12 February 2016

EBF Response to Basel Consultation on TLAC Holdings

The European Banking Federation (EBF) members key messages

The notion of contagion: whilst EBF members agree that the effects of contagion must be limited as far  as  is  possible,  contagion  itself  cannot  be  eliminated,  as  it  is  axiomatic  that  if  TLAC  is bailed-in, TLAC-holders must suffer from negative impacts. Any rules that seek to eliminate contagion from one sub-section of the population (e.g. banks) thus necessarily concentrate the impact of contagion elsewhere in the system. It may be preferable to allow moderate contagion  effects  across  a  wide  population rather than to  concentrate  the  effects on  a smaller population, where it is more likely to prove ‘fatal’.

The  severity  of  contagion: Given  that  Tier  1  and  Tier  2  holdings  are  already  subject  to  a deductions regime, which it is rightly not proposed to be amended, this proposal in reality deals only  with  TLAC-eligible  instruments  that  are  not  Tier  1  or  Tier  2. 

The eviction  effect of  the  deduction  approach: the  approach  taken,  of  deducting  TLAC holdings from Tier 2 instruments, will have the effect of making investment in TLAC-eligible debt instruments economically unviable for the banking sector. Whilst this may meet the narrow  aim  of  preventing  contagion  from  a  failing  bank  to  other  banks,  it  will  also concentrate  the  effects  on  the  non-bank  and  often  non-regulated  sector,  where  the potential for ‘fatal’ contagion may be higher.

The EBF recognizes the FSB view to disincentivise internationally active systemic banks from holding external TLAC issued by other G-SIBs in a manner generally parallel to deductions for  investments  in regulatory  capital instruments in  other  banks in  order to  mitigate contagion risk.

Furthermore, the  principle  for  deduction of holdings  of  TLAC instruments should  not  be more severe than the principle for deductions in capital instruments already in place under the Basel framework. It would be necessary to exclude them being applied also to indirect holdings of TLAC.

The  Tier  2  treatment  for  TLAC  eligible  instruments that  rank  senior  to  Tier 2 instruments would unduly penalise these more senior instruments by disregarding the lower risk profile and lower PD of these instruments. The EBF therefore recommends deductions should be made from TLAC rather than Tier 2 as is currently proposed.

If  the  proposed  deduction  approach  is  retained  and  the  positions  of  relevance  for  the threshold are broadly expanded to include TLAC holdings, EBF suggests that, in addition to the   current   10%   of   common   equity   threshold,   another   10%   threshold   specific   to investments in TLAC instruments be set up to ensure an active, deep and liquid market for TLAC eligible instruments.

The  EBF  considers  the  a symmetric treatment,  i.e.  broadening  the  definition  of  TLAC holdings to cover instruments that are not or no longer TLAC eligible for the issuer, to be inappropriate.  The  definition  should,  in  principle,  be  identical  with  the  TLAC  eligibility criteria. However, to avoid likely negative consequence for the market for senior unsecured instruments, we recommend that instruments which qualify for TLAC solely by virtue of the 2.5-3.5% allowances should not be subject to the deduction approach but be captured by large exposure limits.

Furthermore, EBF members question how these instruments will be treated under Solvency II. If there is a different treatment, then this could give rise to arbitrage, if not different the market would become even smaller.

Full response

© EBF