IFR Bank Capital Roundtable 2015: Part 2
IFR: Just on the pricing point, there are risks that you can see, risks that you can’t see, risks that you can extrapolate, risks you can interpolate, that you can evaluate or model in some way. But given where we are in the capital debate, where it’s very clear what the expectations are going to be but we haven’t seen the final term sheet yet, how do you price those risks in – particularly given that we’re in a fairly artificial market environment as well, with QE and so on?
Laurent Frings, Aberdeen Asset Management: Yes, you’re absolutely right. I think QE is the distorter, not just QE but all central bank actions to the point on covered bonds and where they trade versus senior unsecured. In terms of pricing, ultimately there is no perfect model; it’s still very much a kind of finger in the air and market participants just looking at where things are trading today and taking that for granted that this is the fair market pricing for instruments, as opposed to taking a forward-looking view as to actually what the risks are, both from a PD perspective and loss-severity perspective.
We’re still very much in an imperfect world when it comes to bank instrument pricing. Personally, as I said earlier, I believe that the PD element is mis-priced at this point in time, which is why we are long the sector, and you can express it in many different ways. The way to really think about it is then to look at the differential between structures.
What’s interesting is how the market is looking at potential changes to German insolvency law and not necessarily thinking about it from a bigger picture in that other countries may want to do the same thing and how to price French senior unsecured paper, as an example. Again, it feels to me the market is looking at what’s in front of them and then trying to look at the bigger picture or what that picture may look like in two years’ time.
IFR: Gerald, from a global perspective we’ve seen lots of jurisdictions come out with frameworks. Are we creating a global market that’s almost impossible to compare because allowable features are different or regulatory environments are different? I’m talking Europe, non-Europe, US, EM, Japan. Are you comfortable with where those conversations are going?
Gerald Podobnik, Deutsche Bank: Generally, yes, but we still have a lot of divergence, due to historic and regional realities. Let me touch on three things: Tier 1, Tier 2 and the whole resolution idea behind it all.
On Tier 1 we have a big divide globally. We have Europe and some other countries that require triggers, and we have the United States and some countries that use the Basel allowance where if you have an equity accounted instrument you don’t need anything. If you look at Canadian, at US preferred stock, they don’t have triggers, so they don’t have this debate at all. The flipside of this in the United States is that prefs are not tax deductible so we can’t compare these instruments necessarily.
The other thing which I think is quite interesting is that we have quite a global divergence on those that have triggers with regards to trigger levels and on the permissions on means of loss absorption.
In Europe most countries can choose between conversion, permanent writedown or temporary writedown; other jurisdictions go for one or two only, so you have to analyse those transactions in detail because there is no harmonious treatment around the world.
In Tier 2 it’s easier, except it isn’t really because we have statutory PONV (like we have in Europe); some countries have contractual PONV and others have triggers, not just the Swiss CoCos but real classic Tier 2. If you look at Mexican Tier 2, for example, or Brazilian Tier 2, you find triggers. These are usually the minimum triggers, but they are triggers.
Again this has to be looked at differently, and we need to be very careful in all of those areas with the use of the word ‘CoCo’, because I think it has been over-stretched. We would rather call it ‘Tier 2’ and ‘AT1’ and then look at the details, otherwise you might be misled.
In the third area – resolution – we still see a lot of divergence although I think it might harmonise when TLAC comes out. But on the other hand not really, because TLAC is only meant for G-SIBs. If you look where the G-SIBs are, it’s the US, EU, Switzerland, Japan and China (although China is exempt because emerging market-based G-SIBs are exempt).
When we look at resolution regime development, Europe is obviously very well advanced. The US has its own systems under Dodd-Frank with the Orderly Liquidation Authority (OLA). But in the US we will need to wait and see whether there are any political developments on the back of this. In this regard, the Republicans in Congress are working on the Financial Institutions Bankruptcy Act – which has a different idea of bringing the resolution of SIBs in the United States back into the bankruptcy courts and reforming Chapter 11, so it’s not necessarily a given.
If you look at the Asian world, there is also a lot of interest and development of resolution regimes behind the scenes. But I wouldn’t say it’s as advanced as we have in Europe or the US right now. Going forward we have to see how Europe finalises its regime, and what the US finalises on its own. S&P commented very well in a piece where they talked about the ratings of large US bank holding companies, saying that they might remove State support if there is more clarity in how OLA is operated and how the hierarchy works.
So, there’s still a lot out there. It might be that in five years we have a super-harmonised resolution regime outstanding around the world but I doubt it, because again the differences based on history are just so specific in the banking sector around the world.
IFR: Khalid, bearing all of that in mind, how do you position these factors in a market environment where you have to get investors on board and have to tell a story. It sounds as if this can be a heavily nuanced process.
Khalid Krim, Morgan Stanley: It is nuanced but I think there are a couple of things that issuers keep in mind when they look at putting a transaction in the market whether it’s Tier 1, Tier 2, or senior. The point about doing what is right and in line with the current regulation is a key principle i.e. I’m going to be issuing something that I can explain and justify. Swiss or UK banks can be first movers because they have their regulators giving them guidance or working with them so that they can come out and post a change of regulation and communicate that; for instance, HoldCo debt is the way to go for TLAC for a UK or Swiss bank.
But Europe is lagging, waiting for clarification on MREL for instance, and for regulators to tell us which way to go. The nuances are more around: “what can I tell you and what can I disclose to you as a bank?” so that investors are comfortable what they are buying and what risks they’re taking. When we talk about bail-in and resolution, the key things from my perspective are around going out and disclosing the bail-in buffer.
But not only the quantum and how much you will be holding because, frankly, for G-SIBs or large banks, we’ll get to a point where everything is harmonised. Everyone will want to show that they have a number that is aligned to their peers, because, as Steven was saying, there is an exercise for investors that is more like a relative-value exercise. If I’m buying a Barclays bond, I’m going to look at Deutsche Bank and I’m going to look at other peers, and I’m not necessarily going to look at the country, or the resolution authority, or the passport, of the bank; I’m just going to look at the fact that these two banks are comparables.
The quantum of the bail-in buffer is one thing; the other is the composition. What is protecting me in terms of quality of capital in a bail-in scenario? This is very much focused on bail-in but what banks will need to do and investors will need to think about is the fact that the resolution strategy isn’t all about bail-in; there are other tools that you can use at that critical point.
We’ll enter that scenario at a time where a resolution authority walks in and tells us I have a weekend to come up with the right plan. Banks are working on resolution plans with their resolution authorities and we have new agencies coming into play, so in Europe we have the Single Resolution Board (SRB), the equivalent of the Single Supervisory Mechanism, which was created in March 2015.
Resolution authorities will need to come out and tell the market: “this is how resolution will work”. We’re all focused on bail-in, on the fact that the only thing that will happen is bail-in. But frankly, we moved from bail-out to bail-in two or three years ago and it’s now fully accepted. It’s no longer taboo to have senior bail-in; people are living with it. But what people need to understand is if bail-in is happening, how will it work? Hence the waterfall.
Transparency about how internal TLAC is working will be key. To navigate the nuances of disclosure, there’s a combination of clarity in terms of message and communication; and of credit work in terms of whether we’re facing a G-SIB, a large institution or a smaller bank. We’re talking about 30 G-SIBs, half of which are in Europe but we have 6,000 banks that are supervised by the SSM, so it’s not ‘one size fits all’.
Sandeep Agarwal, Credit Suisse: I have a comment on that. Differentiating G-SIBs from D-SIBs is a myth. My sense is that most of the D-SIBs are global, or certainly present in multi-jurisdiction environments and therefore will subject themselves indirectly or directly, whether through an investor or through a rating agency, with a similar – if not the same – scale.
What the jurisdictional outline and the implementation of the rules is will be relevant because of the systemic importance. The framework will therefore continue to play an important. To the extent we can get a harmonised approach, great, but we are not going to get that, and the regulatory impetus will be different within each jurisdiction. We know that, so we have to recognise it. That’s going to be an important element to consider when looking at the relative play. One hopes for harmonisation, but I am not confident that comes into play.
Steven Penketh, Barclays: Harmonisation is key for all issuers and drives at the heart of the main benefits of a universal organisation like the Financial Stability Board: to try and ensure harmonisation on an international level with G-SIBs. If you look at the draft paper on the Regulatory Technical Standards on MREL, for example, it’s a key principle there too, the fact that there should not be, effectively, jurisdictional arbitrage created through the way that these rules are actually implemented.
I have a little bit more faith than some others here. I think that finding international accord when implementing these rules in a harmonised way was always going to take time, which means we have the difficulty of having to execute in the face of ambiguity without ‘memorandums of understanding’ between different regulators having been established. I think we will get there in the end. The harmonisation piece is absolutely critical.
IFR: Daniel, do you share that optimism? Or hope?
Daniel Shore, HSBC: We should put a probability on it. I agree with Steven that policymakers have to do that, but if you look at the financial crisis that we are emerging from and think about what drives decision making, you can’t ignore the influence of taxpayer considerations. You have to take into account the specifics of the home market including domestic investors.
Steven and Sandeep’s points are valid in that we need to have people ensuring there won’t be this sudden closing of all doors and protecting home countries differently than you would if you go across to a firm that’s a global multiple-point-of-entry institution, compared to, say, an institution that operates in one country. We have to hope that that will happen.
The FSB is driving towards that; I think they do understand it. The SSM, in particular, is looking for this. We talk about harmonisation, but it’s also looking for that level playing field as well. We can’t have a carve-out for one particular part of the world which then disadvantages another part of the world. I think everybody realises that.
Steven Penketh, Barclays: But it’s difficult, because you’ve got different jurisdictions starting from completely different places and navigating it is not an easy task, but I have confidence that the FSB will deliver.