Loss Absorbency Requirements: Federal Reserve Adopts Final TLAC and Related Requirements for U.S. G-SIBs and U.S. Intermediate Holding Company Subsidiaries of Non-U.S. G-SIBs

Sullivan & Cromwell LLP - December 16, 2016

Yesterday, the Federal Reserve adopted final rules implementing and accelerating, for U.S. G-SIBs (“Covered BHCs”) and U.S. intermediate holding company subsidiaries of global systemically important foreign banking organizations (“Covered IHCs”), total loss absorbing capacity (“TLAC”) requirements, including long-term debt (“LTD”) and clean holding company requirements.  In the supplementary information accompanying the final rules (the “Supplementary Information”), the Federal Reserve explains that the final rules have two overall objectives—improving the resiliency and the resolvability of Covered BHCs and Covered IHCs—and notes that the TLAC and LTD requirements build on, and are complementary to, the Federal Reserve’s capital adequacy requirements.

The Federal Reserve’s adoption of final TLAC rules, alongside related measures taken by regulators in other jurisdictions, represents one of the final and most important actions in establishing a resolution process for large financial services companies that accomplishes two basic purposes:  (i) minimizing the risk that resolution of such an institution could have broader systemic implications, and (ii) ending too-big-to-fail.  In addition, the availability of TLAC to cushion a resolution may, in fact, reduce the need for resolution because funders and counterparties will have increased confidence that losses, if any, will be minimal in a resolution.

The final rules retain core aspects and the approach of the original proposed rules, and reflect a Federal Reserve decision not to make changes in response to concerns raised by commenters regarding a number of key areas, including the exclusion of all structured notes from eligible external LTD, the retention of standalone LTD requirements in addition to the TLAC requirements, the retention of both risk-based and leverage-based TLAC and LTD requirements, the absence of any “grace period” to cure a breach of the LTD requirements (which will have the effect of requiring Covered BHCs and Covered IHCs to maintain a margin beyond stated minimum requirements), and the definition of eligible LTD with respect to acceleration provisions and governing  law (although there is some accommodation through the grandfathering provisions discussed immediately below).  However, the final rules do incorporate important changes from the proposed rules in response to comments.