TLAC and MREL: Building a new layer in the bank capital structure

TLAC and MREL: Building a new layer in the bank capital structure

Emil, can you tell the Risk Insights readers about yourself and your professional experiences?

I lead the capital solutions team at Nomura. We are responsible for advising Nomura’s investment banking clients on a broad range of issues relating to their capital positions; including the structuring and origination of capital and other loss absorbing instruments, the impact of bank recovery and resolution regimes and the implications of bank structure reform.

We look forward to you presenting at both the forthcoming TLAC and MREL 2017 and Risk EMEA 2017 events where you will be discussing TLAC and MREL. What benefits will banks see by building a new layer in the capital structure?

The introduction of additional loss absorbency requirements is one of the consequences of the 2008 financial crisis and the realisation 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 recapitalise failing banks without direct recourse to the taxpayer. Think of it as a second spare tyre 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”. TLAC (Total Loss Absorbing Capacity) is a requirement developed by the Financial Stability Board and applicable to Global Systemically Important Banks (G-SIBs), while MREL (Minimum Requirement for Own Funds and Eligible Liabilities) is a similar standard applicable to banks that are deemed “systemically Important” in the European Union. TLAC and MREL are there to ensure that resolution authorities are able to recapitalise a failing bank without the need to spend taxpayer money. Using bank resolution jargon, the TLAC and MREL eligible liabilities are “bailed in” to recapitalise the bank instead of relying on a taxpayer-funded “bail out”.

MREL and TLAC: How far are they the same or different and what impact does this have on implementation for institutions that are subject to both?

Both MREL and TLAC are meant to address the same issue and the EU has made an effort to fully incorporate TLAC into MREL. That said TLAC applies only to a small number of global systemically important banks and, as such, is designed to be effective regardless of any national laws on bank recovery and resolution. MREL, on the other hand, relies on a harmonised legal framework (principally, BRRD or the EU Bank Recovery and Resolution Directive) but applies to a much more diverse group of institutions, from not-so-large national or regional cooperative banks to complex G-SIBs. Therefore, MREL has to be a lot more flexible by design to allow for adaptation to different business models and national specificities of the different EU member states.

What considerations should investors have in market practice?

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…

How do you see the role of the capital management professional changing over the next 6-12 months?

Capital managers will have a lot more to manage. Not only in terms of quantum (amount of capital) but also in terms of complexity with multiple overlapping regulations, requirements computed on multiple bases and supplemented by numerous buffers, etc.