FSB rules threaten to reshape structured note industry

Proposed rules meant to safeguard financial stability threaten to reshape the structured note industry, where the world's biggest banks sell billions of dollars of securities each year to secure funding and earn fees.

A proposal by the Financial Stability Board (FSB), led by Bank of England Governor Mark Carney, doesn't count structured notes towards meeting a new capital buffer known as "total loss-absorbing capacity," or TLAC. The measure is designed to ensure banks have enough liabilities to "bail in" creditors and avert a government rescue from insolvency.

Banks are struggling with the implications for their programmes that issue structured notes - debt packaged with derivatives often sold to individual investors.

"Banks have used structured notes as an important part of their funding," said Robert Smalley, who heads the credit desk analyst group at UBS in New York.

"If those are not included, either the notes themselves will have to be conformed to something more TLAC friendly or they'll have to issue different unsecured debt in their place."

Issuers sold US$41.4 billion of structured notes registered with the US Securities and Exchange Commission last year and US$76.8 billion of such securities elsewhere. The numbers capture a fraction of what is an opaque market where deals may be only a few million dollars in size, and often there is no regulatory requirement that they be reported.