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02 Apr 2024
BY Madison Liebmann , Matthew Morrison AND Sinovuyo Damane

South African SIFI banks and holding companies are required to issue Flac (unsecured debt) instruments for resolution readiness

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

 

Matthew Morrison

Executive | Corporate Commercial Department

mmorrison@ENSafrica.com

 

Madison Liebmann

Senior Associate | Corporate Commercial Department

mliebmann@ENSafrica.com

 

Sinovuyo Damane

Candidate Legal Practitioner | Corporate Commercial Department

sdamane@ENSafrica.com