Friday letter: TLAC a double win for private debt

Mark Carney, chair of the Financial Stability Board (FSB) and governor of the Bank of England, rejected the claim that regulations he revealed this week amounted to Basel IV. 

“There is no Basel IV. There is the completion of Basel III … What we’re doing is ironing out issues that have been identified over time in terms of the application of Basel III,” he told journalists as he unveiled rules for so-called Total Loss Absorbing Capacity (TLAC) for the largest global banks. 

The policy will apply to the 30 institutions defined as global systemically important banks (G-SIBs). By January 2019 these must hold 16 percent of their risk-weighted assets in instruments that can be converted into equity and so absorb losses. That percentage increases to 18 percent by 2022. Exemptions for large emerging market-based lenders have been scrapped and they will now have to raise TLAC, albeit a lower percentage. 

To comply with the new rules, it’s estimated the G-SIBs are going to have to raise as much as €1.1 trillion in TLAC-compliant debt. 

Helping provide that debt is a big and obvious opportunity for alternative credit providers backed by long-term, yield-hungry investors. And plenty are already jumping in.

Orchard Group is raising a regulatory capital-focused fund, PDI understands, while Apollo’s European non-performing lending group also play in regulatory capital and the dislocation in financial institution capital markets. 

And while not focused on the largest banks affected by the new regulations, Anglo-French manager Axiom has just raised £50.7 million from an initial public offering of an investment trust that will invest in regulatory capital of smaller European financial institutions. 

But it doesn’t end at that €1.1 trillion (and beyond). Higher capital requirements for banks translate into a more opportunities for non-bank lenders. 

The FSB was careful to emphasise that the new requirements will only increase borrowing costs for the average borrower by an estimated 2.2 to 3.2 basis points. And spread out across the totality of lending markets, that’s probably a fair assumption. What it fails to take into account, though, is that bank lenders hit by higher capital requirements may retreat from non-core strategies and lending that carries higher risk-weightings. 

One manager who runs a firm focused on a number of different specialist lending markets confirmed that the FSB announcement, while not immediately applicable to any of his strategies, was welcome given its likelihood to force more lenders to exit the niche sectors his firm targets. 

Immediately following the global financial crisis private debt managers made hay from highlighting Basel III-related capital pressures on banks. But with the rules well flagged and stress tests like the ECB’s asset quality review showing that banks are positioned for the new rules, banging the Basel III drum to sell your fund is getting a bit old.

So while Mark Carney may reject the Basel IV moniker for his new regulations, that is how debt managers will welcome it; another capital charge that will prompt more strategic retrenchment by traditional lenders, opening up opportunities for alternatives.