On December 15, 2016, the Board of Governors of the Federal Reserve System (the “Federal Reserve”) issued a final rule requiring global systemically important banking organizations (“G-SIBs”) to issue minimum amounts of “plain vanilla” unsecured long-term debt and total loss-absorbing capacity (“TLAC”) instruments, and to maintain so-called “clean” holding companies that have no “runnable” liabilities.

The final rule represents a significant post-crisis milestone for the Federal Reserve and G-SIBs in structuring G-SIBs’ balance sheets to minimize the likelihood and systemic impact of failure.  In particular, the long-term debt and clean holding company requirements facilitate the “single point of entry” resolution strategy favored by most U.S. G-SIBs.  The requirements do so by providing, through structural subordination, for all losses to be imposed on the holding company’s equity and long-term debt-holders, which cannot run, before they are imposed on the creditors of the holding company’s material subsidiaries, including short-term creditors that can run. As a result, in the event of the insolvency or bankruptcy of the holding company, such structural subordination of the large required amount of holding company equity and long-term debt will allow material subsidiaries such as banks and broker-dealers to continue to operate with a substantially reduced risk of runs or disruptions in funding.  The large required amount of TLAC will also allow the holding company, after absorbing all losses in bankruptcy or insolvency proceedings, to reorganize and recapitalize through the conversion of remaining long-term debt into equity.

As with the Federal Reserve’s October 2015 proposed rule, the final rule applies different, but related, sets of requirements to the top-tier bank holding companies of the eight U.S. G-SIBs (“Covered BHCs”) and the top-tier U.S. intermediate holding companies of foreign G-SIBs (“Covered IHCs”).  Compared to the proposed rule, the final rule makes a number of key changes:

• Grandfather of legacy long-term debt.  A significant focus of industry comment letters on the proposed rule was the treatment of Covered BHCs’ outstanding long-term unsecured debt securities that are commonly considered “plain vanilla” instruments, but would not have satisfied the proposed rule’s stringent requirements to be counted as eligible long-term debt.  While the final rule includes the same stringent requirements for debt issued on or after December 31, 2016, with one modification discussed immediately below, the final rule grandfathers certain nonconforming debt issued before December 31, 2016.  Specifically, such “legacy” debt will be treated as eligible long-term debt even if (1) it is not governed by U.S. law, or (2) it may be accelerated upon specified events of default – as long as such debt would satisfy all the other requirements to be eligible.

• Mandatory 30-day cure period for acceleration clauses.  The final rule requires acceleration clauses for eligible long-term debt issued on or after December 31, 2016 to include a cure period that allows the issuer to make principal and interest payments on the instrument for 30 days after their due date before principal and interest on the instrument may be accelerated (absent a receivership, insolvency, liquidation or similar proceeding of the Covered BHC).

• Lower calibration.  For Covered BHCs, the minimum leverage-based TLAC requirement has been reduced to 7.5 percent in the final rule from 9.5 percent in the proposed rule.  However, that change is offset by a new 2 percent leverage-based TLAC buffer sitting “on top” of the minimum requirement that, if not fully satisfied, would subject Covered BHCs to restrictions on capital distributions and discretionary bonus payments similar to the capital conservation buffer in existing regulatory capital requirements.  For Covered IHCs, the long-term debt requirements have been reduced slightly under the final rule.  The binding long-term debt requirement for Covered IHCs under the final rule is calculated as the greatest of:  (a) 6 percent of risk-weighted assets (compared to 7 percent under the proposed rule), (b) 2.5 percent of total leverage exposure for Covered IHCs subject to the supplementary leverage ratio (“SLR”) (compared to 3 percent under the proposed rule, and (c) 3.5 percent of average total consolidated assets (compared to 4 percent under the proposed rule).

• External long-term debt permitted for Covered IHCs.  The proposed rule would have required all Covered IHCs to issue long-term debt only to foreign parent entities.  The final rule permits Covered IHCs that are expected to enter into resolution proceedings under a “multiple points of entry” strategy for resolution of the foreign G-SIB to issue long-term debt to third parties.  However, because the final rules permit those Covered IHCs to issue long-term debt to third parties, they also introduce a cap on “unrelated liabilities” that Covered IHCs may issue, similar to the cap that exists for Covered BHCs.

• No phase-in period.  The proposed rule would have begun taking effect on January 1, 2019 and would have been phased in fully by January 1, 2022.  As a result of its more generous grandfathering provisions, the final rule will generally apply in full beginning January 1, 2019.  In addition, foreign G-SIBs subject to the rule will have to submit a certification to the Federal Reserve by June 30, 2017, indicating whether their resolution strategy involves their Covered IHC and U.S. subsidiaries entering resolution.

• Clarification on structured notes.  The final rule clarifies that an instrument will not be considered a structured note – and therefore subject to a cap at the holding company level when issued pari passu with eligible long-term debt of a Covered BHC – solely because it is non-dollar-denominated, or because its interest payments are based on an interest rate index.

• Deduction for cross-holdings not finalized.  The final rule does not address the regulatory capital treatment of TLAC held by other banking organizations, notwithstanding a recent international standard issued by the Basel Committee on Banking Supervision that specifies how those instruments should be deducted from the holder’s regulatory capital. The preamble to the final rule indicates that the Federal Reserve will address this issue jointly with the Office of the Comptroller of the Currency and the Federal Deposit Insurance Corporation at a later time.

The long-term debt and TLAC requirements of the final rule are summarized below:

RWAs:  the greater of the Covered BHC’s risk-weighted assets as calculated under the standardized approach and the advanced approaches.

Total leverage exposure:  the denominator of the supplementary leverage ratio.

G-SIB surcharge:  the Covered BHC’s binding capital surcharge under the Federal Reserve’s U.S. G-SIB surcharge rule.

Method 1 G-SIB surcharge:  the Covered BHC’s G-SIB surcharge calculated under method 1 of the G-SIB surcharge rule, which is generally less than or equal to the Covered BHC’s binding G-SIB surcharge.

Countercyclical capital buffer:  any amount required to be held under the countercyclical capital buffer of the banking agencies’ existing regulatory capital requirements, which is currently set to zero.

RWAs:  the Covered IHC’s risk-weighted assets as calculated under the standardized approach.

Total leverage exposure:  the denominator of the SLR.

Average total consolidated assets:  the denominator of the generally applicable leverage ratio.