Moody's: European legislative developments and global resolution framework implementation impact creditor hierarchies, increase complexity

A number of developments, particularly in Europe, have affected the rank ordering of bank liabilities within creditor hierarchies, said Moody's Investors Service. The ratings agency said these changes are reflected in its Advanced Loss Given Failure (A-LGF) analysis, a key component of its global bank rating methodology. 

In a new report, Moody's provides an overview of the key legislative updates that have affected the rank ordering of bank's liabilities, a key determinant of the application of losses to creditors in the event of a bank failure. Among the developments, the agency noted that several countries subject to the European Union (EU) Bank Recovery and Resolution Directive (BRRD) -- including Germany, France and Italy -- are legislating different insolvency hierarchies that will enable banking groups to meet resolution capital requirements and better protect depositors. Moody's analysts said that, as a result, the creditor hierarchies it applies to each EU country may differ and noted that the differing approaches would increase complexity for debt investors. 

"We're seeing greater fragmentation in national implementation of the Bank Recovery and Resolution Directive (BRRD), which will further complicate bail-in and resolution process -- particularly for cross-border institutions," said Moody's Vice President Meredith Roscoe. "The varying approaches, while aimed at protecting senior unsecured obligations and bank depositors, increase complexity for investors who need to understand where they will rank in a bank's creditor hierarchy in the event of its failure." 

In Europe, the United Kingdom is the first country to propose specific qualifying requirements for resolution capital liabilities, known under the BRRD as MREL (minimum requirement for own funds and eligible liabilities). Moody's said the UK MREL rules largely mirror those of the Financial Stability Board's Total Loss Absorbing Capacity (TLAC), setting MREL as a function of risk weighted assets and requiring subordination for eligible liabilities. The ratings agency said it expects EU authorities will propose legislation aimed at harmonizing the various regulatory requirements applicable to global banks including Basel III, MREL and TLAC in the coming year. 

Moody's said that in the United States, regulators' proposed version of the TLAC rules supports its view that the holding company will be used as the primary loss absorbing vehicle to pass losses up to the holding company.