It will be some months before the US finalises its implementation of the Financial Stability Board's (FSB) total loss-absorbing capacity (TLAC) framework, but already the rules are having a seismic effect on the US structured products market.
As every bank on the Street works through the required operational changes, one law firm above all others was sought out for the quality of its advice and thought leadership on the rules: Morrison & Foerster.
The TLAC framework will force all global systemically important banks (G-sibs) to hold loss-absorbing debt equivalent to 16% of their risk-weighted assets. Debt instruments such as structured notes that feature embedded derivatives are largely ineligible, so issuers have had to think carefully about the make-up of their debt profile - and more fundamentally, the corporate structure through which they issue it.
The TLAC restrictions apply to structured notes issued at holding company level. As a result, virtually every house on the Street is understood to be in the process of setting up new finance or operating company entities through which to issue structured notes and other debt products in the future – an immensely complex undertaking.
TLAC has been a huge focus for us over the past 12 months. All of the major US issuers are currently in the process of setting up finance subsidiaries from which, going forward, they will issue their structured notes
Anna Pinedo, Morrison & Foerster
"TLAC has been a huge focus for us over the past 12 months. All of the major US issuers are currently in the process of setting up finance subsidiaries from which, going forward, they will issue their structured notes. We're working on those for some issuers, and working with a number of banks on other issuance programmes as well – global medium-term note offerings, for instance. A lot of the regulatory and funding issues need very careful thought, particularly the parent guarantee relationships," says Anna Pinedo, a New York-based partner at Morrison & Foerster.
Structured notes issued from the new corporate entities need parental guarantees, which dictate the relationship between a bank's holding company and its subsidiaries in a bankruptcy event. Dealers say the negotiation of these guarantees is one of several thorny regulatory problems, another being the heightened scrutiny of new subsidiary registration documentation.
"The major US issuers of structured notes are amending their registration statements, or filing new ones. In many cases this requires a soup-to-nuts recreation of the shelf documentation: investor prospectuses, bond indentures, programme agreements – the entire infrastructure for the issuance entity. Not all of these issuers are eligible to file automatically effective registration statements, and those that are not eligible have to be ready for the possibility of a detailed review of their documents by the US Securities and Exchange Commission. These issuers are preparing for that accordingly," says Lloyd Harmetz, a partner at Morrison & Foerster in New York.
Clients single out Harmetz's ability to zero-in on such issues and come up with solutions. "Lloyd's attention to detail is fantastic; he 'knows the law'. He has incredible market knowledge and a great support team behind him," says a senior executive at one issuer.
Morrison & Foerster's work on TLAC extends beyond issuance and associated regulatory advice. The firm has acted as counsel for the US Structured Products Association and co-counsel for another US trade association in their public dialogue with regulators over the rules.
Another major practice area that clients praise is the firm's tax advice, with New York-based partner Remmelt Reigersman singled out for his work helping clients comply with the US Internal Revenue Service's (IRS) Section 871(m) rule. The rule is designed to prevent investors from avoiding withholding tax that would be due on equities investments by using other equity-linked instruments. Dealers must subject the instruments to a delta test to determine whether the tax is due.
Staying on top of the rules and associated guidance from the IRS – the test itself has gone through multiple versions before the most recent iteration was finalised – has been a tall order. Firm-wide, Reigersman totals the number of man-hours dedicated to Section 871(m) advisory at more than a thousand.
"When the regulations came out, there was a lot of work that had to be done on understanding the implications and walking clients through them – and that's before you even get to implementation and systems building advice. Clients also want very product-specific advice, looking at how securities will be affected even before an issuance programme has been developed, for instance," says Reigersman.
The firm also advised on $14.8 billion worth of product issuance in 2015 across roughly 500 offerings, and onboarded a number of new clients, several of whom were newcomers to the US market.