Financial institution issuers of structured products probably are all too aware of the heightened regulatory capital requirements and new quantitative liquidity measures that form part of the Basel III framework. To some extent, the liquidity measures, such as the Liquidity Coverage Ratio (LCR) and Net Stable Funding Ratio (NSFR), will affect a financial institution’s funding plans, including an issuer’s interest in issuing shorter term or callable instruments. The newest proposed requirements may have a more direct impact on structured products.

In November 2014, the Financial Stability Board (FSB) launched a consultation on the adequacy of the loss-absorbing capacity of global systemically important banks (G-SIBs) in resolution. Banks in both Europe and the United States are subject to certain minimum regulatory capital requirements, as well as certain capital buffers, and, for the largest banks, a capital “surcharge.” Despite these requirements, the FSB consultation discusses an internationally-agreed standard regarding the appropriate level and the form of total loss absorbing capacity for G-SIBs necessary to ensure orderly liquidations without the need for taxpayer injections of capital in a crisis scenario.

In brief, the FSB’s proposed approach is to require that G-SIBs maintain a minimum level of capital that can absorb losses on both a going concern and a gone concern basis, which includes the capital that is held to satisfy the Basel III minimum capital requirements, but excludes capital held as part of the Basel III capital buffers, such as the capital conservation buffer (and the G-SIB extension of this buffer) as well as the counter-cyclical capital buffer. A G-SIB may be required to maintain a minimum TLAC of 16-20% of risk-weighted assets and a minimum leverage ratio of 6%. The FSB consultation also discusses the entities within a financial institution group that must hold TLAC and the types of eligible instruments. Generally, Tier 1 and Tier 2 capital instruments are “eligible.” In order to satisfy the requirements, other debt securities must, among other things: be unsecured; have a minimum remaining maturity of at least one year; and be subordinated to excluded liabilities on the balance sheet of the resolution entity within the financial institution group. Certain types of liabilities are excluded, such as liabilities arising from derivatives or debt instruments with derivative-linked features like structured notes. The FSB’s proposed exclusion from TLAC of structured notes and other securitized derivatives has proven controversial, especially for those containing a prescribed level of principal protection, and European banks would have been expecting to be able to count such liabilities towards their minimum loss-absorbing liabilities requirements under the European resolution scheme, the Bank Recovery and Resolution Directive, or BRRD. Given that such securities can, in principle, be bailed-in in a resolution, it seems difficult to justify not being allowed to count them as bail- inable for the purpose of calculating TLAC. The consultation period on the FSB proposal closes on February 2, 2015. As a result of the comments on the proposal, the final formulation of the TLAC requirement may differ, perhaps significantly from the requirements describe in the FSB consultation. For example, many commenters have argued that at least a subset of structured notes (those that are principal protected) should “count” for TLAC purposes.