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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