South African SIFI Banks And Holding Companies Are Required To Issue Flac (Unsecured Debt) Instruments For Resolution Readiness – Capital Adequacy/BASEL

Introduction

Banks designated as systemically important financial
institutions (“SIFIs“) by the South
African Reserve Bank (“Reserve Bank“)
and their holding companies will be required to meet minimum Flac
requirements as set out in the Draft Prudential Standard RA03
titled ‘Flac Instrument Requirements for Designated
Institutions’ (“Standard RA03“).
Standard RA03, as set out in the Prudential Authority’s
(“PA“) explanatory statement, is
envisaged by the PA to be published in Q2 of 2024 and to become
effective from 1 January 2025. Standard RA03 was
issued for public comment in December 2023 and closed on 19
February 2024.

Understanding Systemically Important Financial Institutions
(“SIFIs”)

The Governor of the Reserve Bank has designated six South
African banks as Systemically Important Financial Institutions
(“SIFIs“), all of which have accepted
their designations. The banks in question are:

• Absa Bank Limited,




• Capitec Bank Limited,




• FirstRand Bank Limited,




• Investec Bank Limited,




• Nedbank Limited; and




• The Standard Bank of South Africa Limited

The Reserve Bank is collaborating with the PA on a methodology
to identify insurance companies that could potentially qualify as
SIFIs. Once the methodology is finalised, the same process will be
followed as was followed with the banks.

While the Reserve Bank holds extensive powers in resolution
matters, which potentially apply to all designated
institutions in terms of s29A, it’s important to note that the
Flac requirements only apply to the SIFI banks and their holding
companies. Our previous article on the new resolution regime
further discusses the powers of the Reserve Bank over designated
institutions.

What is Flac and why is it necessary?

Following the introduction of the resolution framework in the
Financial Sector Regulation Act, 2017
(“FSRA“), as amended by the Financial
Sector Laws Amendment Act, 2021 that came into effect on 1 June
2023, the PA published Standard RA03. Standard RA03 requires these
designated institutions to have Flac instruments readily available
for bail-in in resolution to allow the Reserve Bank to exercise
bail-in powers in respect of the Flac instruments. In summary, Flac
instruments are unsecured, subordinated debt instruments, issued
internally by the bank to its holding company and issued externally
to third parties by the holding company each meeting the
requirements set out in Standard RA03.

The bail-in powers the Reserve Bank has for designated
institutions in resolution, as set out in the FSRA, include writing
down shareholders’ equity and unsecured subordinated debt
instruments or converting all or part thereof into
shareholders’ equity. This new requirement is thus aimed at
ensuring that designated institutions have sufficient
loss-absorbing and recapitalisation capacity for orderly
resolution.

When is it required to be in place?

According to Standard RA03 in its current draft form, a phase-in
approach will be followed to allow sufficient time for designated
institutions to meet these new Flac requirements. While the
phase-in period will commence on 1 January 2025, should Standard
RA03 come into effect then designated institutions will only have
to meet requirements for Flac from 2027.

It is worth noting that the phase-in period in relation to
minimum Flac requirement (“MFR“) only
applies to the base component of the MFR
(“bMFR“) for the relevant designated
institutions. However, it does not apply to the idiosyncratic
component of the MFR (“iMRF“) which is
institution-specific (as specified by the Reserve Bank), the
phase-in period of which will only be determined and phased in once
the resolution planning process has reached a mature state. The PA
will communicate the effective date and the phase-in period for
this component, as directed by the Reserve Bank.

In terms of the phase-in approach, designated institutions must
have 60% of the bMFR by 2027 which will increase annually until
100% is met in 2030. In addition, the Flac instrument issuances
component of the bMFR expressed as a percentage of the
institution’s total loss absorbing capacity
(“TLAC“) must be 20% of the designated
institution’s TLAC by 2027 and should reach the minimum Flac
instrument issuance of 33.33% by the end of the phase-in period in
2030.

What is the Minimum Flac requirement and composition?

Designated institutions must maintain a sufficient level of Flac
instruments or other qualifying instruments that will be available
during resolution for bail-in, to enable the designated institution
to be recapitalised to a level that meets its minimum capital
adequacy requirement (minCAR) as determined by the PA.

The principles for calibration of and composition of the MRF are
set out in Standard RA03. In terms of paragraph 11.4(a) of Standard
RA03, the MFR must comprise a minimum amount of Flac instrument
issuances and excess regulatory capital can be used to contribute
to the MFR to top-up the minimum Flac instrument issuances
required. According to the cost of MFR analysis conducted in the
explanatory statement accompanying Standard RA03, the use of excess
regulatory capital to top-up the minimum Flac instrument issuances
required would attract higher costs for the designated
institutions. The MFR is an additional requirement to the minimum
capital adequacy requirement. Any excess regulatory capital used to
contribute towards the MFR, must not be used simultaneously to meet
the total minimum required amount of capital and reserve funds.
Designated institutions may also consider any existing unsecured
debt, namely senior unsecured debt, that can be converted into Flac
instruments to reduce the cost of Flac instruments issuances.

Consequences of Non-Compliance

Failure of a designated institution to comply with Flac
requirements as set out in the Standard RA03 may result in the PA
taking action against it. These actions include:

• Increasing the designated institution’s Flac instrument
  requirement;




• Increasing the designated institution’s required regulatory
  capital;




• Placing restrictions on distributions as envisaged in the
  bank’s capital adequacy legislation; and




• Any other action that the Reserve Bank or the PA may be
  empowered to take.

Given the wide-reaching actions the PA may take against
designated institutions that fail to comply with Flac requirements,
the relevant designated institutions will need to ensure their
compliance within the time frames stipulated in Standard RA03.

*Article published on 2 April 2024

The content of this article is intended to provide a general
guide to the subject matter. Specialist advice should be sought
about your specific circumstances.