1. A rts on capital and eligible liabilities updated in line with CRR2 and BRRD2
CRR2 published in May 2019, updated the framework of capital and liabilities eligible for MREL with some targeted adjustments and focused on the competent authority’s prior approval regime for capital reduction.
At the same time, BRRD2 introduced, within the existing MREL, the TLAC requirement for GSIB banks.
These two measures constitute the “Risk Reduction Package” and complement the banking framework aimed at:
- Reducing the risk of bank failure.
- Reducing the impact of bankruptcy and the costs to the taxpayer in the event of an inevitable bank failure.
Since the publication of the CRR, the EBA has been mandated to clarify some of the capital eligibility criteria and to draft the corresponding regulatory technical standards (“RTS”). These mandates resulted in the adoption of Delegated Regulation (EU) No 241/2014 (the “Capital RTS”).
As the eligibility criteria and the rules on the prior authorisation regime to reduce own funds have been amended in the new regulations, the current RTS on own funds needed to be amended accordingly.
The CRR2 also mandated the EBA to specify some of the criteria for MREL-eligible liability instruments. These criteria will help to build high-quality loss-absorbing capacity.
The new RTS was finalised on 26 May 2021. It will enter into force one day after its publication in the Official Journal of the European Union. It will be mandatory and directly applicable in all member states.
2. Criteria for identifying eligible commitments that are now almost identical to those for equity instruments
2.1. Prohibition of direct or indirect financing of eligible liabilities by the resolution entity
The acquisition of ownership of eligible liabilities shall not be funded directly or indirectly by the resolution entity.
CRR2 extends to eligible liability instruments an eligibility criterion already applicable to own funds. The acquisition of ownership of the liability must not be financed directly or indirectly by the resolution entity. This essential requirement prohibits a bank from issuing to entities with which it has some form of interdependency. These interdependencies would, in the event of distress, create a feedback loop that would diminish or neutralise the loss absorption that these instruments are intended to provide.
The CRR2 therefore instructs the EBA to draft RTSs to specify the applicable forms and the nature of direct and indirect financing of eligible liability instruments. The new specifications must be fully aligned with the existing specifications for own funds.
2.2. The absence of an early repayment incentive clause
According to CRR2, commitments are only considered as eligible commitment instruments provided that they do not include any incentive “for their principal amount to be called, redeemed prior to maturity or prepaid by the bank, as the case may be, except in the specific cases referred to in the Regulation in Article 72c(3)”. This condition, already present for own funds instruments, now also ensures the permanence of the loss-absorbing capacity for eligible liabilities.
For example, this criterion excludes any foreseeable clauses that would make it more expensive over time for the issuing entity to maintain the financing.
However, the consequences of redemption incentives for eligible liabilities differ from those for equity. For eligible liabilities, redemption incentives lead to a shortening of the maturity of the instrument rather than outright ineligibility as is the case for own funds instruments. The general intention behind this concept is nevertheless the same.
Therefore, CRR2 instructs EBA to specify “the forms and nature of the incentives to redeem” acceptable eligible liabilities, in a manner “fully aligned” with the respective provision for own funds.
2.3. A system of prior authorisation by the competent authority for any reduction in eligible liabilities and/or own funds
The regime of prior authorisation by the competent authority for the reduction of capital is significantly modified in CRR2 by including eligible liabilities. Indeed, CRR2 extends to eligible liabilities the requirement for banks to obtain prior approval from the competent authority before calling, redeeming or repurchasing instruments for a certain predetermined amount and for a limited period of time.
For example, CRR2 now requires prior general authorisation to reduce capital for a specified period, which may not exceed one year. It defines the conditions under which the resolution authority may grant authorisation. Three grounds for authorisation are provided:
- Replacement with equal or better quality of eligible liabilities on sustainable terms for the bank’s earning capacity.
- Reduction by a bank that exceeds its capital and eligible liability requirements by a sufficient margin.
- Replacement necessary to ensure compliance with capital requirements.
Where the prior authorisation relates to the bank’s own funds and eligible liabilities exceeding the requirements of CRR2 and BRRD2 by a sufficient margin, the resolution authority, in agreement with the relevant supervisory authority, will determine the margin over these requirements deemed necessary. A general prior authorisation may be given for a fixed period and a predetermined amount, subject to criteria ensuring that the conditions of the first two grounds for authorisation are met.
Before granting a general prior authorisation, the resolution authority shall consult the competent supervisory authority, and once such authorisation is granted, the competent supervisory authority shall be informed accordingly.
The RRC2 therefore instructs the EBA to develop RTSs to clarify expectations regarding the prior approval regime for the reduction of eligible liability instruments. These include:
- The process of cooperation between the competent supervisory authority and the resolution authority.
- The procedure, including time limits and information requirements, for granting prior authorisation.
- The meaning of “sustainable for the bank’s earning power”.
For some of these aspects, EBA is explicitly required to ensure full alignment between the requirements on eligible liabilities and own funds. In order to ensure consistency between the two regimes, EBA has therefore amended the existing RTS on own funds, extending the provisions on own funds to eligible liabilities.
The EBA has also included specific relief for the renewal of the general prior authorisation in terms of the information to be provided by the bank and the timing of the application.
2.4. Proportionate treatment for banks that are destined to be liquidated in bankruptcy
Banks are also required to seek authorization:
- Where eligible liabilities are not subordinate to excluded liabilities.
- For banks for which the MREL does not exceed the loss absorption amount only (i.e., banks without a recapitalisation amount that would be liquidated in bankruptcy using normal insolvency procedure);
- When liabilities have a remaining maturity of less than one year
It is foreseeable that an entity for which the MREL is equal only to the capital requirements will not be able to issue senior instruments that meet all the new eligibility criteria. EBA has therefore decided to introduce a proportionate treatment for winding-up cases (entities for which the resolution authority has set the MREL at a level not exceeding an amount sufficient to absorb losses). Since for such entities there is no risk that a reduction in eligible liability instruments would lead to a breach of the MREL requirement:
- First, these entities are not subject to the limits applied to other banks with respect to the predetermined maximum amount that can be allowed to be reduced under general prior approval.
- Second, in terms of process, the RTS introduces the possibility for resolution authorities to grant general pre-clearance on the basis of information already provided by winding-up entities as part of the resolution planning.
This general authorisation can also be renewed automatically, subject to conditions.
3. Consistency of TLAC liability and mrel eligible commitments requirements for gsibs
The introduction of TLAC requirements for GSIBs in the EU comes in a context where banks were already subject to bank specific MREL requirements set out in the BRRD. TLAC liability requirements are now integrated into the MREL requirements so that GSIBs meet their TLAC requirement as part of their overall MREL requirement through the definition of common eligibility criteria.
Accordingly, the specifications on direct and indirect financing, repurchase incentives and curtailment authorisations shall also apply to liabilities eligible for TLAC purposes and for MREL purposes. They shall also apply to liabilities eligible for internal TLAC and internal MREL.
4. Alignment of terminology used in the RRC2 and the RTS
CRR2 introduces modified terminology for a number of articles setting out prudential capital requirements. For example, the term “acquisition of ownership” replaces “purchase” as part of the eligibility criteria for instrument capital. Where these changes relate to CRR2 articles for which additional specifications have been provided in the RTS on own funds, the respective RTS provisions have been revised to reflect the new terminology used in CRR2.
Abbreviations and glossary
EBA: European Banking Authority
SREP: Supervisory Review Evaluation Process
RTS: Regulatory Technical Standards
CRR2: Capital Requirement Regulation 2
BRRD2: Banking recovery and resolution direct
GSIB: Global systemic importance bank
MREL: Minimum Capital Requirements and Eligible Liabilities (resolution regime for EU banks)
TLAC: Total Loss absorbing Capacity (resolution regime for GSIB)