December 17, 2015

Market Impact of TLAC Requirements

FIG DCM Bank Capital Solutions

1

RWA vs. SLR Driven TLAC Requirements

• The Fed’s RWA driven minimum TLAC requirements appear to be well aligned with FSB requirements

• The Fed’s leverage ratio driven minimum TLAC (9.5%) materially exceeds FSB requirements (6.75%)

• The Fed’s implied minimum TLAC debt (i.e. 47%) requirement is also more binding than FSB’s 33% TLAC debt requirement

Key1

External LTD requirement (RWA approach – 6.0% + GSIB surcharge)

Capital Conservation Buffer (2.5% + GSIB surcharge)

1.5% Additional Tier 1

4.5% CET1 Minimum

LTD

Tier 1 Capital

TLAC

1. GSIB surcharge applied to minimum LTD requirement and the capital conservation buffer is based on estimates disclosed with the GSIB capital surcharge final rule in July 2015.

23% FSB Max

21% FSB Min

FSB SLR 6.75%

Fed's SLR driven TLAC requirement is more stringent than FSB TLAC framework

13.0%12.0%

11.0% 10.5%11.5% 11.5%

10.0% 9.5%

10.5%

9.5%9.0%

8.0%

9.0% 9.0%

7.5%7.0%

23.0% 22.5% 22.0% 21.5% 21.5% 21.5% 21.0% 21.0%

23.5%

21.5%

20.0%18.5% 20.5% 20.5%

17.5%16.5%

0%

5%

10%

15%

20%

25%

JPM C BAC WFC MS GS STT BK

5.0% 5.0% 5.0% 5.0% 5.0% 5.0% 5.0% 5.0%

4.5% 4.5% 4.5% 4.5% 4.5% 4.5% 4.5% 4.5%

0%

2%

4%

6%

8%

10%

JPM C BAC WFC MS GS STT BK

2

170 158 173 141 72 59 24 16 20 10 6 31 36 33 36 14 10 28 29 5 9 138 136 120 72 146 122 28 1 12 12 0JPM BAC C WFC GS MS

($Bn) 2022 LTD Shortfall 2019 LTD Shortfall Additional TLAC Qualifying Capital Shortfall

Tier 2 Additional Tier 1 Common Equity Tier 1

Source: Bloomberg, SNL, Company Filings as of 6/30/15; debt outstanding as of 10/2/15. 1. We estimate that 10% TLAC / Leverage Exposure is binding for JPM relative to 16% RWA and for BNY & STT relative to 16 & 18% RWA

Capital & TLAC Shortfall Need

U.S. G-SIBs Appear to be Well Positioned

Avg. Annual Sr. Issuance $21.5 $29.0 $20.4 $18.5 $24.2 $19.5 $4.7 $3.3 2022 LTD Need as Multiple 1.3x 0.9x n/a 2.4x n/a n/a n/a 1.2x Sr. Bank Debt Out $52.4 $11.5 $4.8 $18.3 n/a n/a n/a n/a % of 2022 LTD Need 52% 226% n/a 245% n/a n/a n/a n/a

Proposed rule is fairly benign relative to market expectations

We estimate that the US G-SIBs will need $164bn of additional TLAC, $62bn of which is capital shortfall and $102bn of which is due to LTD shortfall

Some of the LTD shortfall can be met by refinancing bank level debt with Holdco leading to ~40bn incremental supply

174 162 173 143

72 59

25 16 1

20

10 6

32

36 34 38

14 11

21 40

120 120

104

62

125

101

27

19

26

26

0

50

100

150

200

250

300

350

400

JPM BAC C WFC GS MS

($Bn)

18

13

2

3

2

1

18

8

4

0

10

20

30

40

BK STT

($Bn)

3

Capital Structure & TLAC Need at 16 / 18% RWAs (6.00 / 6.75% SLR) 1

The Canadian D-SIBs Have Excess Wholesale Funding

Source: Bloomberg, SNL, Company Filings as of 7/31/15; debt outstanding as of 10/23/15. 1. We do not anticipate a 6.75% leverage requirement to be binding for any Canadian bank

Incremental Grandfathered Senior Debt TLAC Required to Reach 18% TLAC Required to Reach 16%

Tier 2 Additional Tier 1 Common Equity Tier 1

Avg. Annual Sr. Issuance $18.3 $10.8 $8.7 $6.0 $24.5 $3.9 $2.0 18% TLAC Need as Multiple 1.1x 2.6x 3.2x 3.2x 0.4X 1.0x 2.0x

25

17 16

6

3

3

2

5

4

2

2

14

7

2

3

5

3

2

1

23

22

7

8

0

20

40

60

80

BMO CIBC CCDJ NBC

Canadian D-SIBs have excess wholesale funding and regularly access the unsecured funding market globally

Given their regular access to the capital markets and upcoming maturity profile, the Canadian banks would be able to meet TLAC needs through refinancing

However, the grandfathering of the outstanding senior unsecured has made the situation more complicated

42 36 37

7

4 5

8

7 9

26

21 21

8

7 7

57

41 24

0

20

40

60

80

100

120

140

160

RBC BNS TD

(CAD Bn)

4

The criteria by which debt will qualify for TLAC in Europe will vary from jurisdiction to jurisdiction

For example, Deutsche Bank appears to have ample senior unsecured and is in a regime that already has a clear solution

CS & UBS, on the other hand, will need to issue HoldCo debt to meet the newly announced 10% leverage requirement for Swiss TLAC

Capital Structure & TLAC Need at 16 / 18% RWAs (6.00 / 6.75% SLR)1

Meaningful Uncertainty Remains in Europe

Source: Bloomberg, SNL, Company Filings as of 6/30/15; debt outstanding as of 10/23/15. 1. We estimate that the 6.75% leverage requirement is binding vs. 18% for BARC, and the 10% requirement is binding vs. both 16 and 18% for CS and UBS. 2. Hatch pattern represents senior debt of banks / in jurisdictions where the treatment is uncertain.

Avg. Annual Sr. Issuance € 12.2 € 13.6 € 7.5 € 8.4 € 8.4 € 16.3 € 2.6 € 13.9 € 10.0 € 1.5 € 10.0 € 3.0 € 8.3 € 2.6 € 16.7

Shortfall to 18% RWAs € 56.9 € 63.1 € 14.0 € 43.0 € 13.1 - € 1.8 € 21.0 € 29.6 € 23.2 € 25.6 - € 22 € 24 € 7.2

129

68 59 75 66

20

15

32

8 18 9 19

188

84

106

83 96

36

47 3

31 3

21

16 11 12

10

0

50

100

150

200

250

300

350

400

450

HSBC BNP BARC SAN CA

(EUR Bn)

59

40 49 43 43 39 35 36 36

24

3

7 2

4 0 4

7 2

3

7

14 12 12 11 9

16 9 11

4

114

95

63 57 58 56

73

13

4 32

13 22

15 16

22

24 3

2

8 8 8 9

4

0

20

40

60

80

100

120

140

160

180

200

DB RBS BPCE UNI BBVA SG STAN CS UBS NDA

2022 TLAC Shortfall

2019 TLAC Shortfall

Additional TLAC Qualifying Debt

Tier 2

Additional Tier 1

Common Equity Tier 1

For the European banks included in our analysis below, we estimate a total TLAC need at 18% of RWAS to be about €344.5bn

5

70

80

90

100

110

120

130

140

150

160

170

Jan-

14Fe

b-14

Mar

-14

Apr

-14

May

-14

Jun-

14Ju

l-14

Aug

-14

Sep-

14O

ct-1

4N

ov-1

4D

ec-1

4Ja

n-15

Feb-

15M

ar-1

5A

pr-1

5M

ay-1

5Ju

n-15

Jul-1

5A

ug-1

5Se

p-15

Oct

-15

Nov

-15

Dec

-15

GS Feb-23 JPM Feb-23

FSB to Fed Proposal Sep 14 -Sep15 GS/JPM Spread= 15-35ps

70

90

110

130

150

170

Jan-

14Fe

b-14

Mar

-14

Apr

-14

May

-14

Jun-

14Ju

l-14

Aug

-14

Sep-

14O

ct-1

4N

ov-1

4D

ec-1

4Ja

n-15

Feb-

15M

ar-1

5A

pr-1

5M

ay-1

5Ju

n-15

Jul-1

5A

ug-1

5Se

p-15

Oct

-15

Nov

-15

Dec

-15

JPM Sep-22 PNC Nov-22

Fed NPR Oct 30 JPM./ PNC= 15bps

FSB to Fed Proposal Sep 14 –Sep 15 JPM./ PNC Spread= 15-25bps

Spread Moves in U.S. Bank Senior We observed a modest 5 to 15 bps of relative widen in US Senior Holdco Spreads

Euro market (Spread to € Swap) US$ domestic market (Spread to Treasury)

Source: Bloomberg Source: Bloomberg

Pre-TLAC Jan – Aug 2014 JPM/ PNC Spread= 0 -10bps

FSB Proposal Nov 10, 2014 JPM./ PNC= 10bps

Post Fed -NPR Oct-Dec 15 JPM./ PNC 5-15bps

12/8/2015JPM/PNC = 5bps

Pre-TLAC Jan – Aug 2014 GS /JPM Spread= 35-45bps

Post Fed -NPR Oct-Dec 15 GS/JPM =25-35ps

12/82015 GS./ JPM 30ps

FSB Proposal Nov 10, 2014 GS /JPM=35bps Fed -NPR

Oct-Dec 15 GS/JPM ~30bps

6

20

30

40

50

60

70

80

90

100

Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov

DB Jan-23 RABOBK May-23

60

70

80

90

100

110

120

130

140

Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov

DB Feb-19 RABOBK Jan-19

Spreads moves in German bank Senior Confirmation of Bail-in risk has seen German senior spreads widen by 28 to 34bps on a relative basis

Euro market (Spread to € Swap) US$ domestic market (Spread to Treasury)

Source: Bloomberg Source: Bloomberg

10-Mar: German Draft Law

DB / Rabobank Spread = 7bps

Current

DB / Rabobank Spread = 35bps

10-Mar: German Draft Law

DB / Rabobank Spread = -11bps

Current

DB / Rabobank Spread = 23bps

7

Monthly Senior HoldCo Issuance 2013-2015 The Fed's NPR provided the market with clarity on the total amount of required TLAC and LTD

However, the qualification criteria (no cross-defaults, must be governed by U.S. law, etc.) have left issuers with meaningful questions on whether currently outstanding and interim-issued debt will qualify or be grandfathered

This has resulted in less supply from GSIBs since the NPR

Impact of NPR on Issuance Volume

0.0%

5.0%

10.0%

15.0%

20.0%

25.0%

30.0%

Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec

2013

2014

2015

November and December GSIB Senior Holdco issuance has been impacted by the Fed's NPR

Nov and Dec made up 5.6% of supply in 2015 vs. 10.5% and 8.5% in 2013 and 2014, respectively

Issue Date Issuer Ranking Rating Coupon (%) Size ($mm) Maturity Date

11/19/2015 BANK OF NY MELLON CORP Senior HC A1/A 2.450 800 11/27/2020

11/30/2015 WELLS FARGO & COMPANY Senior HC A2/A 2.550 2100 12/7/2020

11/30/2015 WELLS FARGO & COMPANY Senior HC A2/A 1.462 400 12/7/2020

12/1/2015 CITIGROUP INC Senior HC Baa1e/BBB+ 2.050 1650 12/7/2018

12/1/2015 CITIGROUP INC Senior HC A3/BBB+ 1.312 350 12/7/2018

GSIB Senior HoldCo Issuance Since November 2015

8

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The FSB Final TLAC Principles and

the Federal Reserve Board’s LTD,

TLAC and Clean Holding Company

Proposal

December 2015

NY2 763196

2

Objective of TLAC • Where does TLAC fit in?

• For Basel purposes, a bank must satisfy the minimum regulatory capital

requirements

• In addition to the minimum regulatory capital requirements, banks are subject to

the capital conservation buffer and any applicable counter-cyclical capital buffer

• In addition to that, G-SIBs must have “buffer” capital or a G-SIB “surcharge”

• Finally, G-SIBs must meet TLAC requirements

• TLAC is intended to prevent a bank failure

• TLAC would be relied upon to provide additional loss absorbency and

facilitate resolution

3

Where does TLAC fit in?

4

The Financial Stability

Board Principles

5

A timeline • Financial Stability Board Proposal for Comment was issued in

November 2014

• Comment period closed in February 2015

• FSB conducted a quantitative impact study (QIS) in which it collected

information from G-SIBs

• The final TLAC principles were released on November 9, 2015.

6

The FSB Principles-overview • Designed to facilitate orderly resolution of G-SIBs

• 30 banks globally

• Includes 8 US banks

• Calibration of minimum TLAC from January 1, 2019 of 16% of risk weighted

assets (RWAs) rising to 18% from January 1, 2022 and from January 1,

2019, 6% of the Basel III leverage ratio denominator and from January 1,

2022, rising to 6.75% of the Basel III leverage ratio denominator

• Phased in requirements for GSIBs headquartered in emerging markets

• Tier 1 and Tier 2 Capital is “eligible”

• Other eligible TLAC that is not regulatory capital

• Additional TLAC may be required for individual G-SIBs based on risk factors

• Two elements: Risk-weighted TLAC ratio and a TLAC leverage ratio

7

Regulatory capital instruments • TLAC and regulatory capital instruments

• The sum of a G-SIB’s resolution entity’s (1) T1 and T2 regulatory capital

instruments that are in the form of debt, plus (2) other eligible TLAC that is not

regulatory capital, is equal to or greater than 33% of the G-SIB’s minimum TLAC

requirement

• Regulatory capital instruments may count toward minimum TLAC requirement,

subject to certain conditions:

• CET1 regulatory capital instruments used to satisfy minimum TLAC

requirement cannot also be used to satisfy capital buffers

• Non-CET1 regulatory capital instruments must be issued under the laws of a

jurisdiction in which resolution tools, statutory write-down or conversion

powers are effective

• Non-CET1 regulatory capital instruments issued by subsidiaries of the

resolution entity, that are located in a different jurisdiction from the resolution

entity, must be capable of being written down or converted to equity at the

point of non-viability of the subsidiary without the subsidiary having to enter

into a resolution proceeding

8

Regulatory capital instruments (cont’d)

• Regulatory capital instruments issued from entities forming part of a material

subgroup may count toward minimum TLAC only to the extent that home and host

country authorities agree conversion to equity would not result in a change-of-

control

9

TLAC Eligibility Criteria • TLAC Eligibility Criteria:

• External TLAC must be issued and maintained by resolution entities (except, in

some circumstances, regulatory capital issued by wholly and directly-owned

funding entity will be eligible)

• Paid-in

• Unsecured

• Not subject to netting

• Perpetual or minimum remaining contractual maturity of one year (for any security

with a redemption feature, first redemption date would be effective maturity date;

“maturing” instruments would need to be replaced with new TLAC-eligible

instruments)

• Subject to certain limited exceptions, not funded directly by the resolution entity or

a related party of the resolution entity

• Eligible TLAC must contain a contractual trigger or be subject to a

statutory mechanism which permits the resolution authority to write

down or convert to equity

10

TLAC Eligibility Criteria (cont’d)

• Excludes

• Insured deposits, sight deposits and deposits with original maturity of less than 1

year

• Liabilities funded by the resolution entity or a related party (possible exception for

parent-funded TLAC in some circumstances where a multiple point of entry

resolution strategy applies)

• Liabilities arising from derivatives or debt instruments with derivative-linked

features—e.g., structured notes

• Non-contractual liabilities, such as tax liabilities

• Preferred liabilities

• Other liabilities that cannot be written down or converted to equity by resolution

authorities without giving rise to material risk of successful legal challenge/valid

compensation claim

11

TLAC Eligibility • Priority: in order to ensure that TLAC instruments absorb losses prior to

liabilities excluded from TLAC, TLAC eligible instruments generally must be:

• Contractually subordinated;

• Statutorily subordinated; or

• Structurally subordinated

• Redemption: eligible external TLAC instruments cannot be redeemed

without supervisory approval, unless G-SIB would still be in compliance with

TLAC requirements thereafter

• Deductions: a G-SIB must deduct from TLAC any holdings of third-party G-

SIB TLAC instruments (to avoid contagion risk)

12

TLAC Eligibility (cont’d)

• Liabilities that are not TLAC eligible may still remain subject to

potential bail-in under the European BRRD

13

TLAC Eligibility (cont’d)

• Treatment of debt issued by subsidiaries:

• Prior to January 1, 2022, debt liabilities issued by a wholly and directly owned

funding entity of the resolution entity may count for external TLAC purposes,

provided that:

• The issuance is consistent with paragraph 65 of the Basel III framework

(requires a finance company issuance), including that the assets of the

funding entity must meet the eligibility criteria for TLAC instruments;

• There is substantial legal certainty that the TLAC will absorb losses at the

resolution entity in its resolution; and

• Home and host authorities agreed on issuance through funding entity.

• Term sheet also provides for a phase-out from eligible TLAC of regulatory capital

instruments issued from subsidiaries within the resolution group and held by third

parties, except where the instrument constitutes CET1.

14

Internal TLAC • Resolution entity must have “External TLAC” as discussed

• Material sub-groups in jurisdictions outside of bank’s home country

must have “Internal TLAC”

• Each material sub-group must have 75-90% of the external TLAC that would be

required of the material sub-group, if it were a resolution group

• For this purpose, a “material sub-group” is one whose members are incorporated

in the same jurisdiction (other than the jurisdiction of the resolution entity) and are

not themselves resolution entities, do not form part of another material sub-group

of the resolution group and that: (i) has more than 5% of consolidated RWAs of

the G-SIB group; (2) generates more than 5% of total operating income of the G-

SIB group; (3) has total leverage exposures that are more than 5% of the G-SIB

group’s total leverage exposure; or (4) has been identified as material to the firm’s

critical functions

15

Internal TLAC (cont’d) • Internal TLAC:

• Loss-absorbing capacity at material subsidiaries of a resolution entity, which

subsidiaries are incorporated outside of the resolution entity’s home country

intended to facilitate resolution within the host country

• Minimum size of internal TLAC: each material sub-group must maintain internal

TLAC of 75% to 90% of the external minimum TLAC that would apply to the

material sub-group if it were a resolution group, as calculated by the host country.

In addition to the minimum, the host country could impose a firm-specific

requirement as well.

• Internal TLAC should be pre-positioned on-balance sheet at the material sub-

groups; internal TLAC that is not pre-positioned should be readily available

• Substitution: home/host countries may agree jointly to substitute on-balance

sheet internal TLAC with TLAC in the form of collateralized guarantees subject to

certain conditions

• Eligibility Criteria: criteria for internal TLAC and for external TLAC are the same

16

Implementation of FSB Principles How will FSB principles be implemented?

• Each jurisdiction must enact regulations that implement the principles

• In Europe, the BRRD establishes a minimum required eligible

liabilities (MREL) requirement (applies more broadly than the FSB

principles)

• Differences exist between MREL and TLAC:

• MREL applies from January 1 2016

• MREL applies to all European banks, not just GSIBs

• MREL levels are decided by each national resolution authority on a case-by-case

basis for their banks

• MREL eligibility requirements differ in some respects from TLAC (e.g. no

requirement for MREL subordination to excluded liabilities)

17

Implementation of FSB Principles (cont’d)

• MREL levels set by reference to own funds and liabilities i.e. non-risk-weighted

• Reconciliation likely to be achieved by level of discretion given to

national resolution authorities, by requirements to have regard to

issues such as the risk of exclusion from bail-in of otherwise eligible

liabilities and express ability in draft final RTS of EBA for resolution

authorities to consider RWA-based capital requirements and leverage

ratio requirements in setting MREL as a percentage of own funds and

liabilities

18

FRB Proposal

19

Single point of entry resolution

20

FRB proposal • The FRB released its proposal on October 30, 2015 which would

establish for covered BHCs and covered IHCs an external TLAC

requirement in the case of covered BHCs (and an internal TLAC

requirement in the case of covered IHCs), a related TLAC buffer, a

minimum long-term debt requirement for covered BHCs (and a

minimum internal long-term debt requirement for covered IHCs), and

a “clean holding company” requirement

• Premised on the view that TLAC alone is not sufficient to facilitate

SPOE resolution

• As a result, the FRB approach differs from the FSB approach

• In addition, to avoid contagion risk, the FRB proposal also would

penalize banks generally for holding unsecured debt of a covered

BHC

21

FRB proposal (cont’d)

• U.S. covered BHCs must maintain:

• Outstanding eligible external long-term debt equal to the greater of: (i) 6% of

RWAs, plus the applicable G-SIB buffer, and (ii) 4.5% of total leverage exposure,

plus

• Outstanding eligible external TLAC equal to the greater of: (i) 18% of RWAs

(when fully phased-in), and (ii) 9.5% of total leverage exposure

• An external TLAC buffer

22

External long-term debt • What is eligible external long-term debt?

• Debt securities issued directly by the covered BHC that:

• Are unsecured

• Are “plain vanilla”

• Are governed by U.S. law

• Have a remaining maturity of over one year

• Eligible external long-term debt with a maturity of less than two years

would be subject to a 50% haircut

• What is “plain vanilla” debt?

• The debt cannot contain an embedded derivative, have a credit sensitive feature,

contain any contractual conversion or exchange features, or include acceleration

rights, other than on payment defaults

• No structured notes

23

External TLAC • What is eligible external TLAC?

• The sum of (1) common equity Tier 1 capital and AT1 capital issued by the

covered BHC, and (2) eligible external LTD

• What is the amount of the external TLAC buffer?

• An external TLAC buffer is added on top of the 18% risk-based capital component

of the external TLAC requirement, which can be met only with common equity Tier

1 capital

• Equals the sum of 2.5%, any applicable countercyclical capital buffer, and the G-

SIB surcharge calculated under Method 1

• What is the consequence of failing to meet the external TLAC

buffer requirement?

• Restrictions on distributions and discretionary bonuses (similar to CCB)

24

IHCs of Foreign G-SIBs • A covered IHC would be subject to an internal LTD and an internal TLAC

requirement

• FBOs with consolidated global assets of $50 billion or more and

consolidated U.S. assets of $10 billion or more must establish an IHC

• The following are G-SIBs with an IHC requirement (based on FSB’s

11/2015 G-SIB list): • HSBC

• BNP

• Mitsubishi

• Deutsche

• Barclays

• RBS

• Mizuho

• SocGen

• Santander

• UBS

• Credit Suisse

25

IHCs of Foreign G-SIBs (cont’d)

• What is the internal LTD requirement?

• Internal LTD will at least equal the greater of (i) 7% of RWAs, (ii) for covered IHCs

subject to the Supplementary Leverage Ratio, 3% of total leverage exposure, and

(iii) 4% of average total consolidated assets

• What is the internal TLAC requirement?

• The internal TLAC requirement depends on whether the foreign G-SIB parent of

the covered IHC will undergo SPOE or Multiple Point of Entry (MPOE) resolution

• For SPOE, IHC would be required to keep outstanding eligible internal TLAC at

least equal to the greater of: (i) 16% of RWAs (when fully phased in), (ii) for

covered IHCs subject to the SLR, 6% of total leverage exposure, and (iii) 8% of

average total consolidated assets

• For MPOE, IHC would be required to keep outstanding eligible internal TLAC at

least equal to the greater of: (i) 18% of the RWAs (when fully phased in), (ii) for

covered IHCs subject to the SLR, 6.75% of total leverage exposure, and (iii) 9% of

average total consolidated assets

26

Eligible internal LTD • What are the requirements for eligible internal LTD?

• Same general requirements as those applicable to eligible external LTD

• In addition, eligible internal LTD:

• Is required to be held by foreign parent

• Must be contractually subordinated to the covered IHC’s third-party liabilities

• Be required to contain contractual provisions pursuant to which the FRB could

cancel the internal LTD or convert it into equity on a going-concern basis

(without entering resolution) upon the occurrence of certain conditions

27

Eligible internal TLAC • What is the required amount of internal TLAC?

• Eligible internal TLAC equals the sum of (i) common equity Tier 1 capital and AT1

capital issued by the covered IHC to its foreign parent, and (ii) the covered IHC’s

eligible external LTD

• With respect to the RWA component of the internal TLAC requirement, an internal

TLAC buffer would apply on top of the 16 or 18% risk-based capital component

that could be met solely with common equity Tier 1 capital in an amount equal to

the sum of 2.5% and any applicable countercyclical capital buffer (equal to the

existing capital conversation buffer now applicable to IHCs under the capital rules)

28

Foreign banks • Foreign (non-U.S.) banks that are G-SIBs and that are required to

establish IHCs will need to focus on both the FSB and the FRB

requirements

• Depending on their organizational structure and how these FBOs have been

funding themselves in the United States, compliance with both the FSB and the

FRB requirements will create added complexity

• It is possible that other jurisdictions will apply the final FSB TLAC

requirements to their domestic systemically important banks (D-SIBs)

(entities that are not G-SIBs); there already are proposals to this

effect in Canada, for example and in Europe the MREL provisions

apply to all European banks.

29

Clean Holding Company • What is the clean holding company requirement?

• The proposal sets out a “clean holding company” requirement, which has two

parts:

• First, a covered BHC would be prohibited from

• Engaging in short-term borrowings,

• Entering into QFCs,

• Issuing guarantees of subsidiary liabilities that could create cross-default, set-

off or netting rights for creditors of the subsidiary

• Second, a covered BHC’s third-party non-contingent liabilities (other than those

related to eligible external TLAC) that are pari passu with or junior to its eligible

external LTD to a cap of 5% of the value of its eligible external TLAC

• The clean holding company requirement applicable to IHCs differs from the

requirement applicable to U.S. G-SIBs as it does not provide for the 5% bucket of

non-contingent liabilities

30

Regulatory capital deduction • Banks, savings and loans, and similar entities with total assets of

more than $1 billion would suffer from a regulatory capital deduction

for any investments in unsecured debt issued by covered BHCs

(including eligible external LTD) in excess of certain thresholds

31

Timing • As proposed, covered BHCs would be required to comply with the

external LTD and TLAC requirements by January 1, 2019, but the

RWA component of the external TLAC requirement would be phased

in with an initial 16% requirement applicable as of January 1, 2019,

and the final 18% requirement applicable as of January 1, 2022. The

clean holding company requirement would be applicable as of

January 1, 2019.

• Covered IHCs would be subject to similar effective dates and phase-

ins.

• The regulatory capital deduction would become effective as of

January 1, 2019.

32

Issues arising under FRB Proposal

33

Issues arising under FRB proposal • During the comment period, we would anticipate that market

participants will likely consider whether to seek guidance on certain

issues, such as:

• Structured notes

• Covenants contained in senior note indentures

• Survivor’s option provisions

• Guarantees

34

Structured note definition • A “structured note” is a debt instrument that:

• Has a principal amount, redemption amount, or stated maturity that is subject to

reduction based on the performance of any asset, entity, index, or embedded

derivative or similar embedded feature;

• Has an embedded derivative or similar embedded feature that is linked to one or

more equity securities, commodities, assets, or entities;

• Does not specify a minimum principal amount due upon acceleration or early

termination; or

• Is not classified as debt under U.S. generally accepted accounting principles.

35

Structured note definition (cont’d)

• Definition clearly applies to both principal-protected and non-principal

protected structured notes.

• However, the draft Notice states that: “The proposed definition of a

structured note is not intended to include non-dollar-denominated

instruments or instruments whose interest payments are linked to an

interest rate index (for example, a floating-rate note linked to the federal

funds rate or to LIBOR) that satisfy the proposed requirements in all

other respects.”

• The Proposal defines structured notes so as to avoid capturing debt

instruments that pay interest based on the performance of a single index

but to otherwise capture all debt instruments that have a principal

amount, redemption amount, or stated maturity, that is subject to

reduction based on the performance of any asset, entity, index, or

embedded derivative or similar embedded feature.

36

Structured notes • Rate-linked notes are not excluded

• Although these particular requirements would not apply to structured

notes issued by a subsidiary of the BHC that benefits from a parent

guarantee, the “clean holding company” requirements would appear

to limit this

• Therefore, the nature of the guarantee would be critical

37

Structured notes (cont’d)

• For rates, it may be useful to obtain clarity regarding the

“benchmarks”

• The language references LIBOR and Fed Funds as examples

• Objective is to ensure that rates are readily available, “benchmark”

type rates

• For a different purpose (23A/B, transactions with affiliates provisions),

the FRB references securities that have a “ready market”; “prices that

are quoted routinely”—these concepts could be applicable to the

reference rates

38

Structured notes (cont’d)

• These requirements are applicable only at the BHC level, so, they

would not be applicable to: structured bank notes or to market-linked

CDs

• Bank notes: there may be a concern about relying on structured bank notes if the

minimum denominations are high

• Market-linked CDs: pricing may be a factor

39

Covenants • Indentures for most G-SIB issuers would be considered “covenant

lite”

• Covenants are limited to fundamental matters, such as maintaining

corporate existence, remaining financial holding company or bank

holding company, maintaining a trustee and paying agent, etc., but do

not include any affirmative or negative covenants

• However, most indentures currently contain a provision that requires

acceleration of payment obligations where breaches of covenants are

not cured within a specified time period, usually 90 days

• Under the proposed FRB regulations, the acceleration upon

unremedied covenant breach would render a security not eligible as

LTD/TLAC; however, it is unlikely that the banking agencies were

focused on this fundamental covenants or that these fundamental

covenants would be seen as impediments to a resolution

40

Survivor’s option • Many G-SIBs issue “retail debt” securities or “baby bonds” that

contain a survivor’s option (also called a successor’s option) that

permits acceleration of payment upon the bond holder’s passing

• Usually, the issuer imposes a limit on the amount of debt that will be

subject to the survivor’s option feature

• This type of feature is viewed as retail friendly

• Under the proposed FRB regulations, this type of provision would

appear to violate the prohibition against payment acceleration

clauses

41

Next Steps

42

Preparing to comply • Covered U.S. G-SIBs and covered IHCs will want to take stock of

their outstanding debt securities in order to assess which securities

meet the eligibility criteria, which requires:

• Going back to the indentures (or similar agreements) governing the terms of

outstanding debt securities in order to review the applicable default provisions

• Inquiry would be made as to U.S. issuances, as well as all international

offerings

• Was any debt issued with additional relevant or unusual terms?

Supplemental indentures?

• Identifying which instruments qualify as “structured notes” (as defined in the FRB

proposal), or that otherwise would not qualify as eligible debt securities, such as

those with certain acceleration provisions

43

Preparing to comply (cont’d)

• Identifying outstanding debt securities that benefit from a BHC

guarantee and reviewing the terms of all such guarantees

• Reviewing governing law for the outstanding debt securities: are

securities governed by U.S. law?

• Reviewing maturities, as well as put/call features that would affect

effective maturities

44

Preparing to comply (cont’d)

• Amendments

• On a go forward basis, should the issuer put in place new indentures (for debt

securities to be issued in the future)?

• Can the issuer amend the terms of outstanding notes and issued guarantees?

With or without holder consent?

• Is a liability management exercise required?

• FRB notice contemplates replacing “near eligible” debt with eligible debt

• This could be accomplished through consent solicitations and exchange

offers

• What price would debtholders seek?

• Consider the “cap” for certain liabilities that do not meet the criteria

for “clean holding companies”

• How will a G-SIB use this “cap”?

• Assessing liabilities that are not consistent with the clean holding company

requirement also will require significant time and effort

45

Preparing to comply (cont’d)

• FBOs subject to the IHC requirement likely are already well along the

way in formulating their IHC compliance plan

• Now, they will have to consider the requirements that would be

applicable to their IHCs, and how these differ from the requirements

to which the foreign parent will be subject to as a result of the FSB

TLAC requirement

• Is foreign bank a SPOE or MPOE institution?

• Will the IHC be a “resolution entity”?

• Which securities qualify for FSB’s “internal TLAC” requirement but not for FRB’s

“internal TLAC” requirement?

46

Other structuring thoughts • Market participants also likely will want to consider new possible

approaches to issuance of non-TLAC eligible securities, whether

through:

• other issuers within the same group, such as subsidiaries (with or without a

guarantee), or

• third-party issuance (or “repackaging”) vehicles to which BHC sells a plain vanilla

note