Instruments eligible for conversion under bail-in regime:
- debt issued by a D-SIB after the implementation date of the regulations that is:
- unsecured (or, if partly secured, only the unsecured portion will be subject to bail-in),
- tradable, (CUSIP, ISIN or similar number),
- transferable, and
- for an initial term of at least 400 days; and
- subordinated liabilities and preferred shares issued after the implementation date of the regulations that are not non-viability contingent capital (NVCC) instruments. NVCC are instruments that are convertible into common shares by their terms at the point of non-viability of the D-SIB and are not included in bail-in due to their convertibility feature.
Instruments eligible for conversion under bail-in regime:1
- all capital instruments (i.e. Common Equity Tier 1 (CET1), Additional Tier 1 (AT1) and Tier 2); and
- any (other) non-excluded liability issued by a bank (see below).
Instruments not eligible for conversion under bail-in regime:
- non-transferable deposits (e.g. accounts and term deposits), covered bonds, structured notes, derivatives, conversion or exchange rights that are convertible into common shares and other prescribed instruments; and
- debt issued before the date of implementation unless such debt is amended after the implementation date to increase the principal amount or extend the term of the debt. See Transition below.
Instruments not eligible for conversion under bail-in regime:2
- state-guaranteed deposits;
- secured liabilities (if partly secured, the unsecured portion will be subject to bail-in as in Canada);
- liabilities that the bank has by virtue of holding client assets;
- liabilities with an original maturity of less than 7 days which are owed to a bank or investment firm (save in relation to banks or investment firms which are banking group companies in relation to a bank), including liabilities which have no maturity date and are callable on demand (with less than 7 day notice period);
- liabilities with a remaining maturity of less than 7 days arising from participation in a designated settlement system and owed to such systems (including central counterparties or operators or participants in such systems);
- liabilities to employees or former employees in relation to salary or other remuneration except variable remuneration that is not regulated by a collective bargaining agreement, and variable remuneration of ‘material risk takers’ as referred to in Article 92(2) Capital Requirements Directive IV;
- liabilities owed to pension schemes, except for liabilities in connection with the variable component of remuneration that is not regulated by a collective bargaining agreement;
- liabilities owed to a commercial or trade creditor arising from the provision of goods or services that are critical to the daily functioning of the bank’s operations; and
- liabilities to the Financial Services Compensation Scheme (the UK’s deposit guarantee scheme).
- additionally, any eligible liability may be excluded from bail-in at the time of the bail-in due to exceptional circumstances.
Requirements applicable to issuance of bail-in eligible securities:
- documentation regarding bail-in instruments must contain the following terms:
- binding holder to the bail-in regime; and
- submission to the jurisdiction of Canadian courts regardless of governing law of contract.
- any prospectus or other offering or disclosure document relating to an eligible bail-in instrument must include disclosure regarding its eligibility.
Requirements applicable to issuance of bail-in eligible liabilities:
- where they are not governed by the law of an EEA state, all capital instruments and certain bail-in eligible liabilities must contain terms:3
- recognising that the liability may be subject to bail-in; and
- binding the creditor to any reduction of the principal or outstanding amount due or by any conversion or cancellation of the liability.
- where they are not governed by the law of an EEA state, certain financial instruments (e.g. derivatives) and related contracts (e.g. for the purchase or sale of financial instruments) must contain terms binding the holder to the UK’s resolution regime in respect of termination and security rights.4
- any prospectus or other offering or disclosure document relating to a capital instrument or eligible liability must include disclosure regarding the risks relating to bail-in.5
Bail-in process: 6
- bail-in is undertaken by the Canada Deposit Insurance Corporation (CDIC) in one or more steps after OSFI determines that a D-SIB is non-viable or near non-viability and the federal government approves. A resolution order will then be issued. The resolution will set out the terms of CDIC’s temporary control or ownership of the D-SIB. CDIC is the federal deposit insurer of Canadian banks and other member institutions.
- after the bail-in process and other restructuring processes are completed, CDIC must return the bank to private control. This must happen within 1 year of the commencement of the bail-in (subject to extension to 5 years by government order).
- following the resolution, CDIC will offer compensation to shareholders and creditors if they are “worse-off” as a result of CDIC’s actions. See Compensation for bank shareholders and creditors below.
- there are four core elements to a resolution which is conducted (in whole or part) using a bail-in: (i) the run up to a resolution, where preparations are put in place; (ii) the bail-in period; (iii) the announcement of final bail-in terms and compensation arrangements; and (iv) restructuring of the bank after bail-in. Ideally a bank would enter resolution at close of business on a Friday evening, which would give the authorities approximately 48 hours in which to stabilise the bank outside market hours (known as the ‘resolution weekend’).
- in the run up to a resolution, the Bank of England (BoE) will identify those liabilities which are within scope for the bail-in.
- the bail-in is undertaken by the BoE only after the Prudential Regulation Authority (PRA) determines that a bank is failing or likely to fail, having consulted the BoE and with the BoE being satisfied that other relevant pre-conditions are met.
- the in-scope liabilities would be confirmed. This would be confirmed during the resolution weekend and the UK Financial Conduct Authority (FCA) may suspend trading in those instruments. The BoE is also likely to appoint a resolution administrator, acting under the BoE’s instruction, to direct the bank’s board and exercise the rights of the bank’s shareholders.
- at the end of the resolution weekend, the BoE will announce the nature of the resolution strategy being carried out and the liabilities that will be affected. The resolution administrator will remain in office for so long as is needed to realise the BoE’s strategy.
- a depositary bank will hold the bank’s shares on trust until they can be distributed to former bondholders or other creditors identified as being entitled to compensation, once the final terms of the bail-in are announced.
- following the bail-in, further detailed valuation work will be undertaken to set the final terms of the write-down and conversion of liabilities within scope of the bail-in as soon as possible.
- once the valuation work is complete, the terms of the bail-in are announced. Depending on the number of shares issued, formal approval of a change in control may be needed.
- conversion process is prescribed to maintain “relative” creditor hierarchy.
- CDIC must in carrying out a bail-in:
- consider requirement of a bank under Bank Act (Canada) to maintain adequate capitalization; and
- use its best efforts to:
- convert all equally ranking bail-in instruments on the same proportionate basis; and
- only convert a bail-in instrument if all NVCC instruments and subordinate ranking bail-in eligible instruments have been or will be concurrently converted.
- holders of bail-in securities must receive more common shares per dollar amount of claim than converted subordinate ranking bail-in eligible instruments and NVCC.
- a bail-in is effected by way of a write-down in value and subsequently, for instruments not written-down, a conversion to CET1. The BoE will only conduct write-downs to the extent necessary to restore the bank to a net assets position. Conversion to CET1 is conducted until the bank is sufficiently re-capitalised.
- capital instruments are subject to a mandatory write-down in value and subsequently any remaining AT1 and Tier 2 instruments are converted into CET1 instruments to re-capitalise the bank.
- to the extent necessary following the mandatory capital actions, a bail-in is conducted by writing-down and converting eligible liabilities into CET1.
- following the mandatory capital actions and bail-in, valuations are considered to determine if any creditors are “worse-off” due to the bail-in than they would have been in an insolvency and compensation is paid if this is the case. It is not obligatory to compensate shareholders and creditors affected by the mandatory write-down and conversion of capital.
- the conversion process is prescribed to maintain the creditor hierarchy that would arise on insolvency, meaning that liabilities ranking equally will be treated as such. The exception to this is where liabilities are excluded from bail-in due to the standard exclusions noted above or otherwise under exceptional circumstances.
Compensation for bank shareholders and creditors:
- the regulations provide an updated process for bank shareholders and other creditors to obtain compensation if they are “worse off” as a result of CDIC’s actions as opposed to liquidation.
- CDIC will provide an offer of compensation to such prescribed persons entitled to compensation.
- CDIC’s compensation offer may, if requested by prescribed persons representing at least 10% of the subject shares or liabilities, be reviewed by third party assessor whose determination is final.
- creditors who have liabilities assumed by a solvent third party after the date of the bail-in resolution or who have been made whole will not be entitled to compensation.
Compensation for bank shareholders and creditors:
- in line with the “no creditor worse off” safeguard, any shareholders and creditors directly affected by the resolution must not be left worse off than if the whole bank had been placed into insolvency.
- the exception to this general rule is for holders of capital instruments affected by the mandatory write-down and conversion that occurs prior to a full bail-in and to which the no creditor worse off principle does not apply. Instead, these creditors may receive a write-up in value following the resolution if in hindsight these actions were more severe that was in practice necessary.
- the no creditor worse off provisions require the appointment of an independent valuer to assess: (i) the treatment that the creditor of the failing bank would have received had the bail-in option not been deployed and the bank had been put into insolvency; and (ii) the treatment which creditors have actually received, are receiving or are likely to receive if no compensation (or further compensation) is paid.
- if the independent valuer determines that a person had been made worse off than they would have been had the bank entered insolvency, compensation would generally be payable to that person.
- guidance on two minimum standards published by OSFI to assess whether a D-SIB has the necessary capacity to absorb loss and be returned to viability.
- two standards introduced:
- risk-based TLAC Ratio (TLAC Measure divided by risk-weighted assets); and
- TLAC Leverage Ratio (TLAC Measure divided by Exposure Measure).
- both ratios use the TLAC Measure which is the sum of the D-SIB’s TLAC consisting of prescribed capital of the D-SIB (Tier 1 and Tier 2) and other prescribed shares and liabilities, as adjusted (see below).
- OSFI anticipates beginning November 1, 2021, each D-SIB should have a TLAC Ratio of 21.5% of risk-weighted assets and a TLAC Leverage Ratio of at least 6.75%.
- TLAC Measure consists of the following eligible instruments:
- Tier 1 capital consisting of common equity Tier 1 capital and additional Tier 1 capital;
- Tier 2 capital; and
- prescribed shares and liabilities (known as other TLAC Instruments) that are subject to Bail-in and meeting all the eligibility criteria set out in the Guideline.
- the Guideline imposes additional requirements on other TLAC Instruments in order for them to constitute TLAC Instruments, viz:
- the instrument is issued directly by the parent bank;
- the instrument is issued and paid for in cash or with the approval of the Superintendent of Financial Institutions in property;
- neither the institution or a related party owns the instrument;
- the instrument is neither fully secured at the time of issuance nor covered by a guarantee of the issuer or related party or other arrangement that legally or economically enhances the seniority of the claim vis-à-vis the institution’s depositors and/or other general creditors;
- the instrument is not subject to set-off or netting rights;
- the instrument has acceleration rights limited only to insolvency and non-payment of scheduled principal and/or interest payments (subject to a cure period of no less than 30 business days);
- the instrument is perpetual or has a residual maturity in excess of 365 days;
- the instrument can be called or purchased for cancellation at the initiative of the issuer only and, where any redemption or purchase would lead to a breach of the issuer’s minimum TLAC requirements, with the prior approval of the Superintendent of Financial Institutions; and
- the instrument does not have credit sensitive dividend or coupon features that are reset periodically based in whole or in part on the institution’s credit standing.
- all banks are currently subject to a “minimum requirement for eligible liabilities” (MREL) set at the discretion of the BoE. This is intended to create a sufficient pool of liabilities (which can include capital) such that the preferred resolution strategy (which may include a bail-in) is credible.
- in November 2016 the European Commission issued proposals to amend the Capital Requirements Regulation (CRR) and the Bank Recovery and Resolution Directive (BRRD) to align the existing MREL requirements with the TLAC standard, though this will only apply to global systemically important banks.
- the minimum external TLAC requirement will be met using capital and non-capital eligible liabilities. This requirement will be calibrated using a risk-based ratio at 18% of risk-weighted assets and a non-risk based ratio set at 6.75% of the leverage ratio exposure measure.
- an internal TLAC requirement is proposed to apply to material subsidiaries of non-EU global systemically important banks that are not resolution entities. It is proposed that these banks must satisfy a requirement for own funds and eligible liabilities equal to 90% of the external TLAC requirement.
- public consultation ended July 17, 2017.
- final regulations anticipated in fall of 2017.
- the implementation date of the regime will be 180 days after final regulations are registered.
- it is unclear when the European Commission’s legislative proposals will be finalised. It is also unknown at the moment how Brexit will impact the UK’s implementation of these changes to the CRR and BRRD.
- under the European Commission’s draft Regulation amending the CRR the risk-based ratio will be set at a transitional level of 16% from 1 January 2019 to 31 December 2021.
- under the European Commission’s draft Regulation amending the CRR the non-risk based ratio will be set at a transitional level of 6% from 1 January 2019 to 31 December 2021.