IFR Editor-at-large Keith Mullin
People over the weekend were glibly suggesting that because a lot of the cash stashed in Cyprus is Russian and may be linked to money laundering, it’s OK to steal it. That Cypriot and EU banking and regulatory authorities have been turning a blind eye to hazy financial dealings for such a long time is, to my way of thinking, almost a bigger scandal.
Russians conducting their financial dealings via Limassol and elsewhere has been an open secret for years. Back in the day, I covered emerging market debt and never ceased to be amazed at how many conversations I had with Russian bank issuers, originators and syndicators that involved Cyprus, usually followed by embarrassed silence and an awkward clearing of throats.
As Cypriot officials seek last-minute to change the basic structure of the supposed one-off tax to get it through parliament, it’s impossible not to focus on the bigger implications here. And I don’t just mean the contagion effects through the rest of the eurozone periphery that prompted US economist Paul Krugman to write in The New York Times: “It’s as if the Europeans are holding up a neon sign, written in Greek and Italian, saying ‘Time to stage a run on your banks!’”
I’m talking about the fact that raiding bank deposits obliterates accepted notions of capital hierarchy and adds to already-articulated fears around the sanctity of contracts that underpins the role of institutional investors in capital intermediation.
Would it be any more scandalous if an EU government – after destroying depositor super-seniority in such a cavalier a manner backed by the eurozone and the IMF – were to impose a ‘one-off’ legal change in an exceptionally distressed situation that rolls back the legal sanctity of secured creditors? Not from where I’m sitting.
EU deposit protection codes had pushed depositors clearly and incontrovertibly into the position of super-senior creditors, sitting above senior bondholders. That notion has been crushed. Think about the retroactive contractual changes in Greek law bonds ahead of the Greek debt restructuring and the impact that has had, where investors will now demand spread concessions on bonds containing collective action clauses.
It’s noteworthy that Ireland and Portugal made their return to the voluntary capital markets by opening existing lines of stock rather than launching new issues with CACs.
Fundamental principle
Think also about the impact of Alternative Tier 1 instruments where coupon deferral or suspension features may actually subordinate hybrid creditors below the position of shareholders, where, again, it had been fundamental principle of capital hierarchy that shareholders sat at the bottom and who needed to be wiped out or at the very least where dividends needed to be suspended in tandem with hybrid coupons.
Contingent convertible holders being zeroed as permanent write-down triggers are breached before the issuer technically hits default or is declared insolvent and shareholders are hit is another crazy example where capital hierarchy has been turned on its head.
At an IFR Bank Capital Roundtable I hosted last year, Georg Grodzki, head of credit research at Legal & General Investment Management had this to say: “The degree of regulatory flex or discretion which is becoming almost a new mantra is scary. The regulators seemingly reserve the right to over-rule whatever has been agreed if they see that as necessary or helpful to preserve financial market stability or whatever. We now have to factor in regulatory risk as an additional downside factor. That of course means we need to get paid for it …”
I and others often talk about laws of unintended consequences, where the consequences are, oddly enough, unintended. We haven’t yet seen the outcome of the Cypriot deposit tax, but aggressively and brazenly expropriating deposits seems to me to be every bit a law of intended consequence.
What’s next? I spend a lot of time chatting to people and running events in and around covered bonds. Particularly in Germany, people talk in hushed and reverent tones about the sanctity and safety of traditional Pfandbriefe and their cousins in other jurisdictions, where creditor security is enshrined and protected in law.
Now, am I suggesting that Pfandbriefe investors have anything to fear from the Cypriot raid on deposits? That’s a huge leap at this juncture. But would it be any more scandalous if an EU government – after destroying depositor super-seniority in such a cavalier a manner, backed by the eurozone and the IMF – were to impose a ‘one-off’ legal change in an exceptionally distressed situation that rolls back the legal sanctity of secured creditors? Not from where I’m sitting.
