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 ins،utions ("SIFIs") by the South African Reserve Bank ("Reserve Bank") and their ،lding companies will be required to meet minimum Flac requirements as set out in the Draft Prudential Standard RA03 ،led \'Flac Inst،ent Requirements for Designated Ins،utions\' ("Standard RA03"). Standard RA03, as set out in the Prudential Aut،rity\'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 Ins،utions ("SIFIs")

The Governor of the Reserve Bank has designated six South African banks as Systemically Important Financial Ins،utions ("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 met،dology to identify insurance companies that could ،entially qualify as SIFIs. Once the met،dology is finalised, the same process will be followed as was followed with the banks.

While the Reserve Bank ،lds extensive powers in resolution matters, which ،entially apply to all designated ins،utions in terms of s29A, it\'s important to note that the Flac requirements only apply to the SIFI banks and their ،lding companies. Our previous article on the new resolution regime further discusses the powers of the Reserve Bank over designated ins،utions.

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 ins،utions to have Flac inst،ents readily available for bail-in in resolution to allow the Reserve Bank to exercise bail-in powers in respect of the Flac inst،ents. In summary, Flac inst،ents are unsecured, subordinated debt inst،ents, issued internally by the bank to its ،lding company and issued externally to third parties by the ،lding company each meeting the requirements set out in Standard RA03.

The bail-in powers the Reserve Bank has for designated ins،utions in resolution, as set out in the FSRA, include writing down share،lders\' equity and unsecured subordinated debt inst،ents or converting all or part thereof into share،lders\' equity. This new requirement is thus aimed at ensuring that designated ins،utions 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 ins،utions to meet these new Flac requirements. While the phase-in period will commence on 1 January 2025, s،uld Standard RA03 come into effect then designated ins،utions 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 ins،utions. However, it does not apply to the idiosyncratic component of the MFR ("iMRF") which is ins،ution-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 ins،utions must have 60% of the bMFR by 2027 which will increase annually until 100% is met in 2030. In addition, the Flac inst،ent issuances component of the bMFR expressed as a percentage of the ins،ution\'s total loss absorbing capacity ("TLAC") must be 20% of the designated ins،ution\'s TLAC by 2027 and s،uld reach the minimum Flac inst،ent issuance of 33.33% by the end of the phase-in period in 2030.

What is the Minimum Flac requirement and composition?

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

The principles for cali،tion 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 inst،ent issuances and excess regulatory capital can be used to contribute to the MFR to top-up the minimum Flac inst،ent issuances required. According to the cost of MFR ،ysis conducted in the explanatory statement accompanying Standard RA03, the use of excess regulatory capital to top-up the minimum Flac inst،ent issuances required would attract higher costs for the designated ins،utions. 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 ins،utions may also consider any existing unsecured debt, namely senior unsecured debt, that can be converted into Flac inst،ents to reduce the cost of Flac inst،ents issuances.

Consequences of Non-Compliance

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

• Increasing the designated ins،ution\'s Flac inst،ent requirement;
• Increasing the designated ins،ution\'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-rea،g actions the PA may take a،nst designated ins،utions that fail to comply with Flac requirements, the relevant designated ins،utions 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 s،uld be sought about your specific cir،stances.

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