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MREL Report: Summary and Key Insights

Core Content

The European Banking Authority (EBA) published a final MREL (Minimum Requirement for Own Funds and Loss Absorbency) report on 14 December 2016, following an interim report issued on 19 July 2016. The report was requested by the European Commission to support its legislative proposal on loss-absorbing and recapitalisation capacity of credit institutions, which was issued on 23 November 2016. The final report incorporates stakeholder feedback and expands on the interim findings, providing updated and new recommendations.

Main Differences Between Interim and Final Reports

• Data and Sample: The interim report used data from June 2015 with a sample of 114 banks, while the final report used December 2015 data with a larger sample of 133 banks.
• Scenarios: The final report tightened the range of possible funding needs by updating the calibration scenarios, particularly incorporating subordination requirements and a more realistic approach to resolution strategies.
• Methodology: The final report uses a consolidated approach for calculating MREL ratios and funding needs, in contrast to the interim report which focused on parent entities only.
• New Areas: The final report introduces recommendations on areas not covered in the interim, such as restrictions on maximum distributable amount (MDA), cooperation between supervisors and resolution authorities, and disclosure requirements.

Key Findings

MREL Funding Needs

• Under central estimates, MREL possible funding needs range from EUR 186.1 billion (LA buffer scenario) to EUR 276.2 billion (Buffer/8% scenario).
• The estimates assume:
  • G-SIBs and O-SILs are subject to full subordination (14.5% and 13.5% of RWA respectively).
  • Non-G-SIB and non-O-SIL banks are subject to a 50% recapitalisation scenario and no systematic subordination requirement.
• The range of estimates in the final report is narrower than in the interim report due to methodological refinements and updated data.

Market Capacity for MREL Instruments

• The ability of markets to absorb MREL-eligible instruments is a key factor in determining the actual impact.
• The final report acknowledges uncertainty in market capacity, especially in some EU jurisdictions.
• Mitigating factors include:
  • Transitional periods for compliance.
  • Resolution strategies that may reduce the need for full recapitalisation.
  • Cross-border investment flows facilitated by the Capital Markets Union.

Policy Recommendations

Consequences of MREL Breach

• MREL breaches should be treated as seriously as capital requirement breaches.
• Resolution authorities should have enhanced powers to:
  • Require the preparation and execution of an MREL restoration plan.
  • Remove impediments to resolvability.
  • Request distribution restrictions from competent authorities.
  • Initiate joint restoration plans when both MREL and capital requirements are breached.

Cross-Holdings and Contagion

• Exposures to MREL-eligible instruments issued by other credit institutions should be deducted from MREL on a like-for-like basis.
• This approach aligns with the TLAC term sheet and aims to reduce the risk of contagion.
• The report also suggests introducing a large exposure limit for non-G-SIBs to facilitate market access.

Calibration of MREL with TLAC Standards

• MREL should be calibrated based on the institution's resolution strategy.
• The EBA recommends retaining the current MREL assessment framework (Article 45 of BRRD and RTS on MREL) as the basis for setting firm-specific requirements.
• MREL should be set as the higher of the firm-specific requirement and any Pillar 1 floor.

Subordination Requirements

• Subordination helps align creditor hierarchy with resolution treatment, reducing the risk of breaching the NCWO (No Creditor Worse Off) principle.
• It increases market transparency and discipline, and reduces the likelihood of bank runs.
• The EBA recommends a 13.5% subordination requirement for O-SILs, with a transitional period, to improve resolvability and maintain a level playing field with G-SIBs.

Legal Methods for Subordination

• Subordination can be implemented through statutory, contractual, or structural methods.
• The EBA does not recommend a specific legal method but suggests harmonising statutory subordination across EU member states to reduce complexity and fragmentation.

Disclosure Requirements

• The EBA recommends that institutions disclose the quantum and composition of their MREL-eligible liabilities and the MREL level required by resolution authorities.
• Disclosure should be done in line with international standards, such as the BCBS recommendation.
• During the transitional period, at least information on the creditor hierarchy should be disclosed to investors.

Third Country Recognition

• Cross-border institutions face challenges in implementing bail-in recognition clauses in contracts governed by third country law.
• The final report recommends reducing the compliance burden by narrowing the scope of the requirement while maintaining effectiveness.

Conclusion

The EBA report provides a comprehensive analysis of MREL requirements, highlighting the importance of alignment with resolution strategies, market capacity, and transparency. It advocates for a consolidated approach, subordination requirements for O-SILs, and harmonisation of legal methods to ensure a consistent and effective implementation across the EU.