WASHINGTON — Big-bank representatives are criticizing key aspects of a Federal Reserve proposal designed to end "too big to fail," arguing they are excessive and onerous.
The Clearing House Association, the Financial Services Roundtable, the American Bankers Association, the Securities Industry and Financial Markets Association and the Financial Services Roundtable filed a joint letter praising the main thrust of the Fed's October proposal to ensure global systemically important banks maintain enough "total loss absorbing capacity."
They said a "properly calibrated" plan would represent "the final piece in the regulatory puzzle needed to ensure that U.S. global systemically important banks have enough loss-absorbing resources to result in a durable end to the risk of 'too big to fail.'"
But the groups went on to criticize several core aspects of the proposal, including a provision requiring a portion of TLAC to consist of long-term debt, the overall level of TLAC sought by the central bank and the ways in which the plan differs from a similar proposal put forward by the international Financial Stability Board.
"The standards agreed to at the FSB — including with U.S. representatives — are more than sufficient to accomplish all the goals of TLAC and end 'too big to fail,' " Greg Baer, president of the Clearing House Association, said on a conference call Monday morning. "So in the areas where the Fed has gone beyond the FSB standard, particularly in terms of the standalone debt requirement, and leverage … we believe that's not achieving any goal of ending 'too big to fail' and is simply imposing greater costs on operations, and ultimately market liquidity."
The concept of TLAC was introduced in the Basel III accords and is one of the most significant part of those international agreements that has yet to be implemented. In its simplest form, TLAC requires banks to have a certain amount of long-term debt at any given time, so that in the event of a failure, that debt would be transformed into equity in a newly recapitalized successor bank while the functions of the bank's subsidiaries continue with minimal disruption.
The Fed's proposal would require U.S. G-SIBs to hold a combination of long-term debt and Tier 1 capital. The debt would have to consist of "plain vanilla" obligations issued directly by a "clean" bank holding company. The "plain vanilla" is meant to exclude exotic types of debt such as structured notes or other forms of debt that would flee under stress. The "clean" holding company requirement bars the debt from being held by subsidiaries and bars the parent company from having excessive levels of extraneous debt or derivative exposures — thus creating a so-called "single point of entry" and greatly simplifying resolution.
Under the Fed's proposal, a G-SIB would have to hold either 18% of total risk-weighted assets or 9.5% of total leverage exposure in Tier 1 capital, in addition to a 1%-4.5% G-SIB surcharge required as part of a separate rulemaking. The Fed estimated the funding cost of the rule to the G-SIBs at $680 million to $1.5 billion.
The banks challenged the proposal on a number of fronts. First, the comment letter suggested that the Fed should do away with the long-term dent requirement entirely, saying that banks should be free to fund their TLAC requirement entirely with common equity Tier 1 capital if they so choose. Equity is more dynamic than debt, and can be useful in staving off a bankruptcy as well as bailing in a successor bank, the letter said.
"It is unlikely that a covered BHC will choose to satisfy its entire TLAC requirement with equity rather than long-term debt securities, since long-term debt securities are a less expensive form of loss-absorbing capacity," the letter said. "It would be counterintuitive to prohibit a covered BHC from substituting equity for long-term debt securities since equity can … function as both going-concern and gone-concern capital."
The letter similarly criticized the Fed's plan to hinge capital levels onto a bank's leverage, saying that condition would effectively act as the binding constraint of the rule, which the central bank may not have intended. The associations pointed to statements from the Basel Committee and from Fed Gov. Lael Brainard last year suggesting that the Fed's supplementary leverage ratio for G-SIBs was meant to keep leverage in check and that the surcharge-enhanced capital standards were a more fitting binding constraint. The associations suggested a 14% risk-weighted asset (plus surcharge) ratio or an 8% leverage ratio as a more appropriate capital requirement.
The associations made some more nuanced suggestions as well.
In the proposal, the Fed's requirement that all debt be "plain vanilla" excluded any acceleration events — that is, provisions that would allow the debt holder to ask that their debt is repaid immediately. But the associations pointed out that even relatively straightforward debt issuances have some acceleration events built in to the contracts, but for events that are entirely within a bank's control, such as changing a paying agent. The proposal similarly excludes debt issuances that are governed by foreign law.
The letter said the combined cost of issuing new debt that would meet those standards would be $363 billion, whereas if considerations were made for those two conditions, the burden of acquiring new debt agreements would be more on the order of $56 billion. The groups suggested that, if the Fed opted not to change the requirements for future debt, they could at least grandfather in existing long-term debt arrangements that would otherwise qualify as TLAC.
"We say there is a $360 billion shortfall, but … the great majority of that is attributable to two issues," Baer said. "Namely, the disqualification of debt that has routine acceleration clauses and the disqualification of debt that is issued in foreign jurisdictions, that we are confident the Fed will address — either by no longer disqualifying them, or at the very least, grandfathering them."