FSB's 'loss absorbing' rule could swamp debt market
Banks call for easing of regulation, wider range of securities to comply with proposed rule
Brussels
BANKS from Tokyo to London say the Financial Stability Board's plan for tackling too-big-to-fail banks may drown the corporate bond market in new paper and drive up funding costs for all companies.
With about US$4 trillion of instruments in the market that will fall under the FSB's proposal on total loss absorbing capacity, or TLAC, the regulator needs to widen the range of securities that comply with the rule, according to industry groups including the Institute of International Finance and the Global Financial Markets Association.
An expanded list of securities would allow banks to reach more buyers in a segmented market, the groups said. The FSB should also relax curbs on banks' counting one another's debt toward TLAC requirements in order to broaden the pool of potential investors, they said.
"Given the extent of the existing and new issuance that will be affected, making sure that broad, diverse, deep and liquid markets will not be impeded by the design of TLAC is essential," according to the IIF and GFMA.
The FSB, the regulator led by Bank of England governor Mark Carney, proposed last year that the biggest banks be forced to have subordinated debt and other loss-absorbing liabilities equivalent to as much as a fifth of their assets weighted for risk.
The rule, intended to keep taxpayers off the hook when lenders fail, would apply to the FSB's list of 30 global systemically important banks, with HSBC Holdings Plc and JPMorgan Chase & Co identified as the most significant.
Standard & Poor's estimates that these banks "would potentially need to issue in excess of US$500 billion in TLAC instruments in the next four to five years", based on the lower end of the FSB's proposed requirement of 16 per cent to 20 per cent of risk-weighted assets.
The FSB will carry out an impact study of the draft rule before completing work on it by the end of 2015. While the banking groups say they support the thrust of the TLAC plan, they are pushing for changes in many of its key provisions.
The TLAC rule "will almost certainly raise bank funding costs", and not just for the biggest lenders, "and such increase can be expected to have fallout effects on real-economy financing costs", the IIF and GFMA said in a public consultation response to the FSB.
The impact of the measure on banks' funding costs will be directly linked to the implementation schedule, the Japanese Bankers Association said in its reply. "From the standpoints of market capacity and investor protection," the proposed Jan 1, 2019, start date "is considered to be too early". At the same time, the flood of new bank securities could drive up costs on the broader corporate bond market. Even though holders of TLAC-compliant debt would take losses by design in a crisis, investors may still find it more attractive than offerings by other companies, the groups said.
Bank associations made a number of specific recommendations on expanding the range of TLAC-eligible securities, including that structured notes, a type of debt instrument that also incorporates derivative-style features, should be allowed to count under certain conditions.
Such notes are "a materially important liability class in the funding structures" of many banks, the British Bankers' Association said, suggesting that they should be allowed when it's clear that the design of the instrument means it could be written down in a crisis.
Banks are also urging the FSB to reconsider a ban on debt instruments with a residual maturity of one year or less from counting toward TLAC.
"The TLAC requirement is likely to have a significant impact on the market for debt under one year," the IIF and GFMA said in their response.
Banks already face regulatory constraints on their issuance of such debt and there are "indications in the US market that the absence of short-term paper is already having an effect on money-market funds as supply has diminished significantly", they said.
Revising the minimum to debt issued with an original maturity of over one year and a remaining maturity of at least six months would "make TLAC more manageable from a corporate finance point of view", the associations said.
While there is much overlap in the concerns raised by banks across the world, some issues are specific to a region.
European banks say they risk being placed at a competitive disadvantage by the formulation of rules on how TLAC-eligible debt would be subordinated.
They argue that the absence of holding company structures at many European banks, and the powers for supervisors built into EU rules on bank bondholder writedowns, make it harder to achieve the required subordination.
TLAC as currently designed "clearly discriminates banking groups with an operating company at the top", bankers associations representing Nordic and Baltic nations said in a joint response.
"Such banking groups would have to issue large quantities of new types of highly subordinated debt, which would most likely increase significantly the funding costs for those banks," they said. BLOOMBERG
