GlobalCapital: What is the SRB’s timetable for finalising its MREL policy?
Laboureix: Our MREL policy goal is clear — to make banks resolvable — but our policy is largely a moving target as it is complicated by a number of factors. We have published our policy for 2017, which is based on the current framework we have to implement. But clearly there have been discussions about changes to the MREL framework in the European Commission, Council and Parliament. What we have said is that just because this framework may be changing, it does not mean that we have to take these changes into account already. The present law is the applicable law.
We will continue implementing our policy until we have all the elements we need from the updated BRRD, including an implementation phase and a transposition date. But our MREL policy itself is also changing. We have started at a consolidated level and we want to go beyond that and address other issues, including the internal allocation of MREL.
GlobalCapital: We have already seen the first binding MREL requirements being communicated by the banks.
Laboureix: Yes, this year we decided to cover the biggest and most complex firms with binding MREL targets, including all of the G-SIBs. That’s an important change compared with last year, when we only gave banks an indication of their MREL targets for information purposes. Smaller and less complex banks are still under this informative approach, but the idea is to have more and more binding targets going forwards. The journey to MREL is made of several stops.
Laboureix: Our policy is not to publish targets ourselves because we fundamentally think that they are not easy to understand by market participants and by third party stakeholders.
The way we compute the MREL requirement depends on various elements, including levels of subordination and where MREL is located internally. It is exclusively a Pillar 2 approach — that is to say that it is tailored to the specific risk profile of each bank. This is a bit different from solvency requirements, where there is a clear Pillar 1 target plus an additional Pillar 2 layer, which varies from one bank to another. That is why it can be difficult to disclose MREL targets without a full explanation of what they mean.
It is not because we are against transparency — we are fully supportive of transparency. But we are confronted with difficulties because these MREL targets are moving and they evolve. To put out the requirements and say that banks must respect them could also create a misunderstanding with some investors when they discover next year that the targets have changed.
What we’ve said to the banks is that they should consider for themselves whether there is value for investors in disclosing their targets.
GlobalCapital: Can banks reduce their MREL requirements by removing impediments to resolution?
Laboureix: There are some elements of the MREL computation that can either go up or down, which means that banks can partly have an influence on their final targets. We have recognised the possibility that banks could use what we call recovery options, for instance. If we enter into the crisis room because a bank is failing, it is not for us at that moment to discover the options that we could use in a resolution scheme.
The more that banks develop options that are available to be used at short notice, with immediate consequences on their size and on the riskiness of their balance sheets, the better for recognising them in our MREL computation.
GlobalCapital: How do you determine subordination requirements?
Laboureix: This is entirely new and it was a key feature of the 2017 MREL policy. We have set the subordination level for G-SIBs or OSIIs at 13.5% of their risk-weighted assets. That is based on the TLAC term sheet, which has a level of 16% — of which 2.5% may not necessarily need to be fully subordinated to operating liabilities. That does not mean we will not end up at 16%, but we have started at 13.5% and may decide to go beyond this on a case by case basis. For banks that are not G-SIBs or OSIIs, we have set the minimum for subordinated instruments at 12%.
This is to some extent rather demanding for non G-SIBs, but it reflects the fact that we not only believe that banks should have a sufficient quantity of MREL but also a sufficient quality.
The second feature here relates to the no creditor worse off principle, which says that bailed-in classes should not be treated any worse in a resolution than they would have been in a liquidation. If a bank has a high proportion of MREL-excluded liabilities, it could raise the probability of a breach of no creditor worse off.
To address this risk, we have set a maximum threshold of 10% for excluded liabilities. The threshold is not compulsory in 2018, but we have said that there is a risk that banks have to have more subordinated instruments in the coming years, also based on the resolvability assessment.
GlobalCapital: Do you consider 10% to be a firm threshold for excluded liabilities when you think about the no creditor worse off assessment, or are there grey areas?
Laboureix: Having a threshold of 10% of excluded liabilities will not fully prevent there from being any risk of a breach of no creditor worse off. If you wanted zero risk, you would have to set the threshold at 0%. The way we think about implementing this principle is to do so in a way that does not prevent us from taking the specificities of the profile of the bank into account. We have addressed this issue in the policy work we are currently conducting, but we have not yet decided on the way in which we will implement this in 2018.
GlobalCapital: Once the SRB has applied MREL, is there a possibility that some national resolution authorities can go above and beyond the standards?
Laboureix: We want a common approach and consistency throughout the Banking Union. It would not make sense to let a national resolution authority decide on an adjustment of the level of prudence. It is not for national resolution authorities to decide about this for institutions under our direct remit, which include about 110 significant institutions and 15 less significant ones with cross-border activities.
National resolution authorities do have direct responsibility for less significant institutions (LSIs) than these, but they must first ask us to check the consistency of their draft decisions with our MREL framework.
GlobalCapital: What will change with the 2018 policy?
Laboureix: One key issue we are looking at is the notion of internal MREL, which is not so well established in the current BRRD. If we want to give value to the single point of entry resolution strategy, we need to implement internal MREL. That’s because a single point of entry strategy is based on the idea that you can protect a bank’s subsidiaries from a resolution decision by upstreaming losses and downstreaming MREL instruments. You need to know where MREL is located in order to be able to do this.
There are a number of difficult elements to take into account when calibrating internal MREL. One of them has to do with the pre-positioning of instruments. In the TLAC term sheet there is the idea that you should pre-position liabilities at a material subsidiary of between 75% and 90% of what they might need if they had their own TLAC requirements.
This is the debate we are having in Europe. But you also need to look at how you treat banking group entities if they are all within the Banking Union, and at how you treat them if they operate in third countries. We will start the determination of internal MREL in the 2018 policy.
GlobalCapital: What should happen if a bank breaches its MREL requirements?
Laboureix: A breach should be taken very seriously — just as seriously as a solvency breach. That is why we are monitoring MREL targets, to avoid having to tell banks that they are in breach of their targets and taking the sanctions we have the right to take under the BRRD.
But the right way to talk about the introduction of MREL is not to start telling banks that they must respect the requirements or face sanctions. What we want to do is ask banks to improve their resolvability and make sure that everyone understands that MREL is a key tool in achieving this. There are more carrots than sticks in this process.
A more resolvable bank is better protected from a crisis — this is the magic of MREL. The more banks are resolvable, the less we have to use our tools to resolve them.
GlobalCapital: How have past cases influenced the way in which the SRB looks at the resolvability of financial institutions?
Laboureix: We have only had one case of resolution, with Banco Popular, and three decisions to let banks go into normal insolvency procedures. In the case of Popular, we implemented the framework smoothly. We should not be shy — it was a success. But we were lucky as a number of parameters were well aligned in our favour. The bank had a rather high amount of own funds and eligible liabilities for write down, conversion and bail in.
The lesson we have drawn from the Popular case is that banks should build up an MREL layer, because we need it. We did not have to bail-in the senior classes because the price offered for the bank by Santander matched with the write-down and conversion of the subordinated classes. But if the price had been lower, we would have bailed-in more. We did not stop at the subordinated bond layer because we could not go beyond. We could have gone beyond.
A second lesson is on the liquidity side. In all the cases we have been confronted with, the immediate source of the crisis for the banks was a liquidity shortfall. We have to ensure that once we have taken a bail-in decision, we can find sufficient liquidity for the post-resolution institution to meet its minimum requirements.
The bank must not only respect its solvency ratio, but also the liquidity ratio.