Quarles, in a speech on Wednesday entitled 'Trust everyone — but brand your cattle', signalled that US requirements for internal total loss-absorbing capacity (TLAC) could be adjusted towards the levels other regulators require, potentially prompting a more flexible international regime.
“We continue to believe that the IHC and attendant requirements are appropriate for foreign banks with large US operations,” said Quarles. “However, in light of our experience with these structures, I believe we should consider whether the internal TLAC calibration for IHCs could be adjusted to reflect the practice of other regulators, without adversely affecting resolvability and US financial stability. The current calibration is at the top end of the scale set forth by the FSB [the G20's Financial Stability Board], and willingness by the United States to reconsider its calibration may prompt other jurisdictions to do the same”.
Quarles also said “it may be possible to streamline the elements of our resolution loss absorbency regime, which include both TLAC and long term debt requirements”.
Internal TLAC means loss-absorbing debt pre-positioned in a particular subsidiary — in this case, US “intermediate holding company” subsidiaries issuing to the group holding company, which would in turn issue loss-absorbing debt to the market.
That is meant to allow the local regulatory authority — the Fed — to recapitalise the local subsidiary in a resolution, by pushing losses up to the group level. In theory, this would only be done in consultation with other regulators, who would form “supervisory colleges” and “crisis management groups” to plan resolutions for the biggest banks.
But in a crisis situation, a local regulator could, in theory, act unilaterally, leaving other parts of the banking group sitting on losses.
Who’s in control?
The question is, how much flexibility should local regulators have to do this, if the worst happens and a big bank goes down?
During the fight to agree international TLAC standards during 2015 and 2016, the US was among the strongest advocates of maximising flexibility for local regulators, arguing for 100% internal TLAC (at least, for the US). This means treating the local subsidiary of an international banking group no differently from a standalone domestic bank.
Other regulators argued for a smaller requirement. That, in effect, would give the home regulators of international banking groups more flexibility to allocate capital to cover losses anywhere in the group. In a major banking crisis, though, this could end up leaving parts of a banking group undercapitalised, even if it was strong enough overall.
The compromise was a range from 75% to 90% of internal TLAC, with local regulators able to choose. The US opted for the top end of the range. According to Quarles, it could now reconsider this.
Since the TLAC negotiations finished, the European Union has proposed stiffening its own rules, with an “intermediate parent undertaking” for foreign banks operating in the EU. This is essentially the same structure as the US IHC, producing a separate overall EU entity which would have pre-positioned capital and liquidity, freeing EU authorities to unilaterally take resolution actions.
Co-operation vs America First
In the immediate aftermath of Donald Trump’s election as US president in November 2016, it looked as though global regulatory cooperation was doomed. Congressman Patrick McHenry of North Carolina, chair of the US House Financial Services Committee, asked the Fed to stop participating in international forums on financial regulation, arguing that continued involvement ran contrary to “the message delivered by President Donald Trump in prioritising America’s interest in international negotiations”.
But the actual banking regulation proposals coming from the Trump administration’s Treasury team have suggested making it easier for foreign banks operating in the US. The Treasury’s paper on banking, published on June 12 last year, suggested “changes to the current framework [for foreign banking organisations] should be considered to encourage foreign banks to increase investment in US financial markets and provide credit to the US economy.”
Deutsche Bank’s equity research team noted in August that international groups had been injecting ever more equity into their US IHCs, making it harder for their US businesses to achieve return on capital targets. Deutsche itself has since unveiled a sweeping new set of cuts to its US investment banking and trading businesses.
Meanwhile, US tax treatment, following last year’s package of tax cuts, is also likely to affect foreign bank funding strategies. As first reported in GlobalCapital, some firms could fund themselves out of the IHCs directly, undermining the “single point of entry” approach to resolution.
Others are more likely to issue debt via their US branches, which could be pushed down to IHCs without tripping over cross-border tax provisions. Deutsche Bank has already launched a major liability management exercise to switch dollar debt from its Frankfurt and London branches to New York.