Capital Requirements Regulation and TLAC: Latest Amendments

Capital Requirements Regulation (CRR) and the Total Loss-Absorbing Capacity (TLAC) are pivotal elements within the financial regulatory framework, both aimed at ensuring the stability and resilience of financial institutions. These mechanisms are essential for maintaining the integrity of the financial system, particularly in times of economic distress. Recent amendments, introduced on June 6, 2024, to the Implementing Regulation (EU) 2021/763 and the Directive (EU) 2024/1174, have significantly impacted the supervisory reporting and public disclosure requirements for minimum own funds and eligible liabilities. This article provides an in-depth analysis of these amendments, their far-reaching implications, and underscores the critical importance of TLAC in the global financial landscape.

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Global Systemically Important Banks (GSIBs): TLAC Standards

The 2023 update on Global Systemically Important Banks (GSIBs) highlights shifts in the banking sector, focusing on the impact of Total Loss-Absorbing Capacity (TLAC) Standards and regulatory compliance.

GrandAlessandro Micagni

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What are the Capital Requirements Regulation Amendments?

EU’s CRR amendments strengthen banking sector resilience and financial stability. Updates to CRD and CRR introduce stricter capital and liquidity requirements, enhanced risk management, and measures to reduce bank failures. Expected full implementation by 2023 for more robust EU financial system.

GrandAlessandro Micagni

Overview of the Capital Requirements Regulation (CRR)

The Capital Requirements Regulation (CRR) is a cornerstone of the European Union's financial regulatory framework. Enacted to bolster the resilience of banks and financial institutions, the CRR stipulates stringent capital requirements that institutions must adhere to. These requirements are designed to cover a range of risks, including credit, market, and operational risks, ensuring that banks hold adequate capital to withstand potential losses.

Key Objectives of CRR:

• Enhancing Financial Stability: By imposing higher capital requirements, the CRR aims to reduce the likelihood of bank failures, thereby enhancing the overall stability of the financial system.

• Risk Management: The regulation promotes robust risk management practices by requiring banks to maintain capital buffers that can absorb losses during economic downturns.

• Market Confidence: By ensuring that banks are well-capitalized, the CRR helps to maintain investor confidence and trust in the financial system.

Total Loss-Absorbing Capacity (TLAC)

Total Loss-Absorbing Capacity (TLAC) is a global standard introduced by the Financial Stability Board (FSB) to ensure that globally systemically important banks (G-SIBs) have sufficient loss-absorbing and recapitalization capacity. TLAC is crucial for minimizing the systemic impact of a bank failure and protecting taxpayers from the costs associated with bank bailouts.

Key Components of TLAC:

• Loss-Absorbing Capacity: TLAC requirements mandate that G-SIBs hold sufficient equity and bail-in debt to absorb losses during a resolution, ensuring the continuity of critical functions.

• Recapitalization Capacity: In addition to loss absorption, TLAC provides for the recapitalization of banks, enabling them to continue operations and maintain market stability during and after a resolution process.

• Internal TLAC: This subset of TLAC applies to material sub-groups within a G-SIB, ensuring that these sub-groups have adequate loss-absorbing capacity to support the resolution of the group as a whole.

Detailed Analysis of the Latest Amendments

The amendments introduced on June 6, 2024, to the Implementing Regulation (EU) 2021/763 and Directive (EU) 2024/1174 have brought about comprehensive changes aimed at refining the regulatory framework governing CRR and TLAC. These changes are designed to enhance the transparency, accuracy, and consistency of supervisory reporting and public disclosures.

1. Deduction Requirements:

• Regulation (EU) 2022/2036: This regulation mandates that intermediate entities within a resolution group must deduct holdings of their own funds instruments and eligible liabilities instruments from eligible liabilities items. These holdings are used for compliance with internal TLAC or internal MREL requirements if issued by entities that are not themselves resolution entities but belong to the same resolution group.

• Directive (EU) 2024/1174: This directive further specifies that intermediate entities must deduct their holdings of own funds instruments issued by liquidation entities within the same resolution group, subject to conditions related to the materiality of those holdings. This ensures that internal capital buffers accurately reflect the actual risk exposure and are not overstated.

2. Permissions for Redeeming Eligible Liabilities:

• Entities subject to TLAC (under Article 92a or 92b of Regulation (EU) No 575/2013) or MREL (under Article 45 of Directive 2014/59/EU) can, with prior permission from their resolution authority, redeem, repay, or repurchase eligible liabilities instruments. The impact of such permissions must be reflected in public disclosures and reporting to ensure transparency and an accurate assessment of financial stability.

3. Template and Reporting Adjustments:

• The amendments necessitate updates to the templates used for public disclosure and reporting to competent and resolution authorities. Specifically, templates M 02.00 and M 03.00, Annex II, templates EU TLAC1 and EU ILAC, and Annex VI have been replaced to align with the new regulatory requirements. This ensures that all disclosed information accurately reflects the current regulatory standards and the financial status of the institutions.

Implications of the Amendments

The recent amendments have several significant implications for financial institutions and the regulatory environment:

Enhanced Transparency:

• By reflecting the deduction requirements in the public disclosure templates, the amendments enhance the transparency of financial institutions' capital structures. Stakeholders, including investors and regulators, gain a clearer understanding of the institutions' financial health and risk exposure.

Improved Risk Management:

• The refined deduction requirements ensure that financial institutions maintain accurate internal capital buffers. This improves their ability to manage risks and absorb losses, thereby enhancing their resilience against financial shocks.

Regulatory Oversight:

• The updated reporting templates provide regulatory authorities with comprehensive and up-to-date information. This enables more effective monitoring and assessment of financial institutions, ensuring timely interventions when necessary to maintain financial stability.

Consistency and Harmonisation:

• The amendments promote consistency and harmonisation in the regulatory framework across the European Union. This creates a level playing field for financial institutions and ensures that all entities adhere to the same robust standards, contributing to the overall stability of the financial system.

Timeline for Implementation

To ensure a smooth transition, entities subject to the new reporting and disclosure requirements will have six months from the date of entry into force of the regulation to adapt to the changes. This period allows institutions to update their internal systems, processes, and templates to comply with the new requirements effectively.

Overview of the Recent Amendments to Capital Requirements Regulation and TLAC

The recent amendments to Implementing Regulation (EU) 2021/763 and Directive (EU) 2024/1174 represent a significant enhancement in the regulatory framework for Capital Requirements Regulation (CRR) and Total Loss-Absorbing Capacity (TLAC). These changes are designed to ensure that financial institutions are more resilient and transparent, providing a robust foundation for financial stability.

Key Amendments: Deduction Requirements

Regulation (EU) 2022/2036:

• Scope and Application: This regulation mandates that intermediate entities within a resolution group must deduct holdings of their own funds instruments and eligible liabilities instruments from eligible liabilities items. This requirement is crucial for compliance with internal TLAC (Total Loss-Absorbing Capacity) or internal MREL (Minimum Requirement for Own Funds and Eligible Liabilities).

• Objective: The main objective is to prevent double counting of capital within the same resolution group, ensuring that the reported capital and liabilities accurately reflect the available loss-absorbing capacity.

• Specifics: These deductions are particularly pertinent when the instruments are issued by entities that are not resolution entities but are part of the same resolution group. This regulation ensures that the internal capital buffers are not overstated and that they truly represent the financial health and resilience of the group.

Directive (EU) 2024/1174:

• Refinement: This directive refines the deduction requirements by specifying that intermediate entities must deduct their holdings of own funds instruments issued by liquidation entities within the same resolution group. This is subject to conditions related to the materiality of those holdings.

• Materiality Conditions: The directive introduces materiality thresholds to determine when these deductions should be applied. This ensures that only significant holdings that could impact the resolution group's capital adequacy are deducted.

• Impact: By clarifying and refining the deduction requirements, this directive ensures that the internal capital buffers accurately reflect the actual risk exposure, providing a more realistic view of the financial institution’s stability.

Permissions for Redeeming Eligible Liabilities

Regulation Compliance:

• Entities Covered: Entities subject to TLAC (under Article 92a or 92b of Regulation (EU) No 575/2013) or MREL (under Article 45 of Directive 2014/59/EU) can, with prior permission from their resolution authority, redeem, repay, or repurchase eligible liabilities instruments.

• Prior Permission: This requirement ensures that any redemption, repayment, or repurchase does not undermine the institution's loss-absorbing capacity.

• Public Disclosures: The impact of such permissions must be clearly reflected in public disclosures. This enhances transparency, allowing stakeholders to understand the changes in the financial institution’s capital structure.

• Reporting: Accurate reporting to competent authorities and resolution authorities is essential. This reporting must include detailed information about the redeemed, repaid, or repurchased instruments, ensuring that the regulatory bodies can monitor and assess the financial stability accurately.

Template Replacements and Updates:

• Templates M 02.00 and M 03.00: These templates have been updated and replaced to align with the new regulatory requirements. The updates ensure that the templates capture all necessary data points related to CRR and TLAC, facilitating more accurate and comprehensive reporting.

• Annex II and Annex VI: These annexes have been revised to provide clearer and more detailed instructions for reporting. The changes ensure that financial institutions understand the reporting requirements and can comply without ambiguity.

• Templates EU TLAC1 and EU ILAC: These specific templates related to TLAC and Internal Loss-Absorbing Capacity have been updated to reflect the latest changes in the regulatory framework. The revisions ensure that all reported data is consistent with the current regulatory standards, providing a true representation of the institution’s financial position.

Impact on Financial Institutions:

• Operational Adjustments: Financial institutions will need to update their internal reporting systems and processes. This includes training staff on the new templates and reporting requirements, updating software systems to handle the new data fields, and revising internal procedures to ensure compliance.

• Enhanced Accuracy: The updated templates and reporting requirements improve the accuracy and consistency of supervisory reporting. This ensures that the data submitted by financial institutions reflect their true risk exposure and loss-absorbing capacity.

• Increased Transparency: By providing detailed public disclosures and accurate reporting, the amendments enhance transparency, offering stakeholders, including investors and regulatory authorities, clearer insights into the financial health and stability of institutions.

• Regulatory Alignment: The updates align the reporting requirements with the latest regulatory standards, ensuring that all institutions adhere to the same high standards of risk management and disclosure.

The amendments to Implementing Regulation (EU) 2021/763 and Directive (EU) 2024/1174 mark a significant advancement in the regulatory framework for capital requirements and TLAC. These changes are designed to strengthen the resilience of financial institutions by ensuring accurate reporting and transparency of internal capital buffers and eligible liabilities.

Financial institutions must adapt to these changes to ensure compliance and maintain their stability against financial shocks. As these regulations take effect, they will play a crucial role in safeguarding the global financial system's stability, protecting taxpayers, and ensuring a robust and transparent financial environment. Understanding and complying with these regulations is crucial for financial institutions to maintain their resilience and protect the broader economy from potential financial crises.

TLAC and Its Importance

The Total Loss-Absorbing Capacity (TLAC) standard was introduced by the Financial Stability Board (FSB) in the aftermath of the global financial crisis to address the systemic risk posed by the failure of globally systemically important banks (G-SIBs). TLAC is designed to ensure that G-SIBs have adequate loss-absorbing and recapitalization capacity available during a resolution. This mechanism is crucial for maintaining financial stability, protecting taxpayers from bearing the costs associated with bank failures, and minimizing the broader economic impact.

Key Components of TLAC

Loss-Absorbing Capacity

TLAC requirements ensure that G-SIBs have enough equity and bail-in debt to absorb losses during a resolution. This component is vital for preventing the collapse of a financial institution from spilling over into the broader economy. The loss-absorbing capacity is structured as follows:

• Equity Capital: This includes common equity tier 1 (CET1) capital, which is the highest quality of regulatory capital. CET1 is used first to absorb losses.

• Bail-in Debt: These are debt instruments that can be written down or converted into equity in the event of a resolution. Bail-in debt includes additional tier 1 (AT1) and tier 2 (T2) capital instruments.

• Senior Unsecured Debt: This forms part of the eligible liabilities that can be bailed in, providing an additional layer of loss absorption.

The primary goal of the loss-absorbing capacity is to ensure that sufficient financial resources are available to cover losses and stabilize the institution without requiring taxpayer-funded bailouts.

Recapitalisation Capacity

TLAC also includes provisions for the recapitalization of the bank to maintain critical functions during and after the resolution process. This aspect is essential for ensuring the continuity of key banking operations, thereby maintaining market confidence and preventing disruption to the financial system. The recapitalisation capacity includes:

• Fresh Capital Injection: The requirement for banks to maintain a buffer of high-quality capital that can be uused to recapitalize the institution swiftly.

• Access to Liquidity: Ensuring that banks have access to emergency liquidity assistance (ELA) and other forms of financial support to continue their operations during and after the resolution.

• Operational Continuity: Measures to ensure that critical operations, such as payment processing, trade finance, and deposit services, remain functional during the resolution process.

By maintaining these provisions, TLAC helps ensure that a resolved bank can continue to operate, thereby preserving essential financial services and reducing the risk of contagion to other financial institutions.

Internal TLAC

Internal TLAC is a subset of the overall TLAC requirement that applies to material sub-groups within a G-SIB. This ensures that these sub-groups have sufficient loss-absorbing capacity to support the resolution of the group as a whole. Internal TLAC is structured to ensure:

• Internal Capital Allocation: The parent company must allocate sufficient TLAC resources to its material sub-groups to absorb losses and support recapitalization within those entities.

• Regulatory Compliance: Internal TLAC requirements ensure that all parts of the G-SIB comply with local and international regulatory standards, even during stress periods.

• Group-wide Resilience: By ensuring that material sub-groups have adequate TLAC, the entire G-SIB can be stabilized, reducing the risk of systemic failure.

TLAC in Financial Stability

The introduction and implementation of TLAC have significant implications for the stability and resilience of the global financial system

• Systemic Risk Mitigation: TLAC reduces the risk of systemic financial crises by ensuring that G-SIBs have sufficient resources to absorb losses and continue operations without external support.

• Market Confidence: By maintaining robust loss-absorbing and recapitalisation capacities, TLAC enhances market confidence in the financial system, which is crucial for preventing bank runs and maintaining financial stability.

• Protection of Taxpayers: TLAC ensures that the costs of bank failures are borne by the bank’s shareholders and creditors, rather than taxpayers. This shifts the financial burden away from public funds and reduces the moral hazard associated with bailouts.

• Resolution Planning: The TLAC framework promotes better resolution planning and preparedness among G-SIBs. Banks are required to develop detailed resolution plans, which include strategies for maintaining TLAC and ensuring operational continuity during a crisis.

• Regulatory Oversight: TLAC enhances the ability of regulatory authorities to oversee and manage the resolution of G-SIBs effectively. It provides a clear framework for intervention and ensures that necessary resources are available to support resolution efforts.

Amendments to Capital Requirements Regulation and TLAC

The recent amendments to the Implementing Regulation (EU) 2021/763 and Directive (EU) 2024/1174 have profound implications for financial institutions and the regulatory landscape. These changes are designed to enhance transparency, improve risk management, bolster regulatory oversight, and ensure consistency and harmonization across the European Union.

Enhanced Transparency

Clearer Capital Structures:

• Public Disclosure Templates: The amendments require financial institutions to reflect the deduction requirements in their public disclosure templates. This means that the holdings of own funds instruments and eligible liabilities instruments must be transparently disclosed.

• Stakeholder Insights: By improving the clarity of capital structures, stakeholders, including investors, analysts, and regulators, gain a more precise understanding of a financial institution's health. This transparency helps in assessing the institution's ability to withstand financial shocks and its overall risk profile.

• Trust and Confidence: Enhanced transparency fosters trust and confidence among stakeholders, which is crucial for the smooth functioning of the financial markets. Clear and accurate information helps in making informed decisions and boosts market stability.

Improved Risk Management

Accurate Capital Buffers:

• Refined Deduction Requirements: The amendments ensure that financial institutions maintain accurate internal capital buffers by mandating the deduction of certain holdings from eligible liabilities. This prevents the overstatement of capital and ensures that the buffers reflect true financial strength.

• Risk Absorption: Accurate capital buffers are essential for absorbing losses during financial downturns. The amendments improve institutions' ability to manage risks by ensuring they have sufficient resources to cover potential losses.

• Strategic Planning: Enhanced risk management capabilities allow financial institutions to plan strategically for adverse scenarios. This proactive approach helps in mitigating risks before they escalate into crises.

Regulatory Oversight

Enhanced Monitoring:

• Updated Reporting Templates: The amendments introduce updated templates for supervisory reporting, which provide regulatory authorities with comprehensive and up-to-date information about financial institutions' capital and risk exposures.

• Effective Assessment: With detailed and accurate data, regulators can more effectively monitor the health of financial institutions. This enables timely interventions when necessary to maintain financial stability.

• Regulatory Compliance: The detailed reporting requirements ensure that financial institutions adhere to regulatory standards, reducing the likelihood of regulatory breaches and associated penalties.

Timely Interventions:

• Proactive Regulation: The improved reporting allows regulators to identify potential issues early and take preemptive measures to address them. This proactive approach helps in preventing financial crises.

• Crisis Management: In case of a financial downturn, accurate and timely information enables regulators to implement crisis management strategies more effectively, ensuring the stability of the financial system.

Consistency and Harmonization

Uniform Standards:

• EU-Wide Consistency: The amendments promote consistency in the regulatory framework across the European Union by ensuring that all financial institutions adhere to the same robust standards. This uniformity is crucial for creating a level playing field.

• Regulatory Cohesion: Consistent regulations help in reducing regulatory arbitrage, where institutions might seek to exploit differences in regulatory standards across countries. Harmonized standards ensure that institutions compete fairly and operate under the same rules.

• Market Integration: By harmonizing the regulatory requirements, the amendments facilitate better integration of the EU financial markets. This integration is essential for the efficient functioning of the single market, enhancing cross-border investments and financial stability.

Stability and Resilience:

• Robust Framework: The harmonised regulations ensure that financial institutions across the EU maintain high levels of capital and adhere to stringent risk management practices. This robustness contributes to the overall stability and resilience of the financial system.

• Confidence in the EU Market: Consistency in regulatory standards boosts confidence in the EU financial markets, attracting investors and promoting economic growth. Reliable and predictable regulations make the EU an attractive destination for global investors.

Timeline for Implementation

To ensure a smooth and effective transition to the new regulatory framework, the amendments to the Implementing Regulation (EU) 2021/763 and Directive (EU) 2024/1174 include a clearly defined timeline for implementation. Entities subject to the new reporting and disclosure requirements are given a six-month period from the date of entry into force of the regulation to adapt to the changes. This period is crucial for several reasons:

1. System Updates:

• IT Systems Overhaul: Financial institutions need to upgrade their IT systems to accommodate the new templates and reporting standards. This includes software updates, integration of new data fields, and ensuring the systems can handle increased data complexity and volume.

• Testing and Validation: Institutions must rigorously test their updated systems to ensure accurate data capture and reporting. This involves running parallel reporting cycles to validate the accuracy and consistency of the new system outputs against the old standards.

2. Process Adjustments:

• Internal Processes: Existing internal processes must be reviewed and revised to align with the new regulatory requirements. This includes updating procedures for data collection, validation, and reporting.

• Workflow Integration: Integrating the new processes into the daily workflow of financial institutions is essential. This may involve redefining roles and responsibilities, creating new process flows, and ensuring seamless coordination between different departments.

3. Staff Training:

• Comprehensive Training Programs: Financial institutions must develop and implement comprehensive training programs to educate staff about the new requirements. This includes understanding the updated templates, new deduction rules, and enhanced reporting standards.

• Ongoing Support: Continuous support and training are necessary to address any issues or questions that arise during the transition period. Institutions should establish help desks or support teams to assist staff in adapting to the new system.

4. Regulatory Compliance:

• Compliance Checks: Regular compliance checks and audits should be conducted during the transition period to ensure all aspects of the new regulations are being correctly implemented.

• Feedback Mechanisms: Establishing feedback mechanisms with regulatory authorities can help institutions address any compliance issues promptly and effectively. This collaborative approach ensures that any discrepancies or misunderstandings are resolved quickly.

5. Stakeholder Communication:

• Clear Communication Plans: Financial institutions need to develop clear communication plans to inform stakeholders about the changes. This includes investors, clients, and regulatory bodies. Transparent communication helps maintain trust and ensures all parties are aware of the transition timeline and any potential impacts.

• Regular Updates: Providing regular updates on the progress of implementation helps in managing stakeholder expectations and addressing any concerns proactively.

Strategic Importance of Compliance

Resilience and Stability:

• Enhanced Risk Management: The detailed reporting and deduction requirements ensure that financial institutions can better manage risks, maintain adequate capital buffers, and absorb losses during financial downturns.

• Operational Continuity: By adhering to the new regulations, institutions ensure operational continuity during crises, thereby maintaining market confidence and stability.

Economic Protection:

• Safeguarding Taxpayers: The improved regulatory framework shifts the burden of financial stability from taxpayers to the financial institutions themselves, ensuring that the costs of failures are internalised.

• Systemic Risk Mitigation: Enhanced transparency and accurate reporting help in identifying and mitigating systemic risks early, preventing potential financial crises.

Market Confidence:

• Investor Assurance: Enhanced transparency and accurate reporting bolster investor confidence, which is crucial for maintaining liquidity and stability in the financial markets.

• Global Standards Alignment: By aligning with global standards like TLAC, European financial institutions enhance their competitiveness and stability in the global market.

Regulatory Effectiveness:

• Efficient Supervision: The updated templates and reporting standards provide regulators with comprehensive data, enabling more effective supervision and timely interventions.

• Consistency and Harmonization: standards across the EU create a level playing field, ensuring that all financial institutions adhere to robust risk management and reporting practices.

In summary, the implementation of these amendments is a crucial step toward a more resilient and stable financial system. Financial institutions must prioritize understanding and complying with these regulations to maintain their resilience, protect the broader economy, and ensure a secure financial environment for all stakeholders.