Today, the Basel Committee on Banking Supervision issued its final standard on the regulatory capital treatment of banking organizations’ holdings of Total Loss Absorbing Capacity (“TLAC”) and related instruments issued by global systemically important banking organizations (“G-SIBs”).  The final standard has important implications for the marketability and liquidity of TLAC and other instruments that G-SIBs are required to issue under standards released by the Financial Stability Board (“FSB”) in November 2015.

The Basel Committee’s final standard requires banking organizations to deduct from their own Tier 2 capital any holdings of TLAC that do not otherwise qualify as regulatory capital for the G-SIB issuer, provided the value of such holdings exceeds certain thresholds discussed below.  (Under Basel III, banking organizations are already required to deduct from their own capital any holdings of instruments that do qualify as regulatory capital for the issuer.)  For these purposes, TLAC includes not only instruments qualifying as external TLAC under the FSB’s standards, but also instruments issued by G-SIBs that rank pari passu with subordinated forms of external TLAC, as well as synthetic investments in external TLAC.

The TLAC deduction is subject to the existing Basel III threshold that applies to banking organizations’ holdings of regulatory capital, and a new threshold that should expand the ability of banking organizations to invest in TLAC without being required to deduct such holdings from their own regulatory capital.  A deduction is only required when the value of a banking organization’s holdings exceeds both thresholds.

  • Existing Basel III threshold. Under Basel III, a banking organization that holds 10 percent or less of the outstanding common shares of a bank issuer (known as a “non-significant investment”) must deduct the value of its holdings of regulatory capital issued by such issuer, to the extent the value of the banking organization’s aggregate non-significant investments in banks exceeds 10 percent of the banking organization’s own common equity Tier 1 capital.  Amounts of regulatory capital held by a banking organization that do not exceed 10 percent of its own common equity Tier 1 capital are risk-weighted instead.  The final standard treats TLAC that does not otherwise qualify as regulatory capital as being equivalent to regulatory capital for purposes of this threshold.
  • New TLAC-specific threshold. Under the new threshold, no deduction is required if the value of a banking organization’s aggregate non-significant investments in TLAC that does not qualify as regulatory capital equals less than 5 percent of the banking organization’s own common equity Tier 1 capital.  Where the investing banking organization is itself a G-SIB, the additional 5 percent threshold may be used only for TLAC holdings in the investor’s trading book that are sold within 30 business days.

As with the existing Basel III deductions for regulatory capital, the final standard includes an exception to its deduction requirements for TLAC held by a banking organization as an underwriting position for five working days or fewer.  Notably, however, the final standard does not adopt an exception for a banking organization’s market making positions in TLAC, which industry commenters had requested the Basel Committee to include.

The final standard will be effective with respect to an investment in an issuer at the same time that the FSB’s minimum TLAC requirements are effective with respect to the issuer.  This means that the final standard will be effective beginning January 1, 2019 for investments in the TLAC of most G-SIBs, but January 1, 2025 for investments in the TLAC of G-SIBs that are headquartered in emerging economies.

By its terms, the Basel Committee’s final standard applies only to internationally active banking organizations.  However, the U.S. regulators may apply deduction requirements more broadly in the United States.  The Board of Governors of the Federal Reserve System (the “Board”) proposed TLAC and long-term debt requirements in the United States in October 2015 that would require any Board-regulated institution subject to regulatory capital requirements to deduct from its capital its investments in any type of unsecured debt issued by a U.S. G-SIB, subject only to the existing Basel III deduction threshold.  While the Board’s proposal would only require deductions from the capital of Board-regulated institutions, including state member banks, bank holding companies, and savings and loan holding companies that are subject to the Board’s capital requirements, the Board stated in the preamble to the proposal that it intends to consult with the Office of the Comptroller of the Currency and the Federal Deposit Insurance Corporation regarding consistent treatment for all banking organizations subject to the agencies’ regulatory capital rules.  For more information on the Board’s proposal, please see Covington’s summary.