Inside this Topic Guide
Basel III (2011) aimed to improve the quality and quantity of bank capital. In the wake of the financial crisis policy makers have shifted their focus to bank resolution. Many countries have undertaken reforms to ensure that authorities have a wide range of legal powers – outside the ordinary corporate insolvency framework - for dealing with the failure of a systemically important financial institution (SIFI). Regulators have also begun to address the levels of loss absorbency (over and above the Basel III requirements) that a SIFI would need in order to contain the potential systemic impact of its failure by using existing liabilities to absorb losses and recapitalise the institution.
This regulatory focus forms part of a wider effort to end the phenomenon of institutions perceived as being "too big to fail". In 2010 the Financial Stability Board (FSB) issued the first calls for globally systemically important banks (G-SIBs) to have higher loss absorbency, publishing recommendations for reducing the moral hazard posed by SIFIs. In 2013 G20 leaders endorsed the idea of developing an internationally coordinated proposal on the adequacy of loss-absorbing capacity in resolution. A year later, in November 2014, the FSB opened its consultation on a proposal for a common international standard on total loss-absorbing capacity (TLAC) for G-SIBs, which can be met either by own funds or by an additional layer of debt that is earmarked for conversion into capital to absorb losses and recapitalise the bank. In November 2015, the FSB published its final TLAC standard for G-SIBs and the Basel Committee on Banking Supervision (BCBS) published its consultation document on its proposed treatment of banks' investment in TLAC, which would apply to all bank subject to BCBS standards, including non-G-SGIBs. The BCBS published its final standard on the treatment of TLAC holdings in October 2016.
At the EU level, the Bank Recovery and Resolution Directive (BRRD) also sets out a framework for all European banks and investment firms (not just GSIBs) to satisfy a minimum requirement for own funds and eligible liabilities (MREL). Although the parameters, scope and requirements of TLAC and MREL differ in a number of ways, both aim to ensure that banks have in place sufficient resources to cover losses and meet recapitalisation needs in a resolution. National resolution authorities or (in relation to certain eurozone banks) the Single Resolution Board will set the levels of MREL for individual banks and investment firms based on assessment criteria set out in regulatory technical standards (RTS) adopted under the BRRD.
In November 2016 the European Commission proposed revisions to the EU Capital Requirements Regulation (CRR) with the objective of establishing harmonised TLAC requirements for EU G-SIBs. Simultaneously, the Commission proposed amendments to the BRRD and the Single Resolution Mechanism (SRM) Regulation in order to align MREL requirements with the TLAC standard, including proposals for revised insolvency rankings to help banks satisfy subordination requirements for TLAC eligibility. The Directive on creditor hierarchy was published in the Official Journal in December 2017. The Directive on loss-absorbing and recapitalisation capacity of credit institutions and investment firms was published in the Official Journal in June 2019.
In December 2016 the Federal Reserve Board adopted a final rule on TLAC for US G-SIBs (and the US operations of non-US GSIBs). The final US rule includes "clean holding company" requirements that prevent US G-SIBs from entering into certain contractual arrangements that might impede orderly resolution.
Other countries have also moved to adopt more stringent gone concern loss absorbency requirements. In particular, Switzerland led the way in October 2015 when the Swiss Federal Council adopted a decision requiring Swiss Globally Systemically Important Banks (G-SIBs) to have significantly higher levels of gone concern loss absorbency by end 2019.
TLAC and MREL compared
|Scope||G-SIBs||EU banks and investment firms|
|Level of application||Resolution entities (external TLAC)
Material sub-groups (internal TLAC)
|Solo and consolidated requirements|
|Minimum level||Pillar 1||Pillar 2 approach (but EBA criteria)|
|Denominator||RWAs and leverage ratio denominator||Own funds + total liabilities|
|Eligible liabilities||Narrow category||Broader e.g. structured notes?|
|Subordination||Mandatory (limited exclusions)||Not mandatory (but may be required)|
|Minimum debt||Yes (33% expectation)||No|
|Implementation||Phase in from 1 Jan 2019 to 1 January 2022 (or 2025-2028 for emerging market G-SIBs)||1 Jan 2016* (EBA review by end 2016)|
|Treatment of investments||Deduction regime under consultation||Not covered|
* EBA draft assessment criteria allow resolution authority to set lower MREL to enable an appropriate transitional period (which should be as short as possible)
|Status:||TLAC: In November 2015, the FSB published its Principles on Loss-absorbing and Recapitalisation Capacity of G-SIBs in Resolution and TLAC Term Sheet, together with feedback on the consultation and the findings of the impact assessment.
On 23 November 2016, the European Commission proposed amendments to the CRR and BRRD, in order to implement TLAC requirements and to amend the MREL regime. RTS relating to MREL entered into force between July and September 2016 and the EBA published its final report on the design and implementation of the MREL regime on 14 December 2016. The Directive on creditor hierarchy was published in the Official Journal in December 2017. The Directive on loss-absorbing and recapitalisation capacity of credit institutions and investment firms was published in the Official Journal in June 2019.
On 15 December 2016, the Federal Reserve Board adopted its final rule on TLAC for US G-SIBs and the US operations of non-US G-SIBs.
In October 2016, the Basel Committee published its final standard on the regulatory capital treatment of banks' investments in instruments comprising TLAC. Inter alia, the standard requires that all banks deduct holdings in TLAC instruments not already included in regulatory capital from their own Tier 2 capital.
|Implementation:||TLAC: Phase-in from 1 January 2019 to 1 January 2022 (or 1 January 2022 to 1 January 2025 for emerging market G-SIBs. In the EU, there is a phased implementation of interim and full TLAC-MREL standards and TLOF subordination requirements for G-SIIs, top-tier banks and other MREL institutions up until 1 January 2024.
Deduction of TLAC Holdings: from 1 January 2019.
MREL: 1 January 2016
Article 55 of the BRRD provides that Member States must require institutions potentially subject to resolution under the BRRD to include contractual clauses recognising the bail-in powers of the relevant EU resolution authority in contracts relating to liabilities governed by the law of a third country (i.e. a non-EU state), subject to limited exceptions. The European Commission has adopted a Delegated Regulation specifying the exceptions from Article 55 and the terms of the required contractual clause. A resolution authority may require an institution to demonstrate that its bail-in powers would be effective in relation to liabilities governed by the law of a third country (having regard to the terms of the relevant contract) before those liabilities can count towards MREL.
The UK's departure from the EU meant that the UK became a third country and liabilities governed by UK law became subject to the same rules as those governed by other third country laws. In March 2021, the SRB confirmed that subject to certain conditions, it would consider liabilities governed by UK law without a contractual bail-in recognition clause as eligible for MREL purposes. This temporary exemption will apply until 28 June 2025.
Both the TLAC and MREL initiatives envisage that qualifying debt should be available to absorb losses and to recapitalise the bank without triggering claims for compensation by holders, which in many cases would effectively require that the debt be subordinated to other claims. Subordination can be effected by structural measures (using debt issued out of a holding company) or by contractual or statutory means. The focus on subordination is causing some EU Member States to consider changes to their insolvency hierarchy to accommodate this layer of debt, including (in some cases) proposals to subordinate existing debt holders.
|Yolanda Azanza (Madrid)||Gioacchino Foti (Milan)|
|Marc Benzler (Frankfurt)||Simon Gleeson (London)|
|Jeff Berman (New York)||Frédérick Lacroix (Paris)|
|Lucio Bonavitacola (Milan)||Paul Landless (Singapore)|
|Andrew Coats (London)||Caroline Meinertz (London)|
|José Manuel Cuenca (Madrid)||Jurgen van der Meer (Amsterdam)|
|Caroline Dawson (London)||Simon Sinclair (London)|
|Paul Deakins (London)|