Regulatory Capital Treatment of Investments in TLAC-Eligible Debt: Federal Banking Agencies Propose Regulatory Capital Deductions for Investments by Advanced Approaches Banking Organizations in TLAC-Eligible Debt

Sullivan & Cromwell LLP - April 18, 2019
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Earlier this month, the OCC, the Federal Reserve, and the FDIC issued a proposal that would require “advanced approaches” banking organizations to deduct from their own regulatory capital certain investments in unsecured debt instruments issued by U.S. G SIBs, foreign G SIBs, and subsidiaries of foreign G SIBs, including their U.S. intermediate holding company subsidiaries (“Covered IHCs”), for purposes of satisfying total loss-absorbing capacity (“TLAC”) requirements.  The agencies note that the proposal is intended to recognize the systemic risk posed by banking organizations’ investments in G SIBs’ debt “and to create an incentive for advanced approaches banking organizations to limit their exposure to GSIBs.”

The proposal builds on the Federal Reserve’s final TLAC rule issued in December 2016 (“TLAC Rule”), which requires U.S. G SIBs and Covered IHCs to maintain a minimum amount of TLAC, consisting of Tier 1 capital (excluding minority interest) and eligible long-term debt instruments.  The Federal Reserve’s 2015 proposal for the TLAC Rule would have required banking organizations subject to the Federal Reserve’s capital rules (including bank holding companies and state member banks) to deduct investments in the unsecured debt of U.S. G SIBs from their Tier 2 capital in accordance with the deductions framework for investments in capital instruments.  The TLAC Rule did not implement the proposed deductions.  Rather, the Federal Reserve noted that it would work with the OCC and the FDIC towards a proposed interagency approach regarding the regulatory capital treatment of holdings of unsecured debt issued by U.S. G SIBs.

In October 2016, the Basel Committee published its final standard on the regulatory capital treatment of holdings of TLAC instruments issued by G SIBs.  Notably, in order to facilitate market-making activities, the final Basel standard included a new threshold below which holdings of TLAC-eligible debt would not need to be deducted from Tier 2 capital.  The final Basel standard also provided that G SIBs must deduct holdings of their own TLAC-eligible debt from their TLAC resources instead of Tier 2 capital.