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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.