Canada: Ending Too-Big-To-Fail –TLAC And The Canadian Bail-In Regime

Following the financial crisis, a number of reforms have been proposed, both in Canada and internationally, aimed at limiting the risk of future taxpayer funded bail-outs for the largest financial institutions (so-called "too-big-to-fail" institutions), including proposals that will result in the imposition of new capital standards for such institutions.

On the global front, the Financial Services Board ("FSB") announced on September 25th, 2015 at a meeting in London that a draft agreement had been reached on a global standard for a new capital requirement that will be applicable to Global Systemically Important Banks ("G-SIBs"), which is referred to as the Total Loss-Absorbing Capacity ("TLAC") requirement. Earlier in 2014, the FSB had issued a consultation policy proposal, Adequacy of loss-absorbing capacity of global systemically important banks in resolution, to implement TLAC on G-SIBs with the aim of ensuring that G-SIBs have sufficient capacity to absorb losses. The FSB proposes a single specific minimum Pillar 1 TLAC requirement, whereby the sum of the G-SIB's regulatory capital (Tier 1 and Tier 2) plus long term unsecured debt would be required to be equal to 16 – 20% of risk-weighted assets. Additional subjective "Pillar 2" requirements may also be applicable to particular institutions. There are currently 30 banks identified as G-SIBs to whom the FSB proposal would apply, none of which are Canadian-based banks. The TLAC requirement is expected to be formally implemented in 2019.

In the United States, the Federal Reserve Board proposed on October 30th, 2015 that TLAC requirements and long-term debt requirements be applicable to US G-SIBs and to the US operations of non-US G-SIBs (in each case as identified by the Federal Reserve Board). The Federal Reserve Board proposed that US G-SIBs be required to hold long-term debt in an amount that is at least the greater of (i) 6% plus its G-SIB surcharge of risk-weighted assets and (ii) 4.5% of total leverage exposure; and TLAC in an amount that is at least the greater of (i) 18% of risk-weighted assets and (ii) 9.5% of total leverage exposure. The Federal Reserve Board also proposed that the U.S. operations of non-US G-SIBs be required to hold long-term debt in an amount that is at least the greater of (i) 7% of risk-weighted assets and (ii) 3% of total leverage exposure and 4% of average total consolidated assets, and TLAC in an amount that is at least the greater of (i) 16% of risk-weighted assets, (ii) 6% of total leverage exposure and (iii) 8% of average total consolidated assets. Long-term debt and TLAC of a non-US G-SIB would also be required to be issued internally, from the U.S. operations to the foreign parent, rather than sold to external investors, with the aim of ensuring the US operations of a failed foreign G-SIB could be adequately recapitalized.

As mentioned above, no Canadian-based bank is currently a G-SIB, and therefore Canadian-based banks at this time would not be subject to either the FSB or Federal Reserve Board requirements described above. However, in Canada, the Canadian Government has previously announced that it intends to implement the Taxpayer Protection and Bank Recapitalization Regime ("bail-in regime"), applicable to Canadian systemically important banks ("D-SIBs"). The proposal was initially issued in August 2014 and is discussed in further detail in our prior legal updates, Budget 2015: Financial Institutions Update and Department of Finance Releases Proposal for Canadian Bail-In Regime. This proposal will introduce in Canada a bail-in regime whereby, among other things, the government will be granted the power to permanently convert "eligible liabilities" of D-SIBs into common equity. The proposal also puts forward a new capital requirement to be imposed on D-SIBs, the Higher Loss Absorbency ("HLA") requirement. The Higher Loss Absorbency Requirement is to be calculated on the sum of the bank's regulatory capital and long-term senior debt, and will be subject to a uniform and public minimum requirement administered by the Office of the Superintendent of Financial Institutions ("OSFI"). The Government proposed that the HLA requirement be set at a specific value (as opposed to a range) and that this value be between 17 – 23% of risk-weighted assets.

These reforms are expected to affect the capital raising and debt issuance strategies of affected institutions as they seek to structure their capital and debt to best meet the upcoming requirements.

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