Simon Hills, Director, Prudential Policy, UK Finance
UK Finance has responded to the Bank of England’s recent consultation on its approach to minimum requirement for owns funds and eligible liabilities (MREL) in the resolution of material subsidiaries of U.K. banking groups, or the U.K. subsidiaries of overseas banking groups operating here.
The EU Banking Recovery and Resolution Directive (BRRD) requires the parent company of a bank to issue external MREL to investors. External MREL can then be bailed-in if the bank is at the ‘Point of Non-Viability’ (PoNV), or in other words is about to fail. In this way the bank’s losses are upstreamed to investors in the capital instruments issued by its parent and the resolution process allows the bank to be resuscitated.
And where the banking group has a material subsidiary operating in a different country from its home base, whose individual failure could impact the financial stability of that host country, the local supervisor of the material subsidiary can require it to issue internal MREL to its parent company, rather than to external investors. This would enable losses of a failing material subsidiary to be passed up the chain of ownership, having the effect of recapitalising the material subsidiary, so it can carry on operating and avoid damaging the host country’s economy.
The Financial Stability Board (FSB) issued its final guidelines on internal total loss absorbing capacity (TLAC) in mid-2017 – MREL is the European version of TLAC – and the purpose of the Bank of England’s consultation is to provide clarity on how it will implement the FSB guidelines in the U.K.
In our response, written by my colleague Mark Russell, UK Finance welcomed the broad alignment of the Bank’s proposals with the guidelines. UK Finance has members from all four corners of the globe that will be impacted by these internal MREL requirements. It is important to them that internationally agreed standards, such as the FSB guidelines, are implemented in a harmonised way in all the countries in which they operate. Fragmented implementation may result in unnecessary changes to banking groups’ legal structures, tax implications and extra costs of compliance which will ultimately be passed on to customers.
But we also raised a number of questions about the proposals and suggested alternative solutions.
Chief among our concerns is the Bank’s suggestion that internal MREL should have a contractual trigger at the PoNV of a material sub group, which is not required by the FSB’s TLAC principles. We were also concerned that the Bank seems to be contemplating that it would force the bailing-in of internal TLAC where a material subsidiary’s direct or indirect parent is subject to resolution, even without there being a risk of loss to the material subsidiary. Instead we suggested that the Bank should only have this power in circumstances where, as a result of the parent resolution entity being in resolution, the material subsidiary itself would also be likely to fail. And we noted that proposed revisions to BRRD, expected to come into effect before the date by which banks are required to issue internal TLAC, will extend statutory write down from capital instruments, as at present, to also include internal MREL, negating the need for contractual write-down.
We have also suggested that the Bank should make it clear that any surplus MREL need not be held at the resolution entity at the very top of the banking group. We proposed instead that any surplus could be down-streamed to intermediate sub groups to enable them to provide liquidity to their direct material subsidiaries, which would be more economical and enable them to serve their customers at a lower cost.
The consultation paper also considers the question of how much loss-absorbing capacity should be made available to each provider of operational services within the group to guarantee that operational continuity of the group’s critical economic functions is ensured during the resolution process. The Bank is proposing that the proposed operational continuity MREL requirements, to be set at at least 25% of the annual operating cost of providing the operational services, should be in addition to any other MREL requirements. UK Finance considers this double-counting to be excessive, particularly as the FSB’s original calibration exercise to determine the range of TLAC banking groups should hold included operational continuity requirements.
But I believe the the concerns raised in our response, which is in all other regards supportive of the Bank’s proposals, can be overcome as we continue to engage on the final shape of the UK’s resolution regime. A strong, robust and transparent resolution regime will help make the U.K. an attractive location for banks and their investors and ensure that never again does the U.K. taxpayer have to stump up to stabilise a failing bank.