FSB and IOSCO Seek to Identify Non-bank Non-insurer G-SIFIs

On 8 January 2014, the Financial Stability Board (FSB) and the International Organization of Securities Commissions (IOSCO) published a consultation paper on “Assessment Methodologies for Identifying Non-Bank Non-Insurer Global Systemically Important Financial Institutions” (NBNI G-SIFIs).  The consultation period closes on 7 April 2014. Continue reading

How to Spot a G-SII

Introduction

On 12 December 2013, the European Banking Authority (EBA) published a consultation paper on draft regulatory technical standards (RTS) on the methodology for the identification of global systemically important institutions (G-SIIs)[1] and draft implementing technical standards (ITS) on uniform formats and dates for the disclose of the values of the indicators used for determining the score of G-SIIS[2]. Continue reading

FSB Updates G-SIB List

On 11 November 2013, the Financial Stability Board (FSB) published an updated list of global systemically important banks (G-SIBs) using end-2012 data.

The Basel Committee on Banking Supervision (BCBS) has also separately published the denominators used to calculate G-SIB scores and the Cut-off score and bucket thresholds that were used to allocate G-SIBs to particular buckets. The denominators are to be updated annually, while the cut-off score and bucket thresholds will remain fixed until November 2017, the date when the first three year review of the G-SIB assessment methodology is due to completed. Continue reading

Updated G-SIB Methodology Highlights Importance of Data

Introduction

On 3 July 2013, the Basel Committee on Banking Supervision (BCBS) published an “Updated assessment methodology and the higher loss absorbency requirement” (the “Updated Methodology”) for identifying globally systemically important banks (“G-SIBs”), accompanied by a reporting template and instructions.

The Methodology

The Updated Methodology replaces the BCBS’ previous “Global systemically important banks: assessment methodology and the additional loss absorbency requirement”, published in November 2011.  It defines a methodology for identifying G-SIBs founded on an indicator-based measurement approach.  Each indicator is group into one of five equally-weighted categories, as detailed below:

Quantitative Indicator-Based Approach

Category (and weighting)

Individual Indicator

Indicator weighting

Cross-jurisdictional activity (20%) Cross-jurisdictional claims

10%

  Cross-jurisdictional liabilities

10%

Size (20%) Total exposures as defined for use in the Basel III leverage ratio

20%

Interconnectedness (20%) Intra-financial system assets

6.67%

  Intra-financial system liabilities

6.67%

  Securities outstanding

6.67%

Substitutability/financial institution infrastructure (20%) Assets under custody

6.67%

  Payments activity

6.67%

  Underwritten transactions in debt and equity markets

6.67%

Complexity (20%) Notional amount of OTC derivatives

6.67%

  Level 3 assets

6.67%

  Trading and available-for-sale securities

6.67%

For each bank being assessed, the score for a particular indicator is calculated by dividing the individual bank amount (expressed in EUR) by the aggregate amount for the indicator summed across all banks in the sample.  This figure is then multiplied by 10,000 to express the indicator score in terms of basis points.  Each category score for a bank is determined by taking a simple average of the indicator scores in that category. The overall score for a bank is then calculated by taking a simple average of its five category scores.

Qualitative Supervisory Judgment

The quantitative indicator-based approach described above can be supplemented with qualitative supervisory judgment.  This is only meant to override the indicator-based approach in exceptional circumstances, is subject to peer review and is based on the following four principles:

  • the bar for judgmental adjustment to indicator-based scores should be high;
  • the process should focus on factors pertaining to the impact of a bank’s failure, not the probability of its failure;
  • views on the quality of the policy/resolution framework within a jurisdiction should not be taken into account; and
  • the judgmental overlay should comprise well documented and verifiable quantitative as well as qualitative information.

Identifying G-SIBs and Higher Loss Absorbency

Banks that have an assessment score that exceeds a pre-determined cutoff level will be classified as G-SIBs.  Supervisory judgment may also be used to add banks with scores below the cutoff to the G-SIB list.  G-SIBs will be initially allocated into four equally sized buckets based on their scores, with varying levels of higher loss absorbency (“HLA”) requirements applied to the different buckets, as detailed below.  It is worth noting that the figures below represent minimum levels, with national regulators being free to impose higher requirements if they so wish.

The G-SIB assessment will be performed annually and may lead to the reallocation of a G-SIB into a different bucket.  The timing of the publication of the cutoff score and bucket thresholds has been brought forward by one year to November 2013 and will be based on end-2012 data supplied by banks.  Whereas previously, the BCBS had intended to delay updating the denominators used to calculate banks’ scores until the completion of the first three-year review of the G-SIB methodology, denominators will now be updated on an annual basis so as to avoid creating a “cliff effect” for banks.  The methodology itself will be reviewed every three years in order to capture developments in the banking sector and advances in the measurement of systemic importance.

The HLA requirement is to be met only with Common Equity Tier 1 capital and will be implemented through an extension of the capital conservation buffer.  It will be phased in in parallel with the capital conservation and countercyclical buffers, starting on 1 January 2016 and becoming fully effective on 1 January 2019.

Bucket

Higher Loss Absorbency Requirement (common equity as a percentage of risk-weighted assets)

 

5

3.5%

4

2.5%

3

2.0%

2

1.5%

1

1.0%

If a G-SIB breaches the HLA requirement, it will be required to remediate and will be subject to limitations on dividend payouts in the meantime.  If a G-SIB is reallocated into a higher bucket, it will be required to meet the additional HLA requirement within 12 months.

Disclosure requirements

Starting with financial year-ends on or around 31 December 2013 and continuing thereafter, all banks with a leverage ratio exposure measure exceeding EUR 200 billion (this will automatically include the world’s 75 largest banks) will be required to ensure that the 12 indicators used in the assessment methodology are made publicly available.  This disclosure should be required no later than four months after the financial year-end, and by the end of the following July at the latest.  The reporting and disclosure requirements necessary to facilitate implementation must be enacted by national regulators by 1 January 2014.

Conclusion

The reporting templates through which bank supply the underlying information on which the G-SIB assessment methodology is based, highlights the increasing importance of data in the lives of banks.  The data required to be provided as part of G-SIB identification process is high level but assumes that banks have equally high levels of underlying data integrity as well as ready access to information pertaining to a wide range of activities, including on- and off- balance sheet items, derivatives, security arrangements and payments.

In an environment where regulatory constraints are restricting the ability of banks to broaden their business offerings, the ability to generate and disseminate accurate data is fast becoming the new frontier by which banks can differentiate themselves in front of both their clients and their regulators.  In order to take advantage of this changing landscape, it is imperative that banks focus on the development of a culture whereby data occupies a position of central importance within the institution.  As the updated G-SIB methodology shows, over time, the consequences of failing to get this right will only become yet more serious.

FSB Completes Stage 1 of G-SIB Common Data Template

On 18 April 2013, the Financial Stability Board (FSB) published a press release announcing the completion of a common data template for globally systemically important banks (G-SIBs).

The financial crisis highlighted major gaps in information on systemically important financial institutions, particularly the bilateral linkages between such institutions, or their common exposures and liabilities to financial sectors and national markets.  In response, the G-20 charged the FSB with developing:

  • a common data template for systemically important global financial institutions; and
  • proposals for an international framework to support the collection and sharing of information on such institutions.

 The G-SIB template represents the completion of stage 1 of the project.  Stages 2 and 3 will involve the extension of the framework to include the collection of data on bilateral funding dependencies and consolidated balance sheet.  The data will be held in a central data hub, hosted by the BIS, and will be shared on with national supervisory authorities which are part of the framework.

Resolution Plans for all G-SIBs by End of June 2013

On 16 February 2013, the finance ministers and central bank governors of the G20 published a communique following the closure of their meeting in Moscow on 15 and 16 February 2013.  Amongst other things, the G20 confirmed that operational resolution plans for all global systemically important banks (G-SIBs) should be developed by the end of June 2013 and resolved to address all impediments to effective home-host cooperation of resolution authorities for internationally active banks.

Insurers Less Systemically Important Than Banks Says Geneva Association

Introduction

On 11 December 2012, the Geneva Association, a think-tank for the insurance industry, published a cross-industry analysis comparing the 28 Global Systemically Important Banks (G-SIBs) to 28 of the world’s largest insurers on indicators of systemic risk.

The analysis studied 17 indicators that are regarded as being comparable between insurers and banks to provide an analysis of the size of each activity. The conclusions drawn were that:

Insurers are significantly smaller than banks

  • The average bank’s assets are 3.9 times larger than the average insurer;
  • The largest insurer would rank only 22nd in the list of G-SIBSs by size.

Insurers write considerably less CDS than banks

  • The average bank writes 158 times the value of gross notional Credit Default Swaps (CDS) than the average insurer;
  • The lowest ranked banks on average have 12.5 times the CDS sold by the average insurer.

Insurers utilise substantially less short-term funding than banks

  • Short-term funding as a percentage of total banks assets is 6.5 times higher than short-term funding as a percentage of insurer assets.

Insurers are less interconnected to other financial services providers than banks

  • Banks carry 219 times more gross derivative exposure than the insurer average;
  • The lowest ranked banks carrying 66 times more gross derivative exposure than the average insurer;
  • At the measurement date, banks owed on average 68 times more than insurers in gross negative derivatives;
  • Banks are owed 70 times more from derivatives counterparties through derivatives exposure than insurers.

 

FDIC and BoE Publish Strategy Paper on Resolution Plans

Introduction

On 10 December 2012, the Federal Deposit Insurance Corporation (FDIC) and the Bank of England (BOE) published a joint strategy paper on the resolution of globally active, systemically important, financial institutions (G-SIFIs).

Broadly speaking, there are two main approaches to the resolution of G-SIFIs:

  • “Single point of entry” (or “top down”) resolution pursuant to which a single national resolution authority applies resolution powers to the parent company of a failing financial group; or
  • “Multiple point of entry” resolution whereby resolution powers are applied to different parts of a failing financial group by two or more resolution authorities in coordination.

The paper focuses on “top-down” resolution with respect to both UK and US cross-border financial services groups.  The key advantage of “top-down” resolution is seen as being the ability for viable subsidiaries, both domestic and foreign, to continue to operate.  Not only should this limit contagion but it will hopefully mitigate cross-border complications arising as a result of the institution of separate territorial and entity-focused insolvency proceedings.  However, it is expressly recognised that there are certain circumstances where “multiple point of entry” resolution will be necessary, for example where losses are so great that they could not be absorbed by a group level bail-in or make the job of valuing the capital needs of the institution in resolution too difficult.

US approach to single point of entry resolution

The sequence of events with respect to a US single point of entry resolution is as follows:

Appointment of Receiver

The FDIC is appointed receiver of the parent holding company of the failing financial group.

Asset Transfer

The FDIC transfers assets (primarily equity and investments in subsidiaries) from the receivership estate to a bridge financial holding company.  In contrast, shareholder claims and claims of subordinated and unsecured debt holders remain in the receivership.  As such, the assets of the bridge holding company will far exceed its liabilities.

Valuation

A valuation process is undertaken so as to estimate the extent of losses in the receivership and allow their apportionment to shareholders and unsecured creditors in accordance with insolvency rankings.

Bail-In

Bail-in occurs to ensure that the bridge holding company has a strong capital base.  So as to provide a cushion against future losses, remaining debt claims are converted in part into equity claims in the new operation and/or into convertible subordinated debt.  Any remaining debt claims are transferred to the new operation in the form of new unsecured debt.

Liquidity Concerns are Addressed

To the extent that liquidity concerns have not been addressed by the transfer of equity and investments in operating subsidiaries to the bridge holding company, the FDIC can provide assurances of performance and/or limited scope guarantees.  As a last resort, the FDIC may also access the Orderly Liquidation Fund (OLF), a fund within the U.S. Treasury set up under the Dodd-Frank Act.  However, the Dodd-Frank Act prohibits the loss of any taxpayer money in the orderly liquidation process.  Therefore, any OLF funds used must either be repaid from recoveries on the assets of the failed financial company or from assessments made against the largest, most complex financial companies.

Firm is restructured

In this stage, the focus will be on making the failed firm less systemically important and more resolvable.  Senior management are likely to be removed at this point.

Ownership Transfer

The final stage of the process is to transfer ownership and control of the surviving operation to private hands.

UK approach to single point of entry resolution

The sequence of events with respect to a UK single point of entry resolution is as follows:

Equity/Debt Transfer

Initially, existing equity and debt securities will be transferred to an appointed trustee.

Listing Suspension

Subsequently, the listing of the company’s equity securities (and potentially debt securities) would be suspended.

Valuation

A valuation process would then be undertaken in order to understand the extent of the losses expected to be incurred by the firm and, in turn, the recapitalisation requirement.

Bail-In

Following valuation, an announcement of the terms of any write-down and/or conversion pursuant to the exercise of bail-in powers would be made to the previous security holders.  In writing down losses, the existing creditor hierarchy would be respected.   Inter-company loans would be written down in a manner that ensures that the subsidiaries remain viable.  Deposit Guarantee Schemes would also be bailed-in at this point.  At the end of the process, the firm would be recapitalised and would likely be owned by its original creditors.

Liquidity Concerns are Addressed

So as to mitigate liquidity issues and facilitate market access, illiquid assets could be transferred to an asset management company to be worked out over a longer period.  In the event that market funding was simply not available, temporary funding could be provided by authorities on a fully collateralized, haircut, basis.  However, any losses associated with the provision of such temporary public sector support would be recovered from the financial sector as a whole.

Firm is Restructured

On completion of the bail-in process, the firm would be restructured to address the causes of its failure.

Re-Transfer

Subsequently, the trustee would transfer the equity (and potentially some debt) back to the original creditors of the firm.  Any creditors which are unable to hold equity securities (e.g. due to mandate restrictions) would be able to request that the trustee sell the equity on their behalf.

Resumption of Trading

The final stage of the process would involve the dissolution of the trust and the resumption of trading in the equity and/or debt securities of the restructured firm.

Similarities Between the Regimes

Both approaches emphasise the importance of ensuring the continuity of critical services of the failing group, whether in the home jurisdiction or abroad.  Shareholders under both regimes can expect to be wiped out and unsecured debt holders can expect their claims to be written down (to reflect any losses that shareholders cannot cover) and/or partly converted into equity (in order to recapitalise the entity in question).  Existing insolvency hierarchies will be respected, but in both cases, a valuation process will be required.  The precise mechanics of any such valuation are unlikely to be the same across both the UK and the US, but consideration is being given in both jurisdictions as to the extent to which the valuation process can be prepared in advance.  Not only would the valuation process assess the losses that a firm had incurred and what financial instruments (if any) the different classes of creditors of the firm should receive, but it would also assess the future capital needs of the business necessary to restore “confidence” in the firm.  It seems likely that this will be a level significantly higher than that required simply to restore viability.  In both cases, resolution will be accompanied by an restructuring of the business.  This may involve breaking an institution into smaller, less systemically important entities, liquidating or closing certain operations and a replacement of management.

The future

The high level strategies detailed by the FDIC and BOE will be translated into detailed resolution plans for each firm during the first half of 2013. It is anticipated that firm-specific resolvability assessments will be developed by the end of 2013 on the basis of the resolution plans.

Deadline for G-SIB Resolution Plans Pushed Back

On 5 November 2012, the Financial Stability Board (FSB) published a letter dated 31 October 2012 addressed to the G20 regarding progress made with respect to financial regulatory reforms.

The FSB reported ‘solid but uneven’ progress” in the four priority areas identified by the G20, being:

  • building resilient financial institutions (i.e. Basel III);
  • ending “too big to fail” (i.e. RRP);
  • strengthening the oversight and regulation of shadow banking activities; and
  • completion of OTC derivatives and related reforms.

On the subject on ending “too big to fail”, the FSB noted that a peer review of national actions taken to legislate its “Key Attributes of Effective Resolution Regimes” document will now be published in the first half of 2013.  More importantly, however, on the subject of resolution planning for Globally Systemically Important Financial Institutions (G-SIFIs), the FSB confirmed that the deadline for completion of operational resolution plans for Globally Systemically Important Banks (G-SIBs) has been extended by six months until mid-2013.  Consequently, the FSB’s peer-based resolvability assessment process will now be delayed until the second half of 2013.

Changes to the G-SIFI List

In November 2011, the Financial Stability Board (FSB) published its initial list of Global Systemically Important Banks (G-SIBs).  On 1 November 2012, the list was updated, with BBVA and Standard Chartered being added to the list and Commerzbank, Dexia and Lloyds all being removed.

The significance of being classified as a G-SIB lies in the fact that, under Basel III, any bank identified as a G-SIB in November 2014 will be required to maintain additional loss absorbency.  This requirement will be phased in between January 2016 and January 2019 and ranges between 1% and 2.5% of risk weighted assets depending on the significance of the individual firm.  G-SIBs are also required to meet higher supervisory standards for risk management functions, data aggregation capabilities, risk governance and internal controls.  Any firm newly designated as a G-SIB is required to implement certain resolution planning requirements within specified deadlines.  Furthermore, even where a financial institution is no longer designated as a G-SIB it will continue to be subject to the requirement to prepare an RRP to the extent that it is assessed by its national regulator to be systemically significant or critical in the event of failure.

For the first time, the current list of G-SIBs has been allocated into provisional buckets corresponding to the required level of additional loss absorbency, as set out in more detail in Annex 1 below.  The timetable for implementation of resolution planning requirements for newly designated G-SIFIs is detailed in Annex 2 below.

Annex 1

  

Bucket

G-SIB in alphabetical order within each   bucket

5

(3.5%)

(Empty)

 4

(2.5%)

Citigroup

Deutsche Bank

HSBC

JP Morgan Chase

3

(2.0%)

Barclays

BNP Paribas

 2

(1.5%)

Bank of America

Bank of New York Mellon

Credit Suisse

Goldman Sachs

Mitsubishi UFJ FG

Morgan Stanley

Royal Bank of Scotland

UBS

1

(1.0%)

Bank of China

BBVA

Group BPCE

Group Credit Agricole

ING Bank

Mizuho FG

Nordea

Santander

Societe Generale

Standard Chartered

State Street

Sumitomo Mitsui FG

Unicredit Group

Wells Fargo

Annex 2

G-SIFI Requirement Deadline for completion following date of G-SIFI designation
Establishment of Crisis Management Group (CMG)

6 months

 

Development of recovery plan

12 months

 

Development of resolution strategy and review within CMG

12 months

 

Agreement of institution specific cross-border cooperation agreement

18 months

 

Development of operational resolution plan

18 months

 

Conduct of resolvability assessment by CMG and resolvability assessment process

24 months