OREANDA-NEWS. The Issuer Default Ratings (IDR) of some of the 30 global systemically important banks (G-SIB) may benefit from full implementation of total loss absorbing capacity (TLAC) principles, says Fitch Ratings. But TLAC will generally benefit bank counterparties more than senior bondholders and is more likely to be neutral for bank senior debt ratings.

The Financial Stability Board's final TLAC standards are due to be announced next week, ahead of the G20 summit to be held in Antalya, Turkey in mid-November. There is likely to be little substantive difference to the 2014 proposals, except for a few important concessions, such as making it easier for senior debt to qualify as TLAC.

The purpose of TLAC is to ensure that G-SIBs can be resolved without recourse to tax-payers' money, while at the same time preserving financial stability and ensuring that the banks continue to provide critical economic functions. Senior debt will be able to qualify as TLAC in certain circumstances. But TLAC will generally be subordinated to certain 'excluded liabilities', likely to include derivatives, short-term and insured/preferred deposits and structured notes.

A bank's IDR and senior debt ratings could benefit if TLAC is met with regulatory capital debt or more equity. Otherwise, existing senior debt ratings are only likely to benefit from TLAC rules if a bank issues large volumes of new 'senior subordinated' debt that is contractually or statutorily subordinated to existing senior debt.

Statutory subordination of only new senior debt has not been proposed yet. It could still be adopted by some euro area countries, but euro area authorities seem keen to harmonise approaches and Germany has already agreed a statutory subordination solution that applies to both new and existing senior debt, while Italy plans to implement full depositor preference. Neither of these plans is likely to benefit IDR or senior debt ratings.

The Financial Stability Board's standards will include a mandatory 'Pillar 1' minimum TLAC requirement, which seems likely to settle at the higher of 18% of risk-weighted assets (RWA), mid-way between the 16%-20% range proposed last November, and at least 6% (possibly 6.75% or higher) of leverage exposure. On top of this, banks will be required to hold capital to meet combined buffer requirements and supervisors can require additional firm-specific TLAC.

Switzerland is the first country to formalise TLAC requirements; Credit Suisse and UBS will have to hold total TLAC equivalent to at least 28.6% of RWA and 10% of leverage exposure.

On 30 October 2015, the Federal Reserve Board proposed that domestic G-SIBs must maintain a minimum TLAC equivalent to the higher of 18% of RWA (plus combined buffers) or 9.5% of leverage exposure, as well as a minimum long-term debt amount.

Banks operating under a holding company model are structurally well placed to meet TLAC rules. This is the case of those US, UK and Swiss G-SIBs operating a single point of entry resolution strategy. By down-streaming debt to operating subsidiaries, senior creditors of some major operating subsidiaries will be better protected than creditors of the holding company through structural subordination. We upgraded the IDRs of domestic operating subsidiaries of the eight US G-SIBs' in May 2015 to reflect this.

An emerging market exemption is likely to make TLAC a distant concern for the Chinese G-SIBs and of no consequence for their sovereign-support-driven IDRs. The Japanese G-SIBs are likely to be beneficiaries of the proposed 2.5% of RWA TLAC contribution available where there are commitments to recapitalise a G-SIB with pre-funded industry contributions.

Further information about TLAC rating implications for G-SIBs will be available in a research report to be published once the TLAC requirements are finalised.