THEY SAY IT’S all about timing. And it definitely was for IFR’s 17th annual bank capital conference, which I chaired last week in London. It was a fabulous affair: not even standing room in our packed auditorium for the morning sessions and a crowd watching proceedings from the live relay screen outside. At one point, our security team told us they wouldn’t let anyone else in because of health and safety concerns.
That’s pretty cool. But what was the subject of such immense and popular interest? None other than bank capital, resolution tools, bail-in instruments, Basel IV and asset-side impacts, optimal pricing differentials between various capital and funding buckets, rating methodologies, and, the one that got everyone going: the emergence of non-preferred senior debt at an EU level.
So why my reference to timing? Well, on the day before the conference the European Commission had unveiled the comprehensive package of reforms and adjustments it had agreed with the Basel Committee and the FSB to reduce risk in the banking sector and strengthen EU banks. So we were the first to air the topic in detail in a public forum.
In the press release unveiling the package, Valdis Dombrovskis, EC vice-president responsible for financial stability, financial services and capital markets union, framed the importance of the measures around the need for banks to be able to continue financing economic growth.
That’s interesting, because when it comes to the onerous capital, funding, liquidity and resolution requirements confronting banks, I’m far from convinced we’re going to end up in a good place in that particular regard.
That notwithstanding, the EC’s latest measures pertaining specifically to capital markets issuance got a good airing at the conference and became the focus of many of the panel sessions.
You can see why the measures captured so much interest: among other things, the broad and wide-ranging package will introduce a binding leverage ratio of 3% (note: no LR surcharge for G-SIBs – yet) and a binding 100% minimum net stable funding ratio; a Pillar 1 MREL requirement for G-SIBs that jives with TLAC, and a proposal for a Pillar 2 add-on that banks can fill by issuing highly loss-absorbing debt, as long as the NCWO (no creditor worse off) test is met in resolution.
We got a six-month grace period proposed for banks in breach of MREL and combined capital buffer requirements (while maintaining Pillar 1 and 2 requirements) before restrictions to discretionary payments to holders of regulatory capital instruments kick in.
And we got a proposal for a five-year phasing-in period for early recognition of NPLs via IFRS9 to prevent sudden shocks to capital ratios.
There’s a proposal in there too for a harmonised national insolvency ranking of unsecured debt instruments to facilitate issuance of loss absorbing debt instruments. The EC is clearly exercised by the wide divergences in the ranking of creditor claims in insolvency that were introduced in order to comply with the subordination requirements of TLAC.
Brussels overlords fear the discrepancies could amplify uncertainty for debt issuers, investors and resolution authorities; make the application of bail-in in cross-border resolution more complex and less transparent; create information asymmetry headaches for investors that will make pricing more cumbersome; and lead to competitive distortions as unsecured debtholders are treated differently in different member states.
WHAT’S GOT EVERYONE talking is their solution: the creation at EU level of a new statutory category of non-preferred opco senior debt that ranks below the most senior debt and other senior liabilities for the purposes of resolution.
It’s a solution that neatly gets around the holdco/opco issue for banks that aren’t structured that way.
Non-preferred senior debt already exists in Denmark - Nykredit-Realkredit’s inaugural offering of €500m of senior resolution notes in June was heavily over-subscribed and the notes have tightened dramatically since launch - and just in the past few weeks, France. The expectation is for other EU jurisdictions to implement changes in short order.
In the FAQs accompanying its reform package, the EC said “clear, harmonised rules on the position of bondholders in the bank creditors’ hierarchy in insolvency and resolution could facilitate the way bail-in is applied, by providing greater legal certainty and reducing the risk of legal challenges”. Can’t argue with that.
How this Tier 3-style bucket prices was the subject of some debate and speculation at the IFR conference. The Street loves nothing more than trying to figure out where something will print. Mind you, I’m not sure we reached a consensus on this point.
Whether non-preferred senior prices closer to senior-senior or closer to Tier 2 will be a function of a range of different things: the broad market environment, whether there’s a crowded pipeline at a certain point in time, how a bank has structured its total capital and funding stack, credit and market profile; the mood of investors; the underlying monetary policy environment, and so on.
Given there’s apparently something in the region of €770bn of senior bank debt coming due in the next four to five years against an expected MREL requirement of €550bn, the negative net issuance scenario will drive technicals pretty hard. And you’d imagine that inserting a layer of senior resolution notes should provide a nice uplift to senior-senior spreads.
So much to unfold; so much to play for between now and IFR’s 18th Bank Capital Conference. I’m looking at the O2 for our next venue. Watch this space.
