In a recent update to the G20 Leaders, the Financial Stability Board (FSB) stated that it would seek international agreement on a new, set level of "total loss-absorbing capacity" (TLAC) to be held by global systemically important banks (G-SIBs) that are subject to resolution measures. This is to ensure that large financial institutions can be resolved without recourse to taxpayer funds (by setting a minimum amount of loss-absorbing capital they must hold which can then be written off in a resolution situation), and effectively end the concept of banks that are "too big to fail". To that end, the FSB (in conjunction with the Basel Committee on Banking Supervision) has issued a Consultative Document which proposes: (i) a set of principles on the adequacy of loss-absorbing capital and the recapitalisation capacity of G-SIBs in resolution; and (ii) a detailed "term sheet" on TLAC which sets out the concrete proposals for the key features of the TLAC, including its objective, minimum requirement, eligible instruments, relationship with capital requirements, minimum maturity and priority. The critical proposal is that (subject to final calibration in 2015) the TLAC requirement would be a Pillar 1 requirement to hold 16-20% of risk-weighted assets, and at a minimum, twice the Basel III leverage requirement (which is expected to be 3%), such that G-SIBs with a TLAC requirement could be expected to hold an overall 19.5-25% of risk weighted assets as capital, even before factoring in any of the additional buffers. An "internal TLAC" amount would effectively be distributed to "material" subsidiaries of the G-SIB and in proportion to their size and risks. An "external TLAC" amount (i.e. that held by external creditors) would be written down and/or converted to equity, with losses absorbed according to the applicable creditor hierarchy. However, each G-SIB would have a firm-specific TLAC requirement applied to it. The TLAC instruments would have to meet the eligibility criteria set out in the term sheet, which are very similar to the Basel III criteria for minimum regulatory capital requirements (and, in fact, all G-SIBs currently issue instruments that would eligible for TLAC). The interaction with the Basel III framework, according to the FSB, is that "the TLAC requirement should be met first, before surplus Common Equity Tier 1 (CET1) Capital is available to meet the Basel III buffers". However, in practice, the Basel III risk-weighted assets (RWA) amount will necessarily have to be calculated first, in order to be able to arrive at the TLAC as a percentage of RWA amounts. Disclosures would also have to be made by G-SIBs subject to the TLAC, and the FSB will now be working on these disclosures with the Basel Committee. National supervisors would also have the power to add further TLAC requirements under Pillar 2 (i.e. beyond the Pillar 1 minima).

Comments on the Consultative Document are requested by 2 February 2015, with the final rules not expected to take effect until 1 January 2019. The proposal goes far beyond the revised capital requirements introduced by Basel III, and is expected to make it much more expensive for the largest banks to operate. Initial responses to the consultation show that banks (and regulators) have responded fairly negatively to the proposals, citing the need to raise further billions in capital to satisfy TLAC requirements, as well as structural impediments in Europe that do not facilitate the holding of the TLAC requirement at holding company level (as suggested by the proposals). As you may be aware, G-SIBs are already required to hold additional capital buffers from January 2016, and the FSB has now published its list of G-SIBs as at November 2014, which identifies those banks that would be subject to the TLAC proposals (30 G-SIBs are identified), subject to them remaining on the G-SIB list. Despite the potentially negative impact of these proposals, the identified G-SIBs may have been somewhat relieved to hear the FSB note that these TLAC proposals will "mark the end of the fundamental reforms of the global financial regulatory architecture in response to the 2008 financial crisis".

Useful links:

Financial Stability Board Consultative Document

Financial Stability Board's List of G-SIBs as at November 2014