The regulatory nightmare of TLAC

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On Tuesday the Financial Stability Board released its postmortem on the spate of bank collapses we’ve seen in 2023. It’s all very thoroughly ploughed terrain so there’s probably nothing unexpected . . . 

. . . Oh what’s that?

The SEC and FINMA engaged in discussions with Credit Suisse and its US counsel during the months preceding the firm’s failure. FINMA established an approach to accomplish the bail-in of securities issued in the US in a manner expected to be in compliance with Swiss and US securities law. CMG authorities were presented with this solution and understood that it was prepared to be carried out in a timely and effective manner. Credit Suisse bore the burden of establishing whether an exemption applied to the conversion of its TLAC instruments; the SEC cannot confirm or grant exemptions on an ex ante basis. Instead, the firm had to rely on the advice of US counsel when planning for the application of bail-in. In these situations, the US counsel typically provides the issuer with a legal opinion confirming that the conditions for an exemption are met.

According to the SEC staff, there would have been legal challenges relating to US securities laws in executing a bail-in; they noted that banks need to prepare sufficiently to comply with US securities laws after an open bank bail-in. US investors held bail-in bonds issued by Credit Suisse representing a significant portion of the firm’s TLAC. US securities laws apply to any TLAC instruments held by US investors, irrespective of the currency or governing law of that TLAC instrument.

Under US law, all offers and sales of securities need to be either registered or exempt from registration. The conversion of Credit Suisse’s bail-in-bonds to equity would have constituted a sale, thus requiring registration or an exemption.

HT @JohannesBorgen for the catch, because Alphaville has to admit we’d missed this.

The occasionally conflicting and regulatory approaches of the US and Europe is a fun/frustrating fact of life in finance — viz Mifid II. But this looks like next-level headbanger stuff.

Having easily ‘bail-in-able’ bonds to bolster the total loss absorbing capital of a struggling bank is a cornerstone of the entire global post-financial crisis regulatory edifice! This stuff has been debated ad nauseam for over a decade! The FSB even mandates that at least 33 per cent of a global systemically important bank’s TLAC should be in debt!

And now the SEC basically casually mumbles something about how any equity offering constitutes a new security sale in the US, so an emergency bail-in of bonds expressly designed to be equitised in a crisis would either need to be registered or be considered exempt.

In the Credit Suisse case the TLAC debt was simply wiped out, and this imbroglio presumably wouldn’t affect similar wipeout bonds. But this could theoretically affect any bail-in-bonds anywhere that have any US holders.

Getting that registration isn’t necessarily a walk in the park, and certainly not in the middle of an emergency. For example, it would probably require an entirely fresh set of financial results for investors to mull. Even the SEC warns that the rigmarole would be “difficult” in the midst of a probable fast-moving crisis:

In the view of the SEC staff, among the challenges involved in executing open-bank bail-in in compliance with US federal securities laws is that it would require detailed preparation, including possibly adapting the bank’s systems to enable prompt provision to the market of current and accurate (pro-forma) financial statements. In an open-bank bail-in, the SEC staff considered that it would be difficult for an issuer to compile the disclosures required by securities regulations and anti-fraud laws over a resolution weekend and that ex ante preparations would be necessary to mitigate these challenges.

Exemption is not straightforward either. The SEC notes that it is up to the issuer to argue that it shouldn’t need to do a new security sale registration, and that it cannot grant or approve it.

The SEC told the FSB that the most likely available exemption is Section 3(a)(9).

That exemption is subject to the following conditions: (1) the issuer of the relevant debt securities (e.g. CS’s bail-in-bonds) and the new equity securities (e.g. CS’s new shares) must be the same; (2) the new equity securities must be issued exclusively to the existing holders of the debt securities; and (3) no commission or remuneration is paid in order to solicit investors’ participation in the exchange of the debt securities for the new equity securities.

But you’d still have to contend with US anti-fraud rules, fresh financial information, etc. So any bank that sought to bail in its bail-in bonds to stay a going concern (what the FSB terms an “open-bank bail-in”) could likely be challenged by any US-domiciled investor.

We’re not lawyers here (the ones we reached out to check our understanding haven’t gotten back to us yet; we’ll update if they say anything helpful) but, from a lay perspective, this looks like an unholy mess.

Alphaville still can’t quite grasp how the tens of thousands of lawyers, bankers and government officialsoss Europe and the US that have spent more than a decade tortuously working through all these rules and coming up with new instruments to fit them somehow missed that they might not play nice with US securities law.

Not to fear though! “Further work will be planned.”

In order to ensure confidence in the execution of bail-in, it is essential for authorities to cooperate among themselves and work together with the firms, as part of resolution planning, to reduce legal uncertainties.

Further work will be planned with the SEC to explain potential legal challenges to effective bail-in of TLAC instruments and to describe how firms can undertake actions to comply with the US federal securities laws and thereby enhance the legal certainty of bail-in.

Not all jurisdictions provide resolution-specific exemptions to prospectus and disclosure obligations, for instance for the issuance of new equity securities during bail-in. While there may be certain exemptions in some jurisdictions that could benefit an issuer in resolution, their availability is typically fact-and-circumstance dependent. The conditional nature of these exemptions is sufficiently material for bail-in execution that banks, working with authorities, should engage well in advance and consider strategic plans to ensure a smooth and orderly bailin for issuers with cross-border TLAC issuances held by non-domestic investors; the expectation to do so already forms part of the FSB Principles on Bail-in Execution.

Yes, please do some of this co-operating of which you speak. It sounds like a grand idea.