TLAC is failing its ultimate test — HSBC

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TLAC is failing its ultimate test — HSBC

HSBC is the ultimate test for the international rules on total loss-absorbing capacity (TLAC). If they don’t work for that shop, then how can anyone be certain they will work elsewhere? That’s why it is worrying that the bank has had to compromise its TLAC plan.

HSBC is officially the most complicated bank in the world. It is not quite the largest — its $2.4tr balance sheet comes in well behind ICBC’s $3.52tr — but it is, according to the G20’s Financial Stability Board, the most systemically important institution on the planet.

That means it sets the benchmark for the rules designed to end too-big-to-fail.

Design something that will allow HSBC to be resolved without taxpayer money, and every other bank should be easy by comparison. Unfortunately, the TLAC rules, despite Bank of England governor, Mark Carney’s optimism, do not solve that problem.

In the bank’s annual report on Monday, it laid out how it plans to solve the TLAC problem.

Or, more precisely, it lays out why it still can’t come up with a permanent TLAC solution, despite the urgency of the project. HSBC, and the other globally important banks, have to meet the first layer of TLAC rules by the beginning of 2019, with full phase-in by 2022.

HSBC said it will be issuing $60bn-$80bn of debt to meet its TLAC requirements, with $51bn of senior debt maturing in the same period. That is net new issuance of nearly $10bn per year — a heavy funding load, even for a bank of HSBC’s size.

That is why it is worth getting started right away. Wait for another year, another paper from the Federal Reserve, and another round of G20 meetings, and HSBC could have $15bn per year of extra senior debt to raise instead of $10bn, and other global banks will be crowding through the same slim market windows.

But the TLAC rules remain riddled with inconsistency, mostly about the rights different regulators might hold when a big bank goes down.

TLAC rules require banks to issue debt which regulators can force losses on, protecting taxpayers from the consequences of bank failure, but passing losses onto the debt holder. Within banking groups, this is often, but does not have to be, the parent company.

Where do the losses go?

In a group as complicated as HSBC, planning where losses might fall isn’t easy. HSBC operates in 71 countries, has eight intermediate holding companies, and 21 major operating subsidiaries, according to the bank’s group structure chart.

No regulator wants the HSBC subsidiary in their jurisdiction to be undercapitalised, and all want as much autonomy as possible in forcing losses on bondholders if their subsidiary fails.

They certainly do not want the HSBC group, or its home regulator, still, thanks to last week’s decision, the UK’s Prudential Regulatory Authority, to be able to shift capital around the group without their approval.

But that’s precisely what any home regulator would want to do. If HSBC Egypt gets into big trouble, the PRA will want the HSBC group to make good the losses rather than the Egyptian regulator choosing to write down bonds issued from the subsidiary to the group, which would send losses back up to the HSBC parent company.

The TLAC rules issued by the Financial Stability Board take account of this tension, balancing the rights of home and host regulator. Not all losses can be passed up to group level. Banks are encouraged to issue locally loss-absorbing debt, particularly from their intermediate holding companies (rather than the operating companies which actually do the banking).

Fed has other ideas

However, the Federal Reserve, the most important “host” regulator for any non-US bank, has other ideas. For the Fed, all TLAC debt must come from the parent, despite its insistence on creating a local intermediate holding company for all major foreign banks.

It gets more complicated. The latest TLAC termsheet makes it clear that banks which can be resolved at multiple levels (multiple point of entry or MPE banks) should not suffer any disadvantage compared to banks which do their resolution planning focused on a single point (SPE banks).

But adjusting the capital requirements so MPE banks (likely to be HSBC and Santander) are not penalised will mean taking capital out of a subsidiary — something no regulator will want to volunteer for.

Not surprisingly, even HSBC is baffled. Group finance director, Iain Mackay said on Monday that the bank will stick to issuing all of its loss-absorbing debt from the group holding company, HSBC Holding plc, until further notice — likely to mean at least a year.

“In the short term, one of the reasons for issuing from the group holding company not the intermediate holding company [the US resolution entity] is the Federal Reserve’s proposals on TLAC,” he said.

“The Fed proposals on TLAC potentially challenge the concept of multiple point of entry,” said Mackay. “There’s still quite a lot of work to do with regulators.”

Still not a plan

This isn’t exactly a ringing endorsement of an ambitious new capital regulation. Ending too-big-to-fail is a laudable aim, and making bondholders, not taxpayers, suffer is well worth doing too.

But all resolution rules need certainty, because the task at hand is so astonishingly complex.

In HSBC’s case, it is trying to raise an extra $30bn of debt, locate loss-absorbing capacity around the world, run more than 60 different stress tests, and provide investors in each of its debt and capital instruments with accurate information on its solvency. It needs to provide living will documents to multiple regulators, explaining how it will be wound up. If it has any spare time, it also needs to try to make some money as well.

Resolution rules also need to be certain because regulators need them to be certain. The aim of any of the new resolution tools is to wind up a big bank in a weekend, between the close of choppy markets on Friday and the Asian hours opening on Monday.

More than seven years after Lehman collapsed, TLAC still doesn’t achieve that aim.

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