As part of its legislative package transposing Basel iii into EU law, the European Commission also put forward a new proposal changing the way intermediate parent entities calculate their Minimum Requirement for Own Funds and Eligible Liabilities (MREL) (e.g. Daisy Chain proposal), moving from an approach of risk weighting investments in own funds instruments of subsidiaries to a full deduction of both own funds and eligible liabilities instruments.
Specifically, the European Commission is proposing that intermediate parent entities should deduct their holdings of internal MREL instruments which they have downstreamed to their subsidiaries. The rationale being that this approach:
- avoids the double-counting of the internal MREL eligible resources of the subsidiary for the purposes of compliance by the intermediate parent with its own internal MREL, and
- when a subsidiary reaches the point of non-viability, losses are effectively passed on to the resolution entity and the subsidiary concerned is recapitalized.
This represents a major change to the current capital requirements applied to banks, and in particular for those with a Holding Company structure like in Ireland, creating an unlevel playing field with many peer EU banks who will not be impacted by the proposal.
Most impactfully, the timeframe for implementation of six months represents a significant operational burden for impacted entities to take mitigating actions to avoid a breach of capital/MREL requirements.
In order to mitigate the impact of the proposal, while achieving a similar result, we recommend the policymakers consider the following:
- Extend the entry into force of the proposal until 2024 when MREL becomes binding
- Allow intermediate parent entities to comply with MREL requirements on a sub-consolidated basis
- Focus the deduction on eligible liabilities only
- Apply a “cap” on the amount of MREL that can be deducted at the regulatory level of internal MREL