Forming the background to this are the principles and term sheet published by the Financial Stability Board (FSB) on loss-absorbing and recapitalisation capacity of such institutions in resolution, which will introduce a minimum TLAC requirement as from 1 January 2019. Global systemically important banks (G-SIBs) will then need sufficient debt instruments which, in the worst case scenario, should be readily available for bail-in within resolution (TLAC liabilities).

In order to prevent contagion effects and to incorporate the new resolution regime into the Basel III standard, the BCBS has now developed deduction requirements for the holdings of other banks in the TLAC of G-SIBs. The reason for this is that if other G-SIBs, or smaller banks, hold too high an investment in the TLAC of a global systemically important bank, this carries the risk that they will suffer heavy losses in the recapitalisation or resolution thereof through a bail-in. In the worst case, this could cause them to get into financial difficulties themselves, leading in turn to another bail-in for them. If the holdings of other banks in the TLAC of G-SIBs are too high across the banking sector, the recapitalisation or resolution of a global systemically important bank could thus cause the whole system to falter.

Broad TLAC definition

The TLAC holdings standard stipulates that TLAC liabilities and instruments which are on the same rank as subordinated TLAC liabilities and would be equally affected by a bail-in are to be deducted from Tier 2 capital. Under the deduction requirements of Basel III, this applies to all direct, indirect and synthetic holdings. The standard thus defines TLAC more broadly than the FSB principles.

The deduction of TLAC liabilities from Tier 2 capital is a deviation from the so-called corresponding deduction approach to be applied under Basel III to investments in the regulatory capital instruments of other banks, i.e. that the deduction should be applied to the same component of capital for which the capital would qualify if it was issued by the bank itself. This means that an institution must deduct holdings in Common Equity Tier 1 (CET 1) instruments of another institution from its own CET 1, holdings in Additional Tier 1 (AT 1) from its AT 1, and holdings in Tier 2 from its Tier 2. However, for TLAC this corresponding deduction approach would only be possible for G-SIBs, as only these have to issue TLAC themselves. All other banks do not need to maintain TLAC and therefore would also not be able to apply the corresponding deduction approach. In order to ensure that they are not at a disadvantage compared with G-SIBs and to create an identical regulatory framework for all banks, the BCBS therefore provides for a deduction from Tier 2 capital.

This deduction obligation does not take effect from the first holdings in TLAC liabilities; rather, these are included in the threshold of 10 percent of own Common Equity Tier 1 capital which already exists for regulatory capital. In order to enable a sufficiently liquid market of TLAC liabilities, there will be an additional 5 percent threshold of own Common Equity Tier 1 capital for TLAC liabilities for market making activities. In order to be able to use this additional threshold, the G-SIBs which are invested in TLAC must prove that the TLAC liabilities are in the trading book and are sold on within 30 business days from the purchase date, and that they do not exceed the 5 percent threshold. If these conditions are not met, the deduction from Tier 2 capital applies.

Entry into force and implementation

The TLAC holdings standard is intended to enter into force together with the minimum TLAC requirement, i.e. on 1 January 2019.

Both sets of rules and regulations still need to be transposed into European law. What is important here is the question of how the TLAC can be harmonised with the minimum requirements for eligible liabilities (MREL) stipulated in the Bank Recovery and Resolution Directive.