Single Resolution Board, Board Member, Director of Resolution Planning and Decisions
Banco de Portugal, Member of the Board of Directors
Bank of England, Executive Director, Resolution
Federal Financial Supervisory Authority, Germany, President
Autorité de Contrôle Prudentiel et de Résolution, Director, Resolution Directorat
Crédit Agricole S.A., Corporate Secretary
UBS, Head Governmental Affairs
CaixaBank, Executive Director, Head of Public Affairs
BNP Paribas, Head of Recovery and Resolution Planning
An agreement was reached at the international level at the end of 2015 on the Total Loss Absorbing Capacity requirement, or TLAC, for Global Systemically Important Banks (G-SIBs) with a view to overcoming the “too-big–to-fail” issue and making resolution simpler and more predictable.
The adoption of the Bank Recovery and Resolution Directive (BRRD) in 2014 also brought about a major reform in the EU crisis regulatory framework for banks. At the core of this EU reform is the principle that the costs of bank failures should be borne, first and foremost, by shareholders and creditors rather than taxpayers. In support of this outcome, a new tool, the ‘bail-in’ tool, enables resolution authorities to write-down shares and debt instruments in order to absorb losses and convert debt instruments into new shares to recapitalise systemic functions. The Bank Recovery and Resolution Directive (BRRD) requires banks to meet a minimum requirement for own funds and eligible liabilities (MREL) for all institutions in the European Union so as to be able to absorb losses and restore their capital position, allowing banks to continuously perform their critical economic functions during and after a crisis. Unlike TLAC, MREL is not defined as a pillar I requirement with legal minimum thresholds, but more a Pillar 2 instrument, driven by the risks and resolvability profiles of each institution and the envisaged preferred resolution strategy.
The Chair outlined that the discussion would essentially deal with MREL. He stated that European Union rules require, as a general rule, a bail-in of at least 8% of total liabilities, including own funds, before accessing a resolution financing arrangement, like the Single Resolution Fund. In this context, resolution authorities require bank-specific MREL-targets, in order to ensure that banks have a sufficient amount of own funds and liabilities, which will be eligible for bail-in, and thereby facilitating the resolvability also in extreme crisis situations. Apart from the discussion on MREL, some national authorities in Europe are proposing to use a precautionary recapitalisation outside of resolution if the relevant conditions to use such a form of State Aid without triggering resolution, as listed in the BRRD, are met.
1. Precautionary recapitalisation: issues and stakes
A precautionary recapitalisation describes the injection of own funds into a solvent bank by the state when this is necessary to remedy a serious disturbance in the economy of a Member State and preserve financial stability. It is an exceptional measure that is conditional on final approval under the European Union state aid framework. It does not trigger the resolution of the bank. For the purposes of a precautionary recapitalisation, a bank is considered solvent if it fulfils the minimum capital requirements (i.e. Pillar 1 requirements). In addition, the bank should not have a shortfall under the baseline, but only in the adverse, scenario of the relevant stress test.
The Chair asked a public authority representative to comment on whether the current approach in some Member States undermines the main concept of the BRRD; whether there is a need to wait for the banks to build up a sufficient amount of bail in buffers before they can seriously consider a resolution of a large bank; and whether there is any need to mitigate the measures imposing losses on creditors of failed banks. This representative replied that precautionary recapitalisation is under discussion, and whenever pioneer cases are applied without a well rehearsed or long established practice being in place, this gives rise to lots of difficult questions, some of which the Chair had asked. The Supervisory Board at the ECB is trying very hard to develop a proper practice on this matter.
The non-existence of bail-in eligible instruments is one problem, but there are others, including the fact that a significant portion of potentially bail-in eligible instruments are held by retail investors. No government in the world can ignore this fact in their country; they need to deal with these difficult challenges so as not to lose people’s trust. These challenges cannot be resolved within the concept of precautionary recapitalisation in itself; ways and means of resolving them need to be defined and established.
Another challenge in the area of precautionary recapitalisation is how to deal with liquidity challenges. Precautionary recapitalisation predominantly focuses on capital, but it is very rare that a bank gets into a difficult situation without also facing heavy liquidity challenges, and this issue is currently unresolved. Precautionary recapitalisation, as a tool, is embedded in the existing EU law, and it is legitimate to think about it; however, its use as a tool is supposed to be restricted to truly exceptional cases, rather than to become established as a general way to circumvent a resolution and continue bailing out banks, which is strongly against the general principles of the BRRD. Allowing this to happen would destroy the resolution logic which has been newly established in the EU. As such, precautionary recapitalisation should be a ‘part of the toolbox’, but is not intended to subvert the BRRD.
The most difficult element within this question is how to treat losses or potential losses, for which the precautionary recapitalisation tool cannot and must not be a solution. In the view of the public authority representative, part of the challenge is that the institutional framework, which has been set up according to the current legal interpretations between the Commission and the supervisor, needs to be rethought. As a supervisor, the public authority representative feels uncomfortable with the way that this interaction currently works. They hope that, in the near future, this institutional setup can be reviewed.
Another participant noted that there are some reasons to take precautions in relation to the implementation of the BRRD and the regulation for the establishment of the single resolution mechanism, because it is quite recent and represents a ‘kind of revolution’. Some countries have issues related to legacy, and in many banks balance sheets are not yet adapted to some resolution tools, so it will take time to adjust these. For these reasons, there is some reluctance to move into new areas of banking resolution, but this is not a reason to stop or delay the process. It must be done in a realistic way, and must be a step by step approach, which has been done, for instance, by some resolution authorities in relation to the resolution plans. There is no perfect, comprehensive resolution plan currently, but in time, there will be.
There must be a transition period for the implementation of TLAC and MREL requirements, which should not be too high or too subordinated at the first stage, and the capacity of the markets to respond to the new requirements needs to be taken into account. The BRRD provides some flexibility in this regard, which we should take advantage of. In addition, there are some provisions regarding precautionary recapitalisation, and there is no total exclusion of state aid, although this must be monitored and framed by the text and the Commission. Such provisions in the BRRD should to be used in a realistic and a pragmatic way.
2. The EU crisis management framework is challenged by the legacy issues
2.1. Financial stability impact of MREL
An industry representative stated that the general concept of the BRRD, combined with state aid rules, is a positive idea: taxpayers’ money should not be used when banks are facing difficulties while, when banks provide profits, these profits are not shared. Taxpayers’ money should be safeguarded as much as possible.
Practically, when BRRD is applied, and particularly where certain business models do not foresee to hold bail in eligible instruments in sufficient amounts, it will be a challenge for banks to apply a minimum bail in of 8% of total liabilities, including own funds, in a resolution situation. In addition, the limitation of 5% of the bank’s liabilities, including own funds, for the use of the resolution fund represents a serious risk of needing to bail-in senior debt or even deposits in a crisis situation. Doing this might trigger a systemic impact, and – as the Banking Union is incomplete – lead to huge reputational effects and a crisis of the entire banking system, unless other forms of state aid is used, probably not directly to rescue the bank, but to ease the contagion effects. This, however, would trigger another series of issues. Regarding the development of MREL eligible instruments, enough time should be granted to banks, to enable a smooth transition of the business and funding models.
One participant expressed the view that one problem is that certain banks have very low profitability, due to certain jurisdictions containing a large numbers of NPLs ‘overhang’, although the issue of low profitability is also present even in some of the ‘virtuous’, non-NPL jurisdictions . Until August 2013, state aid has been used to conduct significant bail-outs of banks and – in a lot of jurisdictions – some state supported systemic solutions for NPLs. The crisis occurred after 2014 for several reasons, some of which were linked to over-reaction to the general environment in those jurisdictions. The problem of NPLs increased when BRRD has already been in practice.
The EU Commission (DG Comp) changed state aid regulation in 2013: now, entities cannot rely on being bailed-out in case of their failing, which raises concerns on the systemic impact, in case insolvency or resolution proceedings are applied The most important message is that, with at least part of the Banking Union framework in place (EDIS is not in place), the different stakeholders can get together and manage situations in a way that is logical and does not harm them. Further fine tuning will be necessary.
Another industry representative welcomed these comments. The first priority should be to bear in mind what the goal is: namely, to provide sufficient loss absorbing capacity for resolution. This is not something that is mechanistic, but should be calculated via a tailor-made approach for every banking group, which should be made clear at the outset of the discussion. In any case, there should be sufficient loss absorbing capacity to ensure that the precautionary recapitalisation tool is only used in exceptional circumstances. Ultimately, two parameters, loss absorption and recapitalisation capacity need to be reconciled: namely, the benefits of certainty and stability must be reconciled with the cost of raising debt. For an institution such as the speaker’s, raising debt is going to be a very critical and very expensive issue; ultimately, it is going to affect its profitability, and the speaker would like to be sure that this is done for good reasons, not for the wrong ones.
2.2 Dealing with retail investors that are misled in the purchase of bail-in eligible instruments
The Chair noted that an industry representative had referenced a very controversial issue, the holdings of senior bonds by retail investors. He invited participants to comment on the problems that arise when applying a bail-in to senior or subordinated debt held by retail investors, noting that the natural reaction of an authority is to require more MREL, replacing liabilities that are not easily bail-inable.
The industry representative replied that the question of who holds a given liability is a very different one to the question of whether a given liability is bail-inable or eligible for MREL, and the two should not be confused. There exist very strict rules about the suitability of particular investments for particular classes of investors, as well as on the transparency of investment advice provided and more will be introduced soon. This is the regulation that should be used to address any potential problems of mis selling, rather than through regulation about what is bail-inable or what is eligible for MREL. This would be trying to solve the same problem twice, which has occurred in the past and may create other problems, more difficult to solve, creating conflict among different pieces of regulation.
There is clearly a need for a transition period: if some debt instruments are currently held by retail investors, some time needs to be allowed for these to be moved out of those portfolios. There is also regulation about suitability, which ought to be respected; however, the industry representative did not believe that a distinction should be made between whether a given bond that is bail-inable is held by a retail investor or not. A situation whereby, if that retail investor then sold the bond back to a professional, it became bail inable again, would be unmanageable for both banks and for the resolution authorities. If something is eligible for bail in, it should be bailed in, and if there has been a problem of mis selling, that needs to be dealt with through the mis selling regulations.
The industry representative clarified that they would never suggest distinguishing between retail and institutional investors in relation to the question of what is bail inable. However, he recognises the political challenge, and had been trying to make the point that this challenge cannot be resolved within the resolution or precautionary recapitalisation frameworks. There need to be other solutions, potentially advanced on a national basis, to resolve this challenge.
A representative of a public authority stated that this is a suitability question. Retail investors hold bank equity, and there is no dispute that bank equity can be burnt, so it seems that there should be no special provision made regarding where an investor sits in the credit hierarchy. If they are in the right place in this hierarchy, in terms of absorbing losses, then they should absorb losses; products need to be sold in such a way that investors understand this. Therefore, requirements on information policies, e.g. the layout and content of sales brochures, is much more important than questioning the bail-in or MREL eligibility of instruments.
2.3 Other issues related to holders of TLAC or MREL instruments
According to this public decision maker, the Basel framework contains a restriction on how much of the TLAC instruments issued by other international banks a bank can hold, which is important; the speaker’s institution has been ‘slightly disappointed’ by the dilution of this in the European Commission’s proposal, and feels this could create a situation in which a resolution authority steps back from a bail in, because doing so will transmit the loss to a number of other banks within the system.
More precisely, according to this member of the panel, the CRR is inconsistent with an important Basel standard linked to TLAC. This requires a bank buying a GSIB’s TLAC to deduct this from its own TLAC eligible instruments, reducing the risk of contagion if a GSIB enters resolution. The CRR proposal falls short of this in two respects. First, the rule only applies to GSIBs, permitting other banks to buy these instruments. Second, it is less penal, requiring a GSIB to deduct a holding of TLAC from its own TLAC rather than its capital. This reduces the disincentive the standard is designed to address is inconsistent with the level-playing field Basel standards are intended to accomplish.
From the perspective of holders, that is a bigger issue in terms of putting the right framework in place and dealing with historical legacy issues around how instruments have been sold to retail investors, and a transitional approach should be taken, putting a credible MREL stack in place that can be worked through in some way.
2.4 Should the implementation of the EU crisis management framework be postponed?
The word ‘transition’ has been used multiple times, but the Chair noted that it is understood in the same way by all stakeholders.. In the case of TLAC or global systemic institutions, there is a stricter deadline to comply with that requirement; in theory, with the other entities, compliance can be requested within two, three, or four years. Some people might argue that there seems to be a desire to prolong a bail-out regime instead of introducing burden sharing within a reasonable timeline.
A public authority representative replied that what is important is that resolvability is not binary, although it is often presented that way. Some people present the issue of transition as if until the transition is complete, the situation is hopeless. This is not the case; rather, the goal is to not impose on banks too high MREL requirements, which might trigger adverse consequences in relation to the availability of credit within the economy, and macroprudential costs arising from that.
The big banks, and certainly the G-SIBs and big UK banks, have historically had lots of long term debt in their business models. This has sat pari passu with liabilities which make it very difficult to impose a loss on them in resolution without incurring ‘no creditor worse off’ costs. The goal, therefore, needs to be an orderly replacement of that senior debt with instruments which are subordinated, whereby it is clear to investors that if the firm fails, after the capital instruments, they will be the next to bear loss. This orderly process is taking place; since the TLAC term sheet was agreed, there has been about $400 billion of TLAC instruments issued over the last two years.
Loss absorbency in the large UK banks is now between 22% and 23% of risk weighted assets. The speaker’s institution expects these to have MRELs of 28%, and believes it will take them four to five years to replace it, as their senior debt matures; this is the way that transition should be considered. The majority of large banks, certainly those represented on the panel, already have long term debt within their funding models; the goal should be an orderly replacement of that long term debt in the senior class with subordinated instruments. As such, the public authority representative has some sympathy with the point that has been made about confusion regarding the route to subordination, because this could stand in the way of making progress towards that goal.
3. Operationalising the bail-in tool
A public authority representative stated that there has been discussion of a transition period, but there are no transition periods for the resolution authorities, because they have to be ready to face a crisis in all circumstances. These authorities have to implement the tools and the powers that have been given by the EU regulation. One of those powers is the bail in tool, which needs to be implemented in a practical fashion; there is now some quite comprehensive regulation, and implementation of it must take into account all technical considerations.
The bail in tool allows the authorities to write down the liabilities of a failing bank or convert them into equity, should its failure pose a significant risk to financial stability. This requires a lot of conditions for its implementation. First, some safeguards need to be taken into account; for instance, the principle that no creditor should lose more in resolution than in liquidation is a very important safeguard. Another is the equality of treatment of creditors with the pari passu rules, which should allow for the possibility of excluding some liabilities in very exceptional circumstances, and there is also the independent valuation of assets and liabilities when using the bail in tool.
There are two kinds of problems and operational changes: the first is that the regulation implies multiple stakeholders. The suspension of the listing of existing securities in multiple jurisdictions may be very difficult and challenging for large, international banks, because the regulations are different. It also implies several authorities. A number of practical issues need to be considered: delisting the bailed-in securities, listing newly issued shares with a multiple jurisdiction issue, the implementation of the conversion and the write down – i.e. how to identify[ the bond holders – and whether the conversion can be compared to an exchange from an operational point of view. Other issues include disclosure in the cross-border context, with several different applicable requirements; co-ordination with custodians and with financial market infrastructures; and the right to compensation, including whether some titles can be used. There are some certificates of entitlements in the UK, and there are other forms of recognition of these rights in the Netherlands and the USA. There is a need to be very precise and very practical on these issues, and legal challenges need to be considered.
All parties need to work in an international framework. There is the issue of mature recognition by non-European countries, and there will be a court challenge in every instance where the bail in is employed. Executing the bail-in will combine efforts from resolution and market authorities, banks and market infrastructure, especially in the cross-border context and with the multiplicity of stakeholders. This has been taken into consideration in a very practical fashion at international level; the FSB is working on these aspects, as well as other practical aspects, including control, funding and resolution, and continuity of access to financial market infrastructure. The FSB has begun to work with the industry and the capital market authority to implement these, and to understand how to do so; however, this is very challenging, and there is a lot of work to do.
4. Shaping the MREL framework is challenging
When the resolution authority has to set the MREL target, there are different goals: the first is to achieve a sufficiently predictable outcome for this target, but this has to be weighed against consideration of bank specific adjustments for this target. The Chair invited a representative of a public authority to comment on how much discretion should be given to the resolution authority setting this MREL target.
The public authority representative replied that this is a very relevant issue. A lot of important elements have been mentioned and discussed, but the framework is completely different if the issue is G-SIBs, or institutions that internationally fall more or less under the framework of the TLAC recommendations and requirements. This is a context that requires a lot of details and caveats, but it can work.
The category of Other Systemically Important Institutions – ‘O SIIs’ – nevertheless contains a large variety of banks, and a lot of disparity in terms of business models. Within this type of scope, there is a difficulty relating to what can actually be demanded in terms of bail inables and minimum bail inables: the goal is to make resolution of a bank feasible without triggering systemic impacts. When a bank is asked to sell a certain amount of pre-defined bail inables under these specific circumstances, when these institutions have also been asked to have a more stable capital basis and there is no common solution for the low level of profitability in the industry, this may create problems rather than solving them; ‘the remedy kills the patient’.
As such, it is essential for solutions to be carefully fine-tuned, and to achieve this, it is important to have the kind of debate that the panel has had. There needs to be a decision as to whether a mechanical or horizontal demand or requirement is going to be set; if this is a Pillar 1 type requirement, it needs to be clear what will happen if this is violated. The continued debate is destabilising the market. The solution will need to be fine-tuned very carefully; the public authority representative noted that the initial concept was of an idiosyncratic approach, defined on the basis of the resolution model for each bank.
Flexibility in relation to the second layer of banks should be completely guaranteed, because Europe is again sailing in ‘uncharted waters’. The speaker’s concern is principally in relation to the second set of banks, and there needs to be a distinction between sets in relation to the combination of pari passu and the costs that can arise from a ‘no creditors worse off’ requirement, such as when there is a need to avoid bail inable deposits on top of the covered ones of the €100,000. These are issues that become systemic very easily, and it is very important to fine tune this regulation properly.
An industry representative responded that although they understand the difficulties faced by small and medium size banks, when a player chooses to enter the financial markets, they are required to respect some rules. During the 2008 crisis, and in the years after, a lot of small and medium sized banks failed. The speaker would recommend that the MREL should be as strict for small and medium sized banks as it is for the G-SIBs. Regulators in the European Parliament could allow for a longer transition period, but should also make clear that in 10 to 15 years’ time, every participant in the financial markets should respect the rules that have been agreed, and if they do not then they should not receive aid. If a country’s financial system has more middle sized banks than large ones, and therefore less protection, this constitutes a danger for the Banking Union.
The public authority representative noted that he could understand the previous speaker’s argument in principle. He added that they had not been differentiating between big and small banks, but between G SIBs and others; the distinction is not only based on size, but rather on the business model and other proxies for riskiness.
Another industry representative stated that it is correct to say that MREL setting should not depend on the label that a bank has, whether this is G-SIB, O-SII, or D-SIB. The MREL needs to be a function of the resolution that is going to be applied to that bank. Regarding liquidity, a large number of banks in Europe will need no loss absorbency in resolution, because they will be put into insolvency and deposits will be paid out. In the context of banking union, this is the role of EDIS.
This is an issue of time, as a previous speaker has said. However, where banks – whatever their business model – are providing critical economic functions that cannot be interrupted, for the sake of financial stability or depositor confidence in the market, and Europe expects to apply a bail in strategy to those banks, they need sufficient and adequate MREL consistent with that strategy. Although the BRRD currently says that an entity can count senior liabilities over one year towards MREL, if those senior liabilities are sitting pari passu with a large stock of deposits, derivative counterparties, or trade creditors, which if they were in some way interrupted would have systemic consequences, then that MREL is not credible.
Some banks that have a more deposit based funding model will face a challenge, and this will need to adapt to ensure that the liabilities there can be resolvable. Rather than compromising the end goal of having adequately resolvable banks, this should be addressed via the time period in which this MREL build up takes place. There are risks in the meantime, but this is nevertheless the best path to follow, and it is the one that the UK has opted for.
The public authority representative stated that saying that the solution is insolvency is an oversimplification. In the case of a deposit taking bank, adopting the principle that creditors pay means saying that all depositors above €100,000 will face the loss; she asked whether this can seriously be carried into practice. There are already problems with senior debt, or even junior debt, having been mis sold to customers, and she does not believe that a proposal whereby depositors in a small, traditional entity will be bailed in, with no backstop and no mechanism, to even use the deposit guarantee for the transfer of deposits from one failing bank to the healthy one (given that DG Comp considers DGS as public aid) being considered public aid, is feasible. Taxpayers will ultimately end up shouldering this burden.
The second industry representative replied that this was not their argument. The Chair added that they would prefer not to change the regulations; rather, they would prefer to apply them.
Another participant observed that a new piece of regulation is under discussion at present: BRRD II. Yesterday, there was a discussion about proportionality; from the perspective of an O-SII, BRRD II is very proportionate, and will hopefully go through the European Parliament.
The debate is about how to meet the requirement, because whatever the law says, governments are going to bail-in depositors. This is an ‘absurd’ situation, where the question is how to meet the requirement, rather than dealing with what the level of the requirement should be, and there appear to be some people who consider this issue to be a “fait accompli” and that Europe is saying what recapitalisation is going to be. BRRD II is worth reading; it contains some good aspects, and the participant thanked the Commission for the good work that they have done on BRRD II, and hopes that it will be fully taken into account in the discussions that take place during 2017.
There will be limitations of the capacity to absorb eligible debt. Countries that already have legislation in place will have the advantage of going first, and the overall impact is going to be much higher for banks like the participant’s, because they fund themselves through customer deposits and covered bonds. This bank will need to deal with a massive and costly issuance of additional debt, which the participant does not believe will be good for the economy. A balance must be struck in relation to the level of MREL. The participant added that he is very concerned about suggestions that O-SIIs should be treated like G-SIBs, and that TLAC should be automatically applied to them, given the effect that this is likely to have on his profitability and ability to do business.
5. Pre positioning of internal MREL raise concerns in the banking sectors
5.1. The Banking Union should be treated as a single jurisdiction, and therefore internal MREL should not be required for cross border banks of the euro area
The Chair noted that one of the industry representatives’ institutions has a single point of entry strategy, with a centralised funding policy and risk management, but is also a competitive group with a solidarity mechanism. They asked this representative to give their views on the debate around internal MREL.
The industry representative replied that internal MREL aims at ensuring a minimum recapitalisation capacity at the level of material entities which are located outside the resolution entity’s home jurisdiction to facilitate cooperation between home and host resolution authorities. A mechanism for loss allocation within banking groups is needed to facilitate resolution and even more so within cross-border groups. However, flexibility is needed regarding its calibration and level of application. However, at the Banking Union level, he stated that it would only be logical that no internal MREL be required. The Banking Union should be treated as a single jurisdiction, and the speaker’s institution regrets that it is not.
The representative’s institution, like the other banks within the Banking Union, falls under a single supervisory mechanism and a single resolution mechanism. It is a bank with a single point of entry strategy; it has centralised risk, and is also a co-operative bank, with a very strong financial solidarity mechanism between the affiliates that allows for a very easy flow of capital and liquidity between them. As such, this institution is ‘surprised’ when internal MREL within the Banking Union is required, but at the present time, the Banking Union has probably not developed far enough. Another industry representative added that within the Banking Union, within a single jurisdiction, cross-border banks or large banks are well aware of how to flow capital and liquidity to the greatest possible extent.
The first industry representative added that, beyond the Banking Union, the calibration of the internal requirement should, as provided by the FSB, be limited to material subgroups and capped by an explicit limit. This would contribute to the effectiveness of MREL as it would enhance legal certainty, facilitate agreement between home and host authorities within resolution colleges and ensure a level playing field with non-EU jurisdictions.
This view was not agreed by several other participants, on the grounds that at the present junction, the Banking Union does not provide the instruments to guarantee that this strategy will not end up triggering important systemic impacts for the host Member state economy.
5.2. Internal MREL: a necessary element of a single point of entry resolution strategy
Regarding internal MREL, a representative of a public authority stated that internal MREL performs two functions: the first is to underpin cross border co operation for international banks, and the second is the mechanism by which losses are transmitted in a reliable fashion from the operating companies where they arise to the resolution entity at the top of the group. Not all banks have solidarity mechanisms in place to perform that type of function. Internal MREL is often portrayed as a ‘terrible imposition’, creating boundaries within the Banking Union area or between Banking Union and other EU countries. Rather, in the view of the speaker’s institution, it is a necessary element of a single point of entry resolution strategy to articulate how the losses get to the resolution entity, and the bail-in occurs not only for cross-border subsidiaries and operating companies but also for domestic subsidiaries. It is also important that holders of operating liabilities in those operating companies can take comfort from the availability of internal MREL.
The UK is fortunate: it is able to put all of its MREL in place through structural subordination and external issuance out of holding companies. The speaker’s institution regards it as very important, in terms of the credibility of their resolution, that when a liability holder, depositor, bank counterparty, or derivatives counterparty in the operating company is facing off to that operating company, they can take comfort from knowing that in a resolution, their liability is not just supported by the capital, but also by internal MREL. As such, although the US has told the speaker’s institution that they have to put 90% internal MREL into Barclays IHC in New York, they will also have an internal MREL requirement for Barclays Bank plc in the UK.
5.3. Internal MREL requirements for subsidiaries of non EU banks should reflect their specific characteristics
An industry representative of a non-EU-headquartered G-SIB highlighted regarding the question of the internal MREL the need for flexibility of risk-adjusted requirements.
Their institution feels that there could be room for adjustment in the internal MREL requirement for non EU headquartered G-SIIs. Currently, the requirement would fix internal MREL for material subsidiaries of non EU G-SIIs at 90% of the external TLAC, which is the top end of the range of 75% to 90% defined by the FSB. This institution would advocate moving back towards the 75% to 90% range, and then setting the internal MREL requirement for G-SIIs according to the institution’s risk profile and the business model via which it undertakes activities in Europe. This should be set by the host or resolution authorities and coordinated through the crisis management group, which the institution regards as an important coordination mechanism that should be further strengthened.
6. The treatment of MREL breaches
In respect of MREL breaches, an industry representative noted that the Commission’s paper triggers automatic MDA restrictions if MREL is not respected, which is a major mistake. Debt is not the same as capital; it has to be paid back, refinanced and reissued, and so there can arise problems respecting the debt portion of MREL for reasons which are market related, rather than linked to the health of the bank.
Regarding the capital portion of MREL, if an entity loses this because it has made losses, it has a capital problem and will have a MDA restriction in any event. If the problem arises from insufficient debt, a MDA restriction would be a ‘wrong punishment’: in certain circumstances, restrictions on distribution might be the right approach to take, but there should be no automaticity, which is the same as the view of the UK authorities. Capital and debt are two different types of liabilities, and cannot be combined.
Another public authority representative agreed with this statement. They do not believe the solution is to dilute MREL by creating a concept of MREL guidance which is ‘neither fish nor fowl’; whereby, if it is breached, there are no consequences. This speaker’s institution’s proposed solution to MREL breaches that are a consequence of problems with debt rollover is that there should be more judgment regarding the application of MDAs, rather than undermining the integrity of the MREL itself.
7. Additional remarks
The Chair asked an industry representative to give their views on whether the proposed harmonisation of the creditor hierarchy is sufficient to deliver a solution across Europe, or whether they should go further in the harmonisation of insolvency laws, at least for banks.
The industry representative replied that insolvency law is not yet sufficiently “Europeanised”, and they would strongly support moving further in that direction. It is very important to improve on the legal framework within which resolution activities are deeply embedded; however, parts of this are fully Europeanised, and others are not. On the national level, many countries have begun serious political efforts to improve their capabilities on enforcement recovery and legal enforcement, which is highly welcome and very important.
Regarding credit hierarchy, this is a very important point, both from a regulatory and an investor point of view. This is one of the components that the speaker would not put at the discretion of a resolution authority. There are various methods of achieving this goal, but the industry representative has sympathy for a mandatory hierarchy approach. This has been introduced in Germany, and has constituted a ‘bold move’, although it has created something of a burden and may face legal impediments in various countries, particularly with respect to the retroactive component of it.
Ultimately, if the EU decides to go for a contractual approach, the price that will have to be paid is a lengthy de facto transitional period. This approach cannot be adopted within two to three years; it will take a very long time. It is an option, but the speaker would prefer for this clarity to be obtained much more quickly.