The Danish Financial Supervisory Authority (FSA) is extending the phase-in of minimum requirements for own funds and eligible liabilities (MREL) for Danish and Faroese banks, while taking into account future lower requirements for SIFIs in Denmark.
The FSA has set MREL requirements for Danish and Faroese banks. The requirements are phased in gradually for small and medium-sized banks, while they have been applied to Danish SIFIs since 1 July 2019.
MREL requirements were introduced after the financial crisis to ensure that banks have the loss absorption capacity required for their resolution in a crisis without excessive negative impact on confidence in the financial system or public finances. Danish SIFIs already comply with MREL. For small and medium-sized banks, MREL is being phased in, with these institutions generally being well on their way to accumulating eligible liabilities.
The FSA considers it crucial to strike an appropriate balance between the banks having a sufficiently large loss absorption capacity to ensure that crisis management is possible also in times of crisis and banks being able, at the same time, to accumulate eligible liabilities either through earnings or via issuance on the financial markets.
Longer phase-in period for small and medium-sized Danish banks, as well as for the Faroese banks
Most small and medium-sized banks and the Faroese banks meet their MREL with capital which they gradually accumulate by retained earnings as the MREL increases until 1 January 2023. The phase-in was determined based on assumptions about the banks’ profitability and that banks should be able to meet the requirements through retained earnings.
According to the FSA’s principles on MREL for small and medium-sized banks,
the phase-in period can be extended by 1–2 years if earnings at sector level are lower than assumed. In June each year, the FSA determines whether, based on the annual accounts from the previous year, there is a basis for extending the phase-in period.
However, it is already clear that the banks’ earnings will be adversely affected by the COVID-19 crisis. The FSA therefore extends the phase-in period for MREL by six months for small and medium-sized Danish banks and for Faroese banks already today. The FSA will review the phase-in period if the results for the first half of 2020 show that earnings have been negative for more than half of the banks and if there is still expected lower earnings.
Reduction of issuing requirements for SIFIs in 2020
MREL for Danish SIFIs have been in force since 1 July 2019, which means that they already comply with their fully phased-in MREL.
MREL can be met with capital and liabilities, which bear losses before unsecured claims (known as a “subordination requirement”). SIFIs typically build MREL by issuing non-preferred senior debt, which bears losses before ordinary senior debt and other unsecured claims. Since non-preferred senior debt bears losses before ordinary senior debt, it is also more expensive to issue than ordinary senior debt.
The subordination requirement is phased in using a transitional arrangement whereby SIFIs can, for a period (until 1 January 2022), include previously issued ordinary senior debt. This means that banks gradually replace the previously issued senior debt instruments with new non-preferred ones.
However, the amendments to the EU Crisis Management Directive (BRRD II) have resulted in an upper limit for the subordination requirement. In the directive, this is set at a maximum of:
- 2 x solvency requirement plus 1 x combined capital buffer requirement and
- 8% of total liabilities and own funds
This upper limit is lower than the current MREL requirements for SIFIs. When the new rules are implemented in Danish legislation (no later than 28 December 2020), there will be a lower subordination requirement than is currently the case. However, in order to ease the burden of having to issue non-preferred senior debt in more difficult market conditions, as of this date the FSA will take into account the forthcoming reduction in the subordination requirement.
Therefore, in the FSA’s reactions to non-compliance with MREL, the FSA will focus on whether SIFIs meet a subordination requirement corresponding to the upper limit mentioned above and are otherwise complying with their MREL. If there is compliance in this regard, the FSA will take note of any non-compliance, but will not exercise the FSA’s more far-reaching powers.
Overall, this allows the banks to issue ordinary senior debt on a substantial scale rather than the more difficult to access non-preferred senior debt. The FSA estimates that the SIFIs’ need to issue non-preferred senior debt in 2020 to meet their MREL will be roughly halved.