The world's biggest banks may gain greater flexibility in meeting new crisis rules as the Financial Stability Board adjusts its total loss-absorbing capacity proposal to eliminate bias against decentralized lenders and opportunities for regulatory arbitrage.

Global industry groups said the FSB's initial proposal last November didn't address a fundamental question: What if a bank like HSBC Holdings Plc, whose major subsidiaries will each face loss-absorbency requirements and be wound down separately, ends up with a higher TLAC requirement than if it had been organized like Citigroup Inc., whose parent is the only entity that would be put into resolution.

The FSB responded to these concerns in an Aug. 24 draft of the TLAC rules, which are intended to solve the problem of too- big-to-fail banks and keep taxpayers off the hook in a crisis. If the sum of minimum TLAC requirements for the multiple subsidiaries of a bank like HSBC is greater than if the bank had only one resolution entity, like Citigroup, "an adjustment may be made to minimize or eliminate the difference," according to the working paper seen by Bloomberg.

Under the TLAC rules, lenders must have capital and subordinated debt available to take losses to ensure they can be recapitalized and restructured in an orderly way without recourse to public funds. The FSB, which brings together regulators and central bankers from the Group of 20 nations, plans to deliver the final rules for endorsement by G-20 leaders in November. The FSB Secretariat declined to comment on the document.

The decision to adjust the TLAC requirement for a bank with a so-called multiple-point-of-entry resolution strategy would be made jointly by its home and host resolution authorities, according to the document. The FSB said there was "consensus" among the members of its Steering Committee to address the industry's concern.

The FSB, led by Bank of England Governor Mark Carney, also sought to prevent regulators in the different nations where major banks have units from ring-fencing loss-absorbing capacity within their jurisdictions when crisis strikes, according to the document. At the same time, regulators are seeking to stop banks from double-counting the securities they have available to take losses across different units.

"To implement an orderly resolution, there must be sufficient flexibility to use loss-absorbing capacity within a G-SIB where needed," the FSB working document states, using the acronym for global systemically important bank. "This means that there will need to be a credible mechanism by which losses and recapitalization needs may be passed with legal certainty to the resolution entity or entities."

The draft introduces "some flexibility" on the movement of TLAC-eligible securities within a banking group. "Regulatory capital of a resolution entity that is surplus to the resolution entity's capital and TLAC requirement can be relied on to help satisfy TLAC requirements and loss absorption or recapitalization needs in resolution at the level of a parent," the document states.

To avoid double-counting, the bank's home and host authorities then decide on "the extent to which the deduction applies at the level of the subsidiary resolution entity or at that of the parent resolution entity," according to the draft.

The Aug. 24 document also makes clear that the FSB plans to retain a ban on structured notes in the TLAC rules, disregarding industry opposition. The working paper cites a "strong consensus" among regulators to exclude structured notes from the list of eligible liabilities. In a June 4 working paper, the FSB had said admitting the notes was an "option under exploration."

The exclusion means that "TLAC-eligible liabilities generally need to be junior to structured notes," the document states. The ban was included in the regulator's initial proposal last November.

"If structured bonds are not going to be TLAC eligible, banks that rely on structured notes for a sizable part of their funding and need to raise TLAC will have to change their funding mix," said Bhaavit Agrawal, head of structured bond trading at Citigroup Inc. in London.

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