Efforts by the European Commission to integrate global loss-absorbing rules in Europe in a harmonised way has caused consternation among debt market participants, who fear it could move the goal posts for bank capital requirements once again.
An expert group at the European Commission was meeting in Brussels on Wednesday. It recently circulated a discussion paper setting out options to help align the implementation of the so-called total loss-absorbing capacity (TLAC), a global framework, and minimum requirement for own funds and eligible liabilities (MREL), a European framework.
Market participants fear that the move threatens to plunge banks' loss-absorption requirements back into uncertainty just as they were getting a better hold on what is expected of them. While many expected some sort of input from the Commission, the discussion paper was variously branded by bankers as surprising, radical and hastily put together.
"We were quite shocked by the paper and it seems quite drastic. We hope that it's not the final direction that the EC will take. It's a very controversial paper and will inspire debate," one industry source said. The paper lays out three options. Its preferred route, it seems, would ask major banks to meet a Pillar 1 going concern capital requirement of 6% of risk-weighted assets and a gone concern Pillar 1 requirement of 12% of RWAs by 2022.
MREL would be transformed into an institution-specific Pillar 2 add-on requirement. The Commission suggests that the 12% of gone concern capital could met be with a modified form of Tier 2 debt that mirrors TLAC eligibility requirements. This is well in excess of the current 2% set in the Basel III framework.
That could turn the tables on recent developments in which a number of countries, including Germany and France, proposed to meet loss-absorbing requirements with senior debt using either structural or statutory subordination. "There is a lot of scope to be more flexible. Germany and France have draft laws to that effect and the paper appears to simply ignore the possibilities that other instruments than Tier 2 can be useful," the industry source added.
French and Italian experts were due to present the changes to their insolvency rankings to the expert group on Wednesday, according to an agenda seen by IFR. Whether the Commission might allow a blend of those securities alongside Tier 2 capital remains to be seen. "It doesn't seem to expressly forbid two layers of gone concern capital, so I'm not sure in terms of the mix. But the overarching theme seems to be that opco senior doesn't seem right, so banks reliant on the 3.5% exemption shouldn't rely on that," said one FIG DCM banker.
The TLAC term-sheet capped senior instruments at 3.5% of RWAs. A key concern among debt market players is that a renewed emphasis on Tier 2 capital could lead to a mushrooming in supply that the market could struggle to absorb. It could also prove more costly for banks. But for all their concerns, bankers accept the initiative is in its very early stages and could be watered down. They suggested that the Commission would also need to factor in input from the Single Resolution Board on MREL that is expected later this year.
"It's a bit of a fantasy to go back and rethink some of the basic elements in the Basel framework. I'm not convinced we'll see their integrated approach," said another banker. A spokesperson at the Commission told IFR on Wednesday that it will provide greater clarity on its intended way forward shortly.
"I can confirm we are currently working to explore appropriate ways to transpose the FSB's TLAC standards into European law in a manner that articulates well with existing MREL and capital requirements for banks," she said. Expectations that the goal posts may move again mean banks will hold off before rethinking their capital strategies, the FIG DCM banker said. "But I'm not sure it's going to go away," he added.
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