in a way that old-style senior debt should also have been able to do but, in practice, did not.