Long-Term Debt Requirements: Interagency Proposed Rule

KPMG Regulatory Insight

• Expansion of requirements to all banks and BHCs with total assets of $100 billion or more.
• Long-term debt requirements intended to:
  • Absorb losses that may otherwise be borne by uninsured depositors and other creditors
  • Promote market confidence in the safety of deposits and limit the potential of bank runs
  • Mitigate potential "fire sale risk" by decreasing the need to liquidate assets to meet withdrawals during resolution.
  • Minimize costs to the Deposit Insurance Fund
  • Provide the FDIC with a broader range of restructuring options
  • Reduce interconnectedness and contagion risk by discouraging investment in the long-term debt issued by other banks and prohibiting specific categories of outstanding liabilities

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August 2023

The Federal Reserve Board (FRB), Federal Deposit Insurance Corporation (FDIC), and Office of the Comptroller of the Currency (OCC) (collectively, “federal banking regulators” or Agencies) jointly issued a proposed rulemaking on long-term debt (LTD) requirements for certain large bank holding companies (BHCs), certain U.S. intermediate holding companies (IHCs) of foreign banking organizations (FBOs), and certain large insured depository institutions (IDIs).

The Agencies state the proposal is intended to “improve the resolvability of these banking organizations in case of failure, may reduce costs to the Deposit Insurance Fund, and mitigate financial stability and contagion risks by reducing the risk of loss to uninsured depositors.”

In particular, the proposed LTD requirement would provide the FDIC, acting as a receiver for a failed IDI, with optionality during a covered entity's resolution under a multiple point of entry (MPOE) or single point of entry (SPOE)  strategy through options including:

• Transferring all deposit liabilities of a failed IDI to an acquirer or a bridge depository institution in a manner consistent with the Federal Deposit Insurance (FDI) Act's least-cost requirement.
• Fully recapitalizing the covered entity by replenishing its going-concern capital to at least the amount required to meet regulatory capital ratios and buffer requirements under the capital refill framework.
• Using eligible LTD to stabilize bridge bank operations providing the FDIC with more opportunities to exit the bridge bank, such as enabling a recapitalized bridge depository institution to exit from resolution as a newly chartered IDI.

The proposal follows an advance notice of proposed rulemaking (see KPMG Regulatory Alert, here).

Long-Term Debt (LTD) Requirements

LTD Requirement for Covered Entities. The proposal would apply to Category II, III, and IV U.S. BHCs, savings and loan holding companies (SLHCs), and IHCs of FBOs that are not global systemically important banking organizations (GSIBS) or currently subject to the existing Total Loss Absorbing Capacity (TLAC) rule under FRB Regs LL and YY (collectively, “covered entities”), and would require them to issue and maintain the following outstanding minimum levels of “eligible LTD” (see separate discussion below):

• A covered entity would be required to maintain outstanding eligible LTD in an amount that is the greater of:
  • 6.0 percent of total risk-weighted assets.
  • 3.5 percent of average total consolidated assets.
  • 2.5 percent of total leverage exposure if the covered entity is subject to the supplementary leverage ratio rule.
• A covered entity would be prohibited from redeeming or repurchasing eligible LTD prior to its maturity date without obtaining prior approval from the FRB when redemption or repurchase would cause a covered entity’s eligible LTD to fall below its LTD requirement.
• The FRB may allow a covered entity to maintain more or less than the minimum required eligible LTD under certain circumstances.

Note: this aspect of the proposal is being issued solely by the FRB.

LTD Requirement for Covered IDIs. The proposed rule would require IDIs that are not consolidated subsidiaries of U.S. GSIBs and that (i) have at least $100 billion in consolidated assets or (ii) are affiliated with IDIs that have at least $100 billion in consolidated assets (“covered IDIs”) to issue and maintain minimum amounts of LTD. Four types of “covered IDIs” are identified in the proposal.

Features of Eligible LTD. Criteria for what may qualify as eligible LTD is similar to that required for firms subject to the TLAC rule. The focus includes ensuring that the LTD can effectively and appropriately absorb losses during an issuer's orderly resolution. The requirements differ for eligible external LTD, eligible internal LTD, and eligible legacy external LTD.

Clean Holding Company Requirements. Under the proposal the operations of covered entities would be subject to the “clean holding company” requirements. In particular, the proposal would:

• Prohibit covered entities from having the following categories of outstanding liabilities:
  • Third-party debt instruments with a maturity of less than one-year.
  • Qualified financial contracts (QFCs) with third parties.
  • Guarantees of a subsidiary’s liabilities with “cross-default rights”.
  • Liabilities subject to 1) “upstream guarantees” or 2) contractual offset against amounts owed to subsidiaries of the covered entity.
• The proposal would also cap the amount of a covered entity’s liabilities that are not eligible LTD liabilities owed to non-affiliates and rank at either the same priority as, or junior to, its eligible external LTD at five (5) percent of the sum of the covered entity’s common equity tier 1 capital, additional tier 1 capital, and eligible LTD amount.

Note: this aspect of the proposal is being issued solely by the FRB.

Deduction of Investments in Eligible External LTD from Regulatory Capital. The proposal would expand the existing deduction framework in the capital rule for LTD issued by U.S. GSIBs, U.S. GSIB subsidiaries, and Category II banking organizations by amending the capital rule’s definition of “covered debt instrument” to include eligible external LTD issued by covered entities and mandatory or permitted externally issuing IDIs to meet the minimum LTD requirements in the proposal (inclusive of legacy external LTD).

Transition Periods & Phase-In. The proposal includes the following transition and phase-in periods:

• A three (3) year transition period for covered entities and covered IDIs to achieve compliance with the final rule on LTD requirements, based on the following phase-in schedule:
  • 25 percent by one (1) year after the date of finalization of the rule.
  • 50 percent two (2) years after finalization.
  • 100 percent after three (3) years.
• The proposed transition period and phase-in schedule would also apply upon a firm becoming subject to the rule sometime after finalization.
• The Agencies may accelerate or extend this transition period in writing for the covered IDIs for which they are the appropriate Federal banking agency, and the FRB may accelerate or extend this transition period in writing for covered entities.

Changes to FRB’s TLAC Rule. The proposal would make certain amendments, including “technical” changes to the existing TLAC rule that applies to both U.S. GSIBs (“TLAC HCs”) and U.S. IHCs of foreign GSIBs (together “TLAC company”).

• Limit to 50 percent the amount of eligible LTD with between one (1) and two (2) years to maturity that may be used to meet the TLAC requirement.
• Require eligible LTD to be issued in minimum denominations.
• Amend the clean holding company requirements to permit TLAC HCs to enter into underwriting agreements, fully paid structured share repurchase agreements, and employee and director compensation agreements.
• Require TLAC HCs to make certain quantitative and qualitative disclosures related to the creditor ranking of the TLAC HC’s liabilities publicly available at least every six months; as proposed, a banking organization that is a consolidated subsidiary of a TLAC HC would not be subject to the proposed disclosure requirements.
• Reserve the FRB’s authority to require a TLAC company to maintain eligible LTD or TLAC instruments great than or less than the minimum requirement.

Note: this aspect of the proposal is being issued solely by the FRB.

Comment Period. The federal banking regulators are seeking comments on this proposal, with a comment submission deadline of November 30, 2023.