United States: A Closer Look At The Final TLAC Rule's Requirements For IHCs

On December 15, 2016, the Board of Governors of the Federal Reserve System (the "Federal Reserve") issued final rules requiring global systemically important banks ("G-SIBs") in the United States, including bank holding companies of U.S. G-SIBs ("covered BHCs") as well as top-tier U.S. intermediate holding companies of foreign G-SIBs ("covered IHCs"), to maintain a minimum amount of total loss absorbing capacity ("TLAC") and long- term debt ("LTD") instruments (the "Final TLAC Rule").1 While we previously briefly summarized the key differences between the Final TLAC Rule and the Federal Reserve's originally proposed TLAC rule for G-SIBs in the United States (the "TLAC Proposal"),2 the differences between the requirements established under the Final TLAC Rule for covered BHCs and covered IHCs deserve further examination.

SPOE and MPOE Resolution Approaches

Since the single point of entry ("SPOE") resolution approach was described by the Federal Deposit Insurance Corporation (the "FDIC") and the Bank of England in a joint White Paper in December 2012,3 "the concept has migrated and become the principal bankruptcy plan under . . . [the Dodd-Frank Wall Street Reform and Consumer Protection Act] (the "Dodd-Frank Act") for all but two of eight [U.S.] G-SIBs."4 Nevertheless, there are reasons for some to prefer a multiple point of entry ("MPOE") resolution approach. For international G-SIBs, an SPOE approach most likely establishes the home country as responsible for the resolution of the top-tier entity, while its subsidiaries in other countries are preserved intact. Under an MPOE approach, particularly where the jurisdiction requires the establishment of an IHC for non-branch assets (as is required in the United States), resolution can take place at the IHC level. The SPOE approach places most of the resolution burden on the home country supervisors, while the MPOE approach may disperse the burden among the home and host country supervisors. The TLAC Proposal, which would have required a covered IHC to issue internal LTD to its foreign parent, seemingly contemplated that foreign G-SIBs, and their foreign supervisors, might be forced into an SPOE resolution approach. The Final TLAC Rule has been modified to more readily support a covered IHC's decision to adopt either an SPOE or MPOE resolution approach and, thus, provides greater flexibility to foreign G-SIBs and their home country supervisors.

Overview of the SPOE Approach. Under the SPOE resolution approach, the top-tier BHC of a banking organization would enter a resolution proceeding within a single jurisdiction and be placed in receivership. The benefit of the SPOE resolution approach is that resolution can be accomplished in a single proceeding—a banking organization's separate subsidiaries could continue to function without the need to enter into multiple proceedings in a multitude of jurisdictions, which could carry with it an "associated destabilizing complexity." Losses associated with a banking organization's failure would be "passed up from the subsidiaries that incurred the losses using one of several potential mechanisms" and then "imposed on the equity holders and unsecured creditors of the [BHC]," which in turn would recapitalize the banking organization's subsidiaries and avoid losses to its third-party creditors. The BHC could be liquidated with losses imposed on stockholders and creditors of the BHC, as opposed to taxpayers in the form of a bailout. The subsidiaries would remain intact and could continue to operate without having to enter into resolution proceedings, engage in an asset "fire sale" or engage in funding runs, any of which could undermine U.S. financial stability.

Overview of the MPOE Approach. Under an MPOE resolution approach, which has been the preferred strategy for some foreign banking organizations ("FBOs"), a banking organization's legal entities would engage in separate resolutions, which could be executed by numerous resolution authorities across several jurisdictions. The assumption underlying the MPOE resolution approach is that the covered IHC will enter resolution if a foreign parent entity fails, as opposed to continuing to operate outside of resolution proceedings of the parent (i.e., an SPOE strategy). However, as noted by the FDIC in its December 2013 request for comment with regard to the SPOE strategy, an MPOE resolution approach would require a banking organization's operations be "housed within subsidiaries that would be sufficiently independent so as to allow for their individual resolution without resulting in knock-on effects.

Treatment of the SPOE and MPOE Approaches Under the Final TLAC Rule. The Final TLAC Rule has been modified to enable FBOs with MPOE resolution approaches to satisfy their TLAC and LTD obligations. A covered IHC that expects to enter into resolution proceedings in the United States based on its FBO parent's MPOE resolution approach may issue LTD:

  1. internally to the FBO parent or to a foreign wholly owned subsidiary of the FBO parent; or
  2. externally to third-party investors.

Unlike the TLAC Proposal, which would have required covered IHCs that intended to serve as a point of entry for resolution to maintain internal LTD issued solely to a parent entity and, in the process, largely impeded the ability to utilize the MPOE resolution approach, the Final TLAC Rule enables certain covered IHCs to issue LTD that best fits either resolution approach.

A covered IHC must certify to the Federal Reserve on the later of June 30, 2017, or one year prior to the date on which the covered IHC is required to comply with the covered IHC TLAC and LTD requirements as to its planned resolution approach.

Comparison of Requirements for Covered BHCs and Covered IHCs

The following provides a comparison of the TLAC, LTD and clean holding company requirements for covered

BHCs and covered IHCs.

Calibration and Eligibility of TLAC

Covered BHCs. Under the Final TLAC Rule, all covered BHCs must maintain specified amounts of outstanding

eligible external TLAC in an amount not less than the greater of:

  1. 18% of the covered BHC's total risk-weighted assets ("RWAs"); and
  2. 7.5% of the covered BHC's total leverage exposure.

Eligible external TLAC is defined as the sum of:

  1. the tier 1 regulatory capital (common equity Tier 1 capital and additional Tier 1 capital) issued directly by the covered BHC; and
  2. the covered BHC's eligible external LTD.

Tier 2 capital counts towards the external TLAC requirement and external LTD requirement as long as it meets

the definition of eligible external LTD.

Covered IHCs. Unlike a covered BHC, the amount of outstanding eligible TLAC depends on whether the IHC's top-tier FBO's planned resolution:

  1. involves the covered IHC or its subsidiaries entering into resolution, receivership, insolvency or similar proceeding (i.e., an MPOE strategy) (a "resolution covered IHC"); or
  2. does not involve the covered IHC or its subsidiaries entering into resolution, receivership, insolvency or similar proceedings in the United States (i.e., an SPOE strategy) (a "non-resolution covered IHC").

Under the Final TLAC Rule, a resolution covered IHC must maintain the greater of:

  1. 18% of the covered IHC's total RWAs;
  2. 6.75% of the covered IHC's total leverage exposure (if subject to the Supplementary Leverage Ratio ("SLR")); and
  3. 9% of the covered IHC's average total consolidated assets.

A non-resolution covered IHC must maintain the greater of:

  1. 16% of the covered IHC's total RWAs;
  2. 6% of the covered IHC's total leverage exposure (if subject to the SLR); and
  3. 8% of the covered IHC's average total consolidated assets.

Calibration and Eligibility of LTD

Covered BHCs. Under the Final TLAC Rule, all covered BHCs must maintain outstanding eligible external LTD in an amount not less than the greater of:

  1. 6% (plus the applicable G-SIB surcharge) of total RWAs; and
  2. a minimum ratio of common equity Tier 1 capital to RWAs of 4.5% (total leverage exposure).

Eligible external LTD is defined as debt that:

  1. is paid in and issued directly by the covered BHC;
  2. is unsecured;
  3. has a maturity of greater than one year from the date of issuance;
  4. is "plain vanilla"; and
  5. is governed by U.S. law.

However, debt instruments issued prior to December 31, 2016, may still count as eligible external LTD, irrespective of whether these instruments contain impermissible acceleration clauses or are subject to foreign law. Principal due to be paid on eligible external LTD in one year or more and less than two years is subject to a 50% haircut for purposes of satisfying the external LTD requirement. But principal due to be paid on eligible external LTD in less than one year will not count toward the external LTD requirement.

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Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

© Morrison & Foerster LLP. All rights reserved

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