TLAC: What you should know

TLAC: What you should know

The Financial Stability Board (FSB) issued the final minimum total loss-absorbing capacity (TLAC) standard for 30 banks identified as global systemically important banks (G-Sibs) that the Basel Committee on Banking Supervision (BCBS) deems at risk from being too big to fail on 9 November 2015.

The TLAC requirements aim to bolster G-Sibs’ capital and leverage ratios, ensuring these banks are equipped to continue critical functions without threatening financial market stability or requiring further taxpayer support.

A comprehensive quantitative impact study (QIS) was completed by the FSB in collaboration with the BCBS to calibrate the optimal Pillar 1 element of the TLAC requirement for all G-Sibs. The FSB proposed a minimum total loss-absorbing capacity (TLAC) requirement for G-Sibs in November 2014, in consultation with the BCBS. Basel III rules require banks to meet a minimum total capital ratio of 10.5% by 2019 – though in some jurisdictions the minimum ratio is far higher. The proposed minimum TLAC requirements for G-Sibs unveiled at the G20 Brisbane summit in November 2014 was 16% to 20% of a group’s consolidated risk-weighted assets. This proposal was under consultation until February 2, 2015, when the requirement was finalized.

Qualifying instruments

The TLAC should consist of instruments that can be written down or converted into equity in case of resolution: capital instruments (CET1, AdT1 and T2), together with long-term unsecured debt – subordinated and senior debt. Debt must be unsecured; have a minimum residual maturity of more than one year; arise through a contract; and be subordinated to liabilities that are explicitly excluded from TLAC.

The minimum TLAC requirement is in addition to minimum regulatory capital requirements, but qualifying capital may count towards both requirements, subject to conditions.

TLAC calibration

From 1 January 2019, the minimum TLAC requirement for G-Sibs will be at least 16% of the resolution group’s risk-weighted assets (RWA’s), increasing to at least 18% from 1 January 2022. Emerging market G-Sibs must meet the 16% RWA and 6% LRE Minimum TLAC requirement no later than 1 January 2025, and the 18% RWA and 6.75% LRE minimum TLAC requirement before 1 January 2028. The period for emerging market G-Sibs conformance will accelerate if, in the five years following publication of the term sheet, aggregated corporate debt issuance exceeds 55% of the economy’s GDP.

Bank manoeuvres

Banks still have much work to do filling out their TLAC ratios at the lowest possible cost.

New Basel regulations disqualify old-style amortizing tier-2 bonds with less than five years remaining to maturity to count in the TLAC computation. In February and early March 2015, a slew of European banks issued 10-year bullet maturity Basel III-compliant, tier-2 (B3T2) subordinated bond deals, as they sought to grow a new market for these lower cost TLAC-eligible instruments. Investor yield-hunger drove strong demand for bonds offering coupons around 2.625%.

  • Crédit Agricole drew €16.5 billion of orders for its €3 billion dual-tranche T2 bond.
  • BNP Paribas attracted €5.5 billion of demand for its €1.5 billion offering at 170 basis points over mid-swaps.
  • Deutsche Bank took €4.4 billion of orders for its €1.25 billion deal priced at 210bp over.
  • Société Générale drew €3.8 billion of orders for its €1.25 billion transaction at 190bp over.

Under the proposed rules, TLAC eligible debt must qualify as long-term debt (LTD) – no debt instruments with residual maturity of less than one year can count towards these ratios. Eligible debt with remaining maturities between one to two years still qualify, but at a 50% haircut. US banks have begun issuing senior debt with call options one year before maturity, with plans to redeem the debt before it stops counting towards their TLAC requirement, allowing them to save on interest payments for debt with no regulatory benefit.

JPMorgan issued the first deal to use a call feature to address TLAC rules in August 2016; the $2.5 billion of five-year bonds that can be called in their fourth year brought in $5.5 billion of orders.

In the four months following JPMorgan’s initial deal, more than $20 billion equivalent of callable senior debt was printed. Reuters reports: “Wells Fargo, Bank of New York Mellon and State Street are the only banks subject to TLAC that have not yet tapped the callable structure.” Issuer calls are subject to regulatory approval if calling the issue would result in breach of TLAC.

TLAC will be formally implemented in 2019. Once established, non-compliance could impede a bank’s ability to make discretionary distributions such as dividend payments or additional tier-1 coupons, as TLAC is part of the Pillar 1 Basel requirements.

Source: Euromoney