Market Impact of TLAC Requirements. FIG DCM Bank Capital Solutions

Transcription

1 Market Impact of TLAC Requirements FIG DCM Bank Capital Solutions December 17, 2015

2 RWA vs. SLR Driven TLAC Requirements Fed's SLR driven TLAC requirement is more stringent than FSB TLAC framework 25% 23.5% The Fed s RWA driven minimum TLAC requirements appear to be well aligned with FSB requirements The Fed s leverage ratio driven minimum TLAC (9.5%) materially exceeds FSB requirements (6.75%) The Fed s implied minimum TLAC debt (i.e. 47%) requirement is also more binding than FSB s 33% TLAC debt requirement 20% 15% 10% 5% 23.0% 22.5% 21.5% 10.5% 9.5% 13.0% 12.0% 23% FSB Max 22.0% 21.5% 21.5% 21.5% 21.0% 21.0% 21% FSB Min 18.5% 20.5% 20.5% 20.0% 17.5% 16.5% 9.0% 9.0% 9.0% 8.0% 7.5% 7.0% 11.0% 11.5% 11.5% 10.5% 10.0% 9.5% Key 1 TLAC 0% 10% JPM C BAC WFC MS GS STT BK LTD External LTD requirement (RWA approach 6.0% + GSIB surcharge) 8% 6% 4.5% 4.5% 4.5% 4.5% 4.5% 4.5% 4.5% 4.5% FSB SLR 6.75% Tier 1 Capital Capital Conservation Buffer (2.5% + GSIB surcharge) 1.5% Additional Tier 1 4% 2% 5.0% 5.0% 5.0% 5.0% 5.0% 5.0% 5.0% 5.0% 4.5% CET1 Minimum 0% JPM C BAC WFC MS GS STT BK 1. GSIB surcharge applied to minimum LTD requirement and the capital conservation buffer is based on estimates disclosed with the GSIB capital surcharge final rule in July

3 U.S. G-SIBs Appear to be Well Positioned Proposed rule is fairly benign relative to market expectations We estimate that the US G- SIBs will need $164bn of additional TLAC, $62bn of which is capital shortfall and $102bn of which is due to LTD shortfall Some of the LTD shortfall can be met by refinancing bank level debt with Holdco leading to ~40bn incremental supply Capital & TLAC Shortfall Need ($Bn) 2022 LTD Shortfall LTD Shortfall Additional TLAC Qualifying Capital Shortfall ($Bn) Tier 2 JPM BAC Additional Tier 1 C Common WFC Equity Tier 1 ($Bn) GS MS JPM BAC C WFC GS MS Avg. Annual Sr. Issuance $21.5 $29.0 $20.4 $18.5 $24.2 $19.5 $4.7 $ LTD Need as Multiple 1.3x 0.9x n/a 2.4x n/a n/a n/a 1.2x Sr. Bank Debt Out $52.4 $11.5 $4.8 $18.3 n/a n/a n/a n/a % of 2022 LTD Need 52% 226% n/a 245% n/a n/a n/a n/a 0 BK STT Source: Bloomberg, SNL, Company Filings as of 6/30/15; debt outstanding as of 10/2/ We estimate that 10% TLAC / Leverage Exposure is binding for JPM relative to 16% RWA and for BNY & STT relative to 16 & 18% RWA 2

4 The Canadian D-SIBs Have Excess Wholesale Funding Canadian D-SIBs have excess wholesale funding and regularly access the unsecured funding market globally Given their regular access to the capital markets and upcoming maturity profile, the Canadian banks would be able to meet TLAC needs through refinancing However, the grandfathering of the outstanding senior unsecured has made the situation more complicated Capital Structure & TLAC Need at 16 / 18% RWAs (6.00 / 6.75% SLR) 1 (CAD Bn) Incremental Grandfathered Senior Debt TLAC Required to Reach 18% TLAC Required to Reach 16% Tier 2 Additional Tier 1 Common Equity Tier RBC BNS TD BMO CIBC CCDJ NBC Avg. Annual Sr. Issuance $18.3 $10.8 $8.7 $6.0 $24.5 $3.9 $2.0 18% TLAC Need as Multiple 1.1x 2.6x 3.2x 3.2x 0.4X 1.0x 2.0x Source: Bloomberg, SNL, Company Filings as of 7/31/15; debt outstanding as of 10/23/ We do not anticipate a 6.75% leverage requirement to be binding for any Canadian bank 3

5 Meaningful Uncertainty Remains in Europe For the European banks included in our analysis below, we estimate a total TLAC need at 18% of RWAS to be about 344.5bn The criteria by which debt will qualify for TLAC in Europe will vary from jurisdiction to jurisdiction For example, Deutsche Bank appears to have ample senior unsecured and is in a regime that already has a clear solution CS & UBS, on the other hand, will need to issue HoldCo debt to meet the newly announced 10% leverage requirement for Swiss TLAC Capital Structure & TLAC Need at 16 / 18% RWAs (6.00 / 6.75% SLR) 1 (EUR Bn) TLAC Shortfall 2019 TLAC Shortfall Additional TLAC Qualifying Debt Tier Additional Tier Common Equity Tier HSBC BNP BARC SAN CA DB RBS BPCE UNI BBVA SG STAN CS UBS NDA Avg. Annual Sr. Issuance Shortfall to 18% RWAs Source: Bloomberg, SNL, Company Filings as of 6/30/15; debt outstanding as of 10/23/ We estimate that the 6.75% leverage requirement is binding vs. 18% for BARC, and the 10% requirement is binding vs. both 16 and 18% for CS and UBS. 2. Hatch pattern represents senior debt of banks / in jurisdictions where the treatment is uncertain. 4

6 Spread Moves in U.S. Bank Senior We observed a modest 5 to 15 bps of relative widen in US Senior Holdco Spreads US$ domestic market (Spread to Treasury) Euro market (Spread to Swap) 170 Pre-TLAC Jan Aug 2014 JPM/ PNC Spread= 0-10bps FSB to Fed Proposal Sep 14 Sep 15 JPM./ PNC Spread= 15-25bps Post Fed -NPR Oct-Dec 15 JPM./ PNC 5-15bps Pre-TLAC Jan Aug 2014 GS /JPM Spread= 35-45bps FSB to Fed Proposal Sep 14 -Sep15 GS/JPM Spread= 15-35ps Post Fed - NPR Oct-Dec 15 GS/JPM =25-35ps FSB Proposal Nov 10, 2014 JPM./ PNC= 10bps 12/8/2015 JPM/PNC = 5bps FSB Proposal Nov 10, 2014 GS /JPM=35bps Fed -NPR Oct-Dec 15 GS/JPM ~30bps Fed NPR Oct 30 JPM./ PNC= 15bps /82015 GS./ JPM 30ps Jan-14 Feb-14 Mar-14 Apr-14 May-14 Jun-14 Jul-14 Aug-14 Sep-14 Oct-14 Nov-14 Dec-14 Jan-15 Feb-15 Mar-15 Apr-15 May-15 Jun-15 Jul-15 Aug-15 Sep-15 Oct-15 Nov-15 Dec Jan-14 Feb-14 Mar-14 Apr-14 May-14 Jun-14 Jul-14 Aug-14 Sep-14 Oct-14 Nov-14 Dec-14 Jan-15 Feb-15 Mar-15 Apr-15 May-15 Jun-15 Jul-15 Aug-15 Sep-15 Oct-15 Nov-15 Dec-15 JPM Sep-22 PNC Nov-22 GS Feb-23 JPM Feb-23 Source: Bloomberg Source: Bloomberg 5

7 Spreads moves in German bank Senior Confirmation of Bail-in risk has seen German senior spreads widen by 28 to 34bps on a relative basis US$ domestic market (Spread to Treasury) Euro market (Spread to Swap) Mar: German Draft Law DB / Rabobank Spread = 7bps Mar: German Draft Law DB / Rabobank Spread = -11bps Current 70 Current DB / Rabobank Spread = 23bps 100 DB / Rabobank Spread = 35bps Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov DB Feb-19 RABOBK Jan-19 DB Jan-23 RABOBK May-23 Source: Bloomberg Source: Bloomberg 6

8 Impact of NPR on Issuance Volume November and December GSIB Senior Holdco issuance has been impacted by the Fed's NPR The Fed's NPR provided the market with clarity on the total amount of required TLAC and LTD Monthly Senior HoldCo Issuance % 25.0% However, the qualification criteria (no cross-defaults, must be governed by U.S. law, etc.) have left issuers with meaningful questions on whether currently outstanding and interimissued debt will qualify or be grandfathered 20.0% 15.0% 10.0% 5.0% Nov and Dec made up 5.6% of supply in 2015 vs. 10.5% and 8.5% in 2013 and 2014, respectively This has resulted in less supply from GSIBs since the NPR 0.0% Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec GSIB Senior HoldCo Issuance Since November 2015 Issue Date Issuer Ranking Rating Coupon (%) Size ($mm) Maturity Date BANK OF NY MELLON 11/19/2015 CORP Senior HC A1/A /27/ /30/2015 WELLS FARGO & COMPANY Senior HC A2/A /7/ /30/2015 WELLS FARGO & COMPANY Senior HC A2/A /7/ /1/2015 CITIGROUP INC Senior HC Baa1e/BBB /7/ /1/2015 CITIGROUP INC Senior HC A3/BBB /7/2018 7

9 This presentation has been prepared by UBS Securities LLC ( UBS ) for the exclusive use of the party to whom UBS delivers this presentation (together with its subsidiaries and affiliates, the Client ) using information provided by the Client and other publicly available information. UBS has not independently verified the information contained herein, nor does UBS make any representation or warranty, either express or implied, as to the accuracy, completeness or reliability of the information contained in this presentation. Any estimates or projections as to events that may occur in the future (including projections of revenue, expense, net income and stock performance) are based upon the best judgment of UBS from the information provided by the Client and other publicly available information as of the date of this presentation. There is no guarantee that any of these estimates or projections will be achieved. Actual results will vary from the projections and such variations may be material. Nothing contained herein is, or shall be relied upon as, a promise or representation as to the past or future. UBS expressly disclaims any and all liability relating or resulting from the use of this presentation. This presentation has been prepared solely for informational purposes and is not to be construed as a solicitation or an offer to buy or sell any securities or related financial instruments. The Client should not construe the contents of this presentation as legal, tax, accounting or investment advice or a recommendation. The Client should consult its own counsel, tax and financial advisors as to legal and related matters concerning any transaction described herein. This presentation does not purport to be all-inclusive or to contain all of the information that the Client may require. No investment, divestment or other financial decisions or actions should be based solely on the information in this presentation. This presentation has been prepared on a confidential basis solely for the use and benefit of the Client; provided that the Client and any of its employees, representatives, or other agents may disclose to any and all persons, without limitation of any kind, the tax treatment and tax structure of the transaction and all materials of any kind (including opinions or other tax analyses) that are provided to the Client relating to such tax treatment and tax structure. Distribution of this presentation to any person other than the Client and those persons retained to advise the Client, who agree to maintain the confidentiality of this material and be bound by the limitations outlined herein, is unauthorized. This material must not be copied, reproduced, distributed or passed to others at any time without the prior written consent of UBS. 8

10 The FSB Final TLAC Principles and the Federal Reserve Board s LTD, TLAC and Clean Holding Company Proposal December 2015 NY

11 Objective of TLAC Where does TLAC fit in? For Basel purposes, a bank must satisfy the minimum regulatory capital requirements In addition to the minimum regulatory capital requirements, banks are subject to the capital conservation buffer and any applicable counter-cyclical capital buffer In addition to that, G-SIBs must have buffer capital or a G-SIB surcharge Finally, G-SIBs must meet TLAC requirements TLAC is intended to prevent a bank failure TLAC would be relied upon to provide additional loss absorbency and facilitate resolution 2

12 Where does TLAC fit in? 3

13 The Financial Stability Board Principles 4

14 A timeline Financial Stability Board Proposal for Comment was issued in November 2014 Comment period closed in February 2015 FSB conducted a quantitative impact study (QIS) in which it collected information from G-SIBs The final TLAC principles were released on November 9,

15 The FSB Principles-overview Designed to facilitate orderly resolution of G-SIBs 30 banks globally Includes 8 US banks Calibration of minimum TLAC from January 1, 2019 of 16% of risk weighted assets (RWAs) rising to 18% from January 1, 2022 and from January 1, 2019, 6% of the Basel III leverage ratio denominator and from January 1, 2022, rising to 6.75% of the Basel III leverage ratio denominator Phased in requirements for GSIBs headquartered in emerging markets Tier 1 and Tier 2 Capital is eligible Other eligible TLAC that is not regulatory capital Additional TLAC may be required for individual G-SIBs based on risk factors Two elements: Risk-weighted TLAC ratio and a TLAC leverage ratio 6

16 Regulatory capital instruments TLAC and regulatory capital instruments The sum of a G-SIB s resolution entity s (1) T1 and T2 regulatory capital instruments that are in the form of debt, plus (2) other eligible TLAC that is not regulatory capital, is equal to or greater than 33% of the G-SIB s minimum TLAC requirement Regulatory capital instruments may count toward minimum TLAC requirement, subject to certain conditions: CET1 regulatory capital instruments used to satisfy minimum TLAC requirement cannot also be used to satisfy capital buffers Non-CET1 regulatory capital instruments must be issued under the laws of a jurisdiction in which resolution tools, statutory write-down or conversion powers are effective Non-CET1 regulatory capital instruments issued by subsidiaries of the resolution entity, that are located in a different jurisdiction from the resolution entity, must be capable of being written down or converted to equity at the point of non-viability of the subsidiary without the subsidiary having to enter into a resolution proceeding 7

17 Regulatory capital instruments (cont d) Regulatory capital instruments issued from entities forming part of a material subgroup may count toward minimum TLAC only to the extent that home and host country authorities agree conversion to equity would not result in a change-ofcontrol 8

18 TLAC Eligibility Criteria TLAC Eligibility Criteria: External TLAC must be issued and maintained by resolution entities (except, in some circumstances, regulatory capital issued by wholly and directly-owned funding entity will be eligible) Paid-in Unsecured Not subject to netting Perpetual or minimum remaining contractual maturity of one year (for any security with a redemption feature, first redemption date would be effective maturity date; maturing instruments would need to be replaced with new TLAC-eligible instruments) Subject to certain limited exceptions, not funded directly by the resolution entity or a related party of the resolution entity Eligible TLAC must contain a contractual trigger or be subject to a statutory mechanism which permits the resolution authority to write down or convert to equity 9

19 TLAC Eligibility Criteria (cont d) Excludes Insured deposits, sight deposits and deposits with original maturity of less than 1 year Liabilities funded by the resolution entity or a related party (possible exception for parent-funded TLAC in some circumstances where a multiple point of entry resolution strategy applies) Liabilities arising from derivatives or debt instruments with derivative-linked features e.g., structured notes Non-contractual liabilities, such as tax liabilities Preferred liabilities Other liabilities that cannot be written down or converted to equity by resolution authorities without giving rise to material risk of successful legal challenge/valid compensation claim 10

20 TLAC Eligibility Priority: in order to ensure that TLAC instruments absorb losses prior to liabilities excluded from TLAC, TLAC eligible instruments generally must be: Contractually subordinated; Statutorily subordinated; or Structurally subordinated Redemption: eligible external TLAC instruments cannot be redeemed without supervisory approval, unless G-SIB would still be in compliance with TLAC requirements thereafter Deductions: a G-SIB must deduct from TLAC any holdings of third-party G- SIB TLAC instruments (to avoid contagion risk) 11

21 TLAC Eligibility (cont d) Liabilities that are not TLAC eligible may still remain subject to potential bail-in under the European BRRD 12

22 TLAC Eligibility (cont d) Treatment of debt issued by subsidiaries: Prior to January 1, 2022, debt liabilities issued by a wholly and directly owned funding entity of the resolution entity may count for external TLAC purposes, provided that: The issuance is consistent with paragraph 65 of the Basel III framework (requires a finance company issuance), including that the assets of the funding entity must meet the eligibility criteria for TLAC instruments; There is substantial legal certainty that the TLAC will absorb losses at the resolution entity in its resolution; and Home and host authorities agreed on issuance through funding entity. Term sheet also provides for a phase-out from eligible TLAC of regulatory capital instruments issued from subsidiaries within the resolution group and held by third parties, except where the instrument constitutes CET1. 13

23 Internal TLAC Resolution entity must have External TLAC as discussed Material sub-groups in jurisdictions outside of bank s home country must have Internal TLAC Each material sub-group must have 75-90% of the external TLAC that would be required of the material sub-group, if it were a resolution group For this purpose, a material sub-group is one whose members are incorporated in the same jurisdiction (other than the jurisdiction of the resolution entity) and are not themselves resolution entities, do not form part of another material sub-group of the resolution group and that: (i) has more than 5% of consolidated RWAs of the G-SIB group; (2) generates more than 5% of total operating income of the G- SIB group; (3) has total leverage exposures that are more than 5% of the G-SIB group s total leverage exposure; or (4) has been identified as material to the firm s critical functions 14

24 Internal TLAC (cont d) Internal TLAC: Loss-absorbing capacity at material subsidiaries of a resolution entity, which subsidiaries are incorporated outside of the resolution entity s home country intended to facilitate resolution within the host country Minimum size of internal TLAC: each material sub-group must maintain internal TLAC of 75% to 90% of the external minimum TLAC that would apply to the material sub-group if it were a resolution group, as calculated by the host country. In addition to the minimum, the host country could impose a firm-specific requirement as well. Internal TLAC should be pre-positioned on-balance sheet at the material subgroups; internal TLAC that is not pre-positioned should be readily available Substitution: home/host countries may agree jointly to substitute on-balance sheet internal TLAC with TLAC in the form of collateralized guarantees subject to certain conditions Eligibility Criteria: criteria for internal TLAC and for external TLAC are the same 15

25 Implementation of FSB Principles How will FSB principles be implemented? Each jurisdiction must enact regulations that implement the principles In Europe, the BRRD establishes a minimum required eligible liabilities (MREL) requirement (applies more broadly than the FSB principles) Differences exist between MREL and TLAC: MREL applies from January MREL applies to all European banks, not just GSIBs MREL levels are decided by each national resolution authority on a case-by-case basis for their banks MREL eligibility requirements differ in some respects from TLAC (e.g. no requirement for MREL subordination to excluded liabilities) 16

26 Implementation of FSB Principles (cont d) MREL levels set by reference to own funds and liabilities i.e. non-risk-weighted Reconciliation likely to be achieved by level of discretion given to national resolution authorities, by requirements to have regard to issues such as the risk of exclusion from bail-in of otherwise eligible liabilities and express ability in draft final RTS of EBA for resolution authorities to consider RWA-based capital requirements and leverage ratio requirements in setting MREL as a percentage of own funds and liabilities 17

27 FRB Proposal 18

28 Single point of entry resolution 19

29 FRB proposal The FRB released its proposal on October 30, 2015 which would establish for covered BHCs and covered IHCs an external TLAC requirement in the case of covered BHCs (and an internal TLAC requirement in the case of covered IHCs), a related TLAC buffer, a minimum long-term debt requirement for covered BHCs (and a minimum internal long-term debt requirement for covered IHCs), and a clean holding company requirement Premised on the view that TLAC alone is not sufficient to facilitate SPOE resolution As a result, the FRB approach differs from the FSB approach In addition, to avoid contagion risk, the FRB proposal also would penalize banks generally for holding unsecured debt of a covered BHC 20

30 FRB proposal (cont d) U.S. covered BHCs must maintain: Outstanding eligible external long-term debt equal to the greater of: (i) 6% of RWAs, plus the applicable G-SIB buffer, and (ii) 4.5% of total leverage exposure, plus Outstanding eligible external TLAC equal to the greater of: (i) 18% of RWAs (when fully phased-in), and (ii) 9.5% of total leverage exposure An external TLAC buffer 21

31 External long-term debt What is eligible external long-term debt? Debt securities issued directly by the covered BHC that: Are unsecured Are plain vanilla Are governed by U.S. law Have a remaining maturity of over one year Eligible external long-term debt with a maturity of less than two years would be subject to a 50% haircut What is plain vanilla debt? The debt cannot contain an embedded derivative, have a credit sensitive feature, contain any contractual conversion or exchange features, or include acceleration rights, other than on payment defaults No structured notes 22

32 External TLAC What is eligible external TLAC? The sum of (1) common equity Tier 1 capital and AT1 capital issued by the covered BHC, and (2) eligible external LTD What is the amount of the external TLAC buffer? An external TLAC buffer is added on top of the 18% risk-based capital component of the external TLAC requirement, which can be met only with common equity Tier 1 capital Equals the sum of 2.5%, any applicable countercyclical capital buffer, and the G- SIB surcharge calculated under Method 1 What is the consequence of failing to meet the external TLAC buffer requirement? Restrictions on distributions and discretionary bonuses (similar to CCB) 23

33 IHCs of Foreign G-SIBs A covered IHC would be subject to an internal LTD and an internal TLAC requirement FBOs with consolidated global assets of $50 billion or more and consolidated U.S. assets of $10 billion or more must establish an IHC The following are G-SIBs with an IHC requirement (based on FSB s 11/2015 G-SIB list): HSBC BNP Mitsubishi Deutsche Barclays RBS Mizuho SocGen Santander UBS Credit Suisse 24

34 IHCs of Foreign G-SIBs (cont d) What is the internal LTD requirement? Internal LTD will at least equal the greater of (i) 7% of RWAs, (ii) for covered IHCs subject to the Supplementary Leverage Ratio, 3% of total leverage exposure, and (iii) 4% of average total consolidated assets What is the internal TLAC requirement? The internal TLAC requirement depends on whether the foreign G-SIB parent of the covered IHC will undergo SPOE or Multiple Point of Entry (MPOE) resolution For SPOE, IHC would be required to keep outstanding eligible internal TLAC at least equal to the greater of: (i) 16% of RWAs (when fully phased in), (ii) for covered IHCs subject to the SLR, 6% of total leverage exposure, and (iii) 8% of average total consolidated assets For MPOE, IHC would be required to keep outstanding eligible internal TLAC at least equal to the greater of: (i) 18% of the RWAs (when fully phased in), (ii) for covered IHCs subject to the SLR, 6.75% of total leverage exposure, and (iii) 9% of average total consolidated assets 25

35 Eligible internal LTD What are the requirements for eligible internal LTD? Same general requirements as those applicable to eligible external LTD In addition, eligible internal LTD: Is required to be held by foreign parent Must be contractually subordinated to the covered IHC s third-party liabilities Be required to contain contractual provisions pursuant to which the FRB could cancel the internal LTD or convert it into equity on a going-concern basis (without entering resolution) upon the occurrence of certain conditions 26

36 Eligible internal TLAC What is the required amount of internal TLAC? Eligible internal TLAC equals the sum of (i) common equity Tier 1 capital and AT1 capital issued by the covered IHC to its foreign parent, and (ii) the covered IHC s eligible external LTD With respect to the RWA component of the internal TLAC requirement, an internal TLAC buffer would apply on top of the 16 or 18% risk-based capital component that could be met solely with common equity Tier 1 capital in an amount equal to the sum of 2.5% and any applicable countercyclical capital buffer (equal to the existing capital conversation buffer now applicable to IHCs under the capital rules) 27

37 Foreign banks Foreign (non-u.s.) banks that are G-SIBs and that are required to establish IHCs will need to focus on both the FSB and the FRB requirements Depending on their organizational structure and how these FBOs have been funding themselves in the United States, compliance with both the FSB and the FRB requirements will create added complexity It is possible that other jurisdictions will apply the final FSB TLAC requirements to their domestic systemically important banks (D-SIBs) (entities that are not G-SIBs); there already are proposals to this effect in Canada, for example and in Europe the MREL provisions apply to all European banks. 28

38 Clean Holding Company What is the clean holding company requirement? The proposal sets out a clean holding company requirement, which has two parts: First, a covered BHC would be prohibited from Engaging in short-term borrowings, Entering into QFCs, Issuing guarantees of subsidiary liabilities that could create cross-default, setoff or netting rights for creditors of the subsidiary Second, a covered BHC s third-party non-contingent liabilities (other than those related to eligible external TLAC) that are pari passu with or junior to its eligible external LTD to a cap of 5% of the value of its eligible external TLAC The clean holding company requirement applicable to IHCs differs from the requirement applicable to U.S. G-SIBs as it does not provide for the 5% bucket of non-contingent liabilities 29

39 Regulatory capital deduction Banks, savings and loans, and similar entities with total assets of more than $1 billion would suffer from a regulatory capital deduction for any investments in unsecured debt issued by covered BHCs (including eligible external LTD) in excess of certain thresholds 30

40 Timing As proposed, covered BHCs would be required to comply with the external LTD and TLAC requirements by January 1, 2019, but the RWA component of the external TLAC requirement would be phased in with an initial 16% requirement applicable as of January 1, 2019, and the final 18% requirement applicable as of January 1, The clean holding company requirement would be applicable as of January 1, Covered IHCs would be subject to similar effective dates and phaseins. The regulatory capital deduction would become effective as of January 1,

41 Issues arising under FRB Proposal 32

42 Issues arising under FRB proposal During the comment period, we would anticipate that market participants will likely consider whether to seek guidance on certain issues, such as: Structured notes Covenants contained in senior note indentures Survivor s option provisions Guarantees 33

43 Structured note definition A structured note is a debt instrument that: Has a principal amount, redemption amount, or stated maturity that is subject to reduction based on the performance of any asset, entity, index, or embedded derivative or similar embedded feature; Has an embedded derivative or similar embedded feature that is linked to one or more equity securities, commodities, assets, or entities; Does not specify a minimum principal amount due upon acceleration or early termination; or Is not classified as debt under U.S. generally accepted accounting principles. 34

44 Structured note definition (cont d) Definition clearly applies to both principal-protected and non-principal protected structured notes. However, the draft Notice states that: The proposed definition of a structured note is not intended to include non-dollar-denominated instruments or instruments whose interest payments are linked to an interest rate index (for example, a floating-rate note linked to the federal funds rate or to LIBOR) that satisfy the proposed requirements in all other respects. The Proposal defines structured notes so as to avoid capturing debt instruments that pay interest based on the performance of a single index but to otherwise capture all debt instruments that have a principal amount, redemption amount, or stated maturity, that is subject to reduction based on the performance of any asset, entity, index, or embedded derivative or similar embedded feature. 35

45 Structured notes Rate-linked notes are not excluded Although these particular requirements would not apply to structured notes issued by a subsidiary of the BHC that benefits from a parent guarantee, the clean holding company requirements would appear to limit this Therefore, the nature of the guarantee would be critical 36

46 Structured notes (cont d) For rates, it may be useful to obtain clarity regarding the benchmarks The language references LIBOR and Fed Funds as examples Objective is to ensure that rates are readily available, benchmark type rates For a different purpose (23A/B, transactions with affiliates provisions), the FRB references securities that have a ready market ; prices that are quoted routinely these concepts could be applicable to the reference rates 37

47 Structured notes (cont d) These requirements are applicable only at the BHC level, so, they would not be applicable to: structured bank notes or to market-linked CDs Bank notes: there may be a concern about relying on structured bank notes if the minimum denominations are high Market-linked CDs: pricing may be a factor 38

48 Covenants Indentures for most G-SIB issuers would be considered covenant lite Covenants are limited to fundamental matters, such as maintaining corporate existence, remaining financial holding company or bank holding company, maintaining a trustee and paying agent, etc., but do not include any affirmative or negative covenants However, most indentures currently contain a provision that requires acceleration of payment obligations where breaches of covenants are not cured within a specified time period, usually 90 days Under the proposed FRB regulations, the acceleration upon unremedied covenant breach would render a security not eligible as LTD/TLAC; however, it is unlikely that the banking agencies were focused on this fundamental covenants or that these fundamental covenants would be seen as impediments to a resolution 39

49 Survivor s option Many G-SIBs issue retail debt securities or baby bonds that contain a survivor s option (also called a successor s option) that permits acceleration of payment upon the bond holder s passing Usually, the issuer imposes a limit on the amount of debt that will be subject to the survivor s option feature This type of feature is viewed as retail friendly Under the proposed FRB regulations, this type of provision would appear to violate the prohibition against payment acceleration clauses 40

50 Next Steps 41

51 Preparing to comply Covered U.S. G-SIBs and covered IHCs will want to take stock of their outstanding debt securities in order to assess which securities meet the eligibility criteria, which requires: Going back to the indentures (or similar agreements) governing the terms of outstanding debt securities in order to review the applicable default provisions Inquiry would be made as to U.S. issuances, as well as all international offerings Was any debt issued with additional relevant or unusual terms? Supplemental indentures? Identifying which instruments qualify as structured notes (as defined in the FRB proposal), or that otherwise would not qualify as eligible debt securities, such as those with certain acceleration provisions 42

52 Preparing to comply (cont d) Identifying outstanding debt securities that benefit from a BHC guarantee and reviewing the terms of all such guarantees Reviewing governing law for the outstanding debt securities: are securities governed by U.S. law? Reviewing maturities, as well as put/call features that would affect effective maturities 43

53 Preparing to comply (cont d) Amendments On a go forward basis, should the issuer put in place new indentures (for debt securities to be issued in the future)? Can the issuer amend the terms of outstanding notes and issued guarantees? With or without holder consent? Is a liability management exercise required? FRB notice contemplates replacing near eligible debt with eligible debt This could be accomplished through consent solicitations and exchange offers What price would debtholders seek? Consider the cap for certain liabilities that do not meet the criteria for clean holding companies How will a G-SIB use this cap? Assessing liabilities that are not consistent with the clean holding company requirement also will require significant time and effort 44

54 Preparing to comply (cont d) FBOs subject to the IHC requirement likely are already well along the way in formulating their IHC compliance plan Now, they will have to consider the requirements that would be applicable to their IHCs, and how these differ from the requirements to which the foreign parent will be subject to as a result of the FSB TLAC requirement Is foreign bank a SPOE or MPOE institution? Will the IHC be a resolution entity? Which securities qualify for FSB s internal TLAC requirement but not for FRB s internal TLAC requirement? 45

55 Other structuring thoughts Market participants also likely will want to consider new possible approaches to issuance of non-tlac eligible securities, whether through: other issuers within the same group, such as subsidiaries (with or without a guarantee), or third-party issuance (or repackaging ) vehicles to which BHC sells a plain vanilla note 46