The Fed sheds light on structured debt

The Federal Reserve has clarified rules around capital treatment of a type of structured #debt which involves the sale of #credit-linked notes that carry the risk of losses on U.S. bank loan portfolios to investors.

These trades, also known as Total Loss-Absorbing Capacity (TLAC) or long-term debt (LTD) trades, are mechanisms that allow banks to issue debt that can be converted into equity in the event of a financial crisis. This helps ensure that banks have sufficient capital to absorb losses and maintain stability in the financial system.

The Federal Reserve’s new guidance states that these bank capital relief trades will be allowed until the end of 2023, after which they will be phased out. This decision aligns with the international regulatory framework set by the Financial Stability Board and the Basel Committee on Banking Supervision. The goal is to promote financial stability and reduce the risk of taxpayer-funded bailouts.

Such transactions, done privately, have been difficult to get done in the U.S., said Michael Bright, CEO of the Structured Finance Association.

Data on them are not public but banks supervised by the European Central Bank (ECB) completed a record 174 billion euros ($189 billion) of such deals last year, the regulator told Reuters in April.

A bank can normally transfer risks of losses equivalent to around 7% to 12% of a loan portfolio in a European trade, market sources previously said.

These clarifications come after growing calls for clarity on which of these bespoke trades issued by U.S. banks would qualify for capital relief, the banking industry sources said.