IFR ASIA: Welcome. Sean, you took part in a similar discussion we hosted almost three years ago, so perhaps you’re the best to kick this off. Where do we stand with bank capital in Asia? How much capital do banks really need here?
SEAN MCNELIS, HSBC: I think when we were having this discussion three years ago, there was still a lack of clarity on the instrument criteria for Additional Tier 1 and Tier 2 in some jurisdictions, and we hadn’t at that time seen the first wave of AT1 and T2 issuance begin. That has now happened across Asia Pacific for all the major jurisdictions. The second phase was investors understanding the discrepancies that exist between the various jurisdictions, for example, how the point of non-viability and CET1 triggers differ in Korea and Japan compared to mainland China, Hong Kong and Singapore. That is now well understood by investors after we’ve seen many transactions come to market.
There was, at the time, some concern around supply, particularly from the Chinese banks, and one of the points I would have been making three years ago was that a lot of that supply would go to the onshore markets. And I think we saw that happen, with, in the case of mainland China. approximately 70% of issuance going onshore and the balance to the offshore markets. And it was proven that the offshore supply could be easily digested by investors.
I think what we’ve also seen is an exceptionally strong performance of the Asian AT1s and T2s in the secondary market, be it the Greater China, Korean or Singapore deals, relative to the global peer group issuances. Despite the volatility seen earlier in 2016 and around Brexit more recently, in Asia the market has remained robust for bank capital.
So I think overall the prognosis is that we have a deep and developed market for bank capital product.
IFR ASIA: OK. It wasn’t exactly plain sailing earlier this year, though, was it?
SEAN MCNELIS, HSBC: I think we’ve seen specific concerns in certain EU countries around AT1, less so for the Tier 2 product. For the AT1 product there are a number of embedded risks, one of which is the extension risk around callable structures. I think investors fully understand and accept that risk. Where a lot of volatility came from earlier this year was concern around coupon payments and the extent to which banks would have been prohibited under law from making coupon payments. There are specific legal restrictions relating to the ability of banks to make discretionary payments on AT1 securities. Under Basel III payments can only be made out of distributable profits – a concept that is subject to accounting guidelines and domestic law, jurisdiction by jurisdiction. For a number of banks this became an increasing concern in the minds of investors as those banks reported losses in Q4 of last year.
But more importantly, there’s a further restriction around the maximum distributable amount, the MDA, limiting the availability of profits for discretionary distributions once a bank is below the upper limit of its pre-defined buffer capital requirement. In the EU banks had a clarification that their Pillar 2 capital requirements would be binding as part of an effective minimal capital requirement.
Banks had previously generally not been disclosing Pillar 2 capital requirements. Now they generally will disclose these as recommended by the EBA under the EU’s SREP (Supervisory Review and Evaluation Process). Investors have therefore started focusing on what’s called the distance to MDA – i.e. how far away the bank’s latest reported CET1 capital ratio is from the sum of the minimum requirements (including the Pillar 2 requirement) plus the various buffer capital requirements.
It’s slightly different in Asia Pacific, where the regulator generally retains an over-arching power to intervene with respect to a bank’s ability to pay coupons and there is a less prescriptive definition in the documentation around the MDA. This lack of prescription in Asia-Pacific is generally viewed by the market as being more friendly to AT1 investors, whereas for the European banks it’s very clear how it works in the documentation with limited scope for regulatory forbearance. Recently there have been some clarifications from the EBA on this topic and it’s now less of a concern, even for European banks.
MARK YOUNG, FITCH RATINGS: This issue has crept in for Korea. We can talk about the frameworks being relatively established and, broadly, I think that is true, but there is also some tweaking going on. In Korea they narrowed the definition of when issuers are restricted in terms of paying out coupons to this year’s profits.
So we currently talk about the issue being a European issue, but it could easily become an Asian issue. I think what is interesting for Asia is that it’s not a uniform market. Each country has its own nuance and so one needs to have a good understanding of each market.
IFR ASIA: Okay. Brian, I’m going to come to you, because this discussion about the European AT1s was revolving around Deutsche. So what happened there, and why have things settled down so much since?
BRIAN WEINTRAUB, DEUTSCHE BANK: Just as a blanket record statement I’m not going to discuss anything to do with Deutsche Bank. More for the sake of starting a bit of a debate here, all the technical issues that you guys are outlining – differences in regimes and frameworks and so on – an investor may want to understand all that to the nth degree and try and place a value on what makes this jurisdiction different from that one. Investors do the work because they have to, but at the end of the day, that then falls away. New issues are going to price against a bunch of comps in the market. There’s these Chinese ones trading out here, and here’s their Tier 1–Tier 2 differential etc.
These instruments are not highly liquid. A lot of them – even the offshore currency ones – they’re distributed to onshore investors. I’m predominantly referring to the Chinese transactions here. So the price discovery is not necessarily what I will call market based. It’s still, of course, a real price, but it’s not distributed 95% to 144A institutional investors.
None of these are bad things, they’re all actually really, really good and supportive for the market – and all the points Sean outlined make this is a very, very conducive market for issuing. But I view it a little bit less around, “Oh, the regime is friendlier.” For a lot of investors, maybe they go through all the data and research or maybe they don’t, they draw the same conclusion: they’re never going to not call this. They’re never going to skip a coupon. They’re never going to declare me not viable.
I’m not saying that people take that extreme point of view in every case. But “never” is being seen as such a tail risk that they price it as if it’s sort of quasi sovereign risk. Aside from whatever the parliamentary rules say about bank resolution and so on, a lot of these are state-supported banks either directly or indirectly. There’s nothing wrong with that whatsoever. And that is another key driver of what has been a big kind of anchor of support for the market in Asia. So that’s just one general thing I wanted to say.
The second thing is that the supply out of Asia is still miniscule. It’s still absolutely tiny. And we can talk about the few big Chinese deals that were done, but at the end of the day these were not widely distributed offshore and once we get out of China the number of transactions we’re talking about I think you could count on two hands. I may be off by one or two there, but it’s a very, very small number and the deals themselves are very small.
There’s still a huge dearth of supply, and if it’s something from a good name that has a little bit more yield associated with it, say a Tier 2 security from a Singaporean bank, that flies off the shelf.
JOHN BARRY, NAB: The AT1 market for Australia is very much a listed market. It’s a domestic retail market and it functions very well. While it’s not immune to international volatility, it has been really quite resilient in that regard. So I think it’s a very good source of Additional Tier 1 for the Australian banks that they can rely upon. It’s interesting that ANZ have just gone offshore in the US market last week, which is a positive development in terms of diversifying the investor base.
IFR ASIA: Yes, it’s the first one isn’t it?
JOHN BARRY, NAB: Yes. And it creates an interesting precedent for the other Australian banks through a private tax ruling and deal that was well received. It gave them access to a 10-year tenor and was oversubscribed. So it bodes well in terms of international diversification. And I think the Australian Tier 2 market is also very well established for reasons we talked about, you know as an attractive credit offering a yield pick-up over senior bonds.
I think one of the points in relation to the investor base here in Asia, the robust nature of the investor base, is that despite the lack of supply, the market is performing well in terms of the investors coming up the curve in understanding the complexity of the structures. And understanding what those structures are. So the investor base is certainly showing that they’re adept at accepting different regulatory regimes that may apply to issuers. I think that positions us very well for further issuance, which will no doubt come.
IFR ASIA: Yes. I think that’s a good cue for an investor’s point of view. Sean, how do you look at capital securities? Are you comparing them against relative value? Or is it more going into the weeds of PONV and all of that?
SEAN CHANG, BARING AM: I think this is becoming a more and more sophisticated area because, you know, as other analysts described, the requirements and the regulation changes are getting very detailed. It actually takes time to analyse those instruments. For instance, the ANZ issue: analysts probably won’t have sufficient time to cover the instruments background just on the day they were marketing that deal.
So I think the differentiations among these securities makes it more challenging to make those investments. To some point I agree with Brian saying that probably it won’t need a very detailed look into those instruments before investing into them, because those banks with strong parents can provide support to some extent even though loss absorption varies in different countries and jurisdictions.
But at the end of the day if someone like us invests for the long term it starts to be meaningful to look into the very fine details. There are many various different frameworks in the US, in the Netherlands, in Asia, so it is surely not comparing apple to apple. And the jurisdictions are totally different. So if you make a long-term investment and hold for long enough these instruments will at some stage will become tested.
Because at this stage all these instruments are new, and the regulations are new. There are no precedent cases. And what happens if one of these rules triggers a bail-in? So for investors like us probably if we invested for short-term purpose it’s slightly different, but long-term wise it really needs a very close look. I’m sure other treasuries would say the same, because some of their treasury investments could be very long term. And they’re also subject to other regulations. So if this does not comply with the internal rules or external rules then I think probably at the initial stage they might choose not to invest. So that’s why I think back two years, three years ago many investors were reluctant to get their hands on those instruments.
IFR ASIA: It’s hard to say no to ANZ at nearly 7% though isn’t it?
SEAN CHANG, BARING AM: Yes, it might be true. But by the same token, if it is not up to those requirements then you understand you need to rethink, right? I’m sure the total return would be one of the considerations, but I think everyone if they do their job properly they need to really know and understand what those instruments are.
IFR ASIA: Okay. Have we been tested though? I mean there hasn’t been anything in Asia, but there are some examples, surely, out of Europe?
SEAN MCNELIS, HSBC: Well, during the global financial crisis the view of regulators and central banks was that the legacy Tier 1 and Tier 2 instruments were not sufficiently loss-absorbing ahead of a formal insolvency process. Hence, the development of the revised criteria for the Basel III AT1 and T2 instruments, introducing new features to allow losses to be taken ahead of a liquidation on Tier 2s, and removing incentives/expectations for banks to redeem for AT1s and T2s through step-ups, for example, and further restrictions around managing coupon payments.
It is true to say that we haven’t yet seen the Basel III instruments tested in times of stress. However, in terms of the performance of the legacy instruments, we did see many examples of banks across the EU suspending discretionary coupon payments on Tier 1 and not redeeming Tier 1 and Tier 2 instruments during times of extreme financial stress. This was most prevalent amongst the banks in Europe that had taken government capital injections during the crisis and where they were restricted from making payments to junior creditors under the EU’s state aid and ‘burden sharing’ requirements. It proved that the instruments do actually work in times of acute stress and of course the new generation of instruments under Basel III have features that specifically allow for that loss absorption.
IFR ASIA: That was the old style, right?
SEAN MCNELIS, HSBC: Yes, that was the old style. We saw that certain legacy Tier 1 and Tier 2 instruments in Germany, for example, were defined so they could be written down, but they could be written back up again if the bank subsequently recovered. And we actually saw those instruments being reinstated in certain cases as banks became profitable again. In other cases across troubled banks, the coupons were simply switched off for a defined period. Some investors would have sat out that period of volatility, but of course many are marked-to-market and in many cases they were offered liability management alternatives through buybacks or exchanges into new generation securities. We saw a lot of that during the crisis.
Some regulators would have argued the old instruments weren’t sufficiently loss absorbing at the time. However, investors were effectively taking losses during the crisis through those below-par liability management exercises so from a prudential perspective the instruments were effective.
What we then saw was these new Basel III instruments being specifically designed with new features, you know, the absence of step-ups, the ability to turn off coupons in a number of different situations, no dividend pushers, conversion or write-down based on a CET1 trigger etc. So, yes, we have a new product, but have Tier 1 and Tier 2 instruments ever been tested during a financial crisis? Yes, the legacy product was very much tested and was loss absorbing but the new instruments are designed to do that in a more prescriptive manner.
IFR ASIA: So as a result the new breed are that little bit less investor friendly, right? They must be rated lower as well?
MARK YOUNG, FITCH RATINGS: Yes, absolutely. I think the authorities clearly want the new instruments to act a lot more loss absorbing than the old ones. And we obviously reassessed the ratings assigned to these new style instruments. And in 95% of the time any AT1 will be sub-investment grade except for those issued by very highly rated issuers.
IFR ASIA: So when it comes to ratings the debate here is always how much state support do you factor in. In places like India or China, China obviously being the big one, how do you reconcile that with the chances of being written off?
MARK YOUNG, FITCH RATINGS: Yes, as Brian suggested earlier, the market to some extent is factoring in that “too big to fail” is still relevant in Asia, more than it is in other regions, and I think that is correct. The whole dynamic of removing support has not shifted to Asia and this is reflected in our ratings.
That said, we do not factor that support into the AT1s, because we are rating to non-performance risk – in particular payment of coupons – and we think that there is a chance that even for the Chinese AT1s coupons could be stopped before other things come into play. But in the Tier 2 market we are factoring in support in Japan, Korea, China, India. So we think it’s a relevant credit feature in those markets, particularly where banks have strong links to a sovereign.
BRIAN WEINTRAUB, DEUTSCHE BANK: Just to clarify the point though, in terms of your methodology. You’re factoring state support into the issuer rating, but not the issue rating?
MARK YOUNG, FITCH RATINGS: For Tier 2s? Yes. Because they’ve almost got to trigger liquidation to enforce a bail-in. The terms says the injection of capital by the sovereign would trigger PONV, but in many cases the sovereign is already a shareholder.
IFR ASIA: We’ve been watching what goes on in India quite closely, because some of these banks there clearly do need capital, and the government doesn’t seem to want to trigger any of these write-downs.
MARK YOUNG, FITCH RATINGS: They’ve had the chance to take a hard line with some of the legacy instruments and haven’t done. So support is still quite strong. It could go beyond the even public sector banks where systemic importance is relevant.
India, and to some extent the other markets in this region, highlights an important issue with regard to the development of this market, and that’s the size of the domestic market. Ultimately they would love to issue a lot more paper in local currency to local investors, but the size of the investor pool isn’t big enough to be able to absorb the volume.
When they’ve attempted to go offshore there has been a discrepancy between price expectation of the issuer and the investor and that has stopped that market from developing. Banks may, ultimately, be forced to go into the cross border market – just because the size of the capital hole is large and the timeframe to fill it is getting shorter. So at some point banks will be forced to go cross border because of the lack of depth in the domestic market. That’s going to be an interesting aspect to watch when it happens in the next couple of years.
IFR ASIA: Any views on India, Brian? Is that not even going to open up? Are they going to finally come overseas?
BRIAN WEINTRAUB, DEUTSCHE BANK: I would love to see that. I actually think the last time I saw Sean we had a beer in Mumbai I think…
SEAN MCNELIS, HSBC: That’s right, yes.
BRIAN WEINTRAUB, DEUTSCHE BANK: A lot of the themes that Mark highlighted are the reasons why that market has not done what China has done. They could have some kind of state directed effort to go offshore and raise tier 1 and Tier 2 securities, but for a whole host of reasons, not least of which is price, it just doesn’t work or isn’t sensible for them to do so right now. That doesn’t mean folks like us haven’t tried, and there has still been a lot of time spent there on this topic.
It has not developed, at least I’d say not in the way we thought it would, but looking back and understanding what’s happened, I’m not surprised that they haven’t had eight state banks go off and do a couple of billion dollars overseas. It just doesn’t make any sense. I’m supportive of that. We still do spend a lot of time there, but it’s not moving in the direction that we originally thought.
I want to address an earlier point, similar to the question you asked me and a comment that Mark had made around how the new-style securities have performed in Asia relative to Europe. We’ve seen a lot of stresses in European examples and we haven’t seen anything in Asia yet…
IFR ASIA: Even this year it didn’t move much, right?
BRIAN WEINTRAUB, DEUTSCHE BANK: Nothing. When we saw spreads completely blow out in European AT1 and to a lesser extent Tier 2, Asia moved only by a fraction of the amount. One of them is wrong – either the price is wrong, or everything here is just that wonderful. And it’s not. The macro backdrop here, there is a lot of underlying potential risk.
Aside from the drivers of why the price did or did not move, the reality is investors don’t think that there is the potential for a crack in the system that would impact one of these securities. You used the phrase too big to fail, but you can call it (the risk of) point of non-viability or a state capital injection, whatever it may be. Nobody thinks anything is going to happen here, and we can prove that just by looking at some simple charts.
Now to me, it is a statistical certainty that something will happen at some point in time. There you go, there’s a very prophetic statement.
It could take 10 years. It could take 20 years. I don’t know when this is going to happen, but statistically a large bank will come under stress in Asia. When that happens I think that’s when we’ll see more of a realistic view of how subordinated bank risk will be priced in Asia, because in my view it’s incorrect to look at what happened in Europe in Q1 and extrapolate it to Asia. This time, nothing happened. I just think that what the market is telling us is not correct.
MARK YOUNG, FITCH RATINGS: I think the difference between Europe and Asia is the investor base. You’ve got more of a wholesale-driven market in Europe, whereas here in Asia you’ve got high-net-worth buyers who are investing on too big to fail or name recognition and pay less attention to risk attached to the instrument.
True, the market didn’t move much earlier in the year, but it stopped potential issuance in this region. Banks we were speaking to said, “We don’t want to issue at this time.” So there was a slight impact, but clearly from a pricing perspective it didn’t push it out too much.
IFR ASIA: Yes. Okay. So I mean the fact it didn’t move suggests that investors are not trading these things, right? They get locked away for years. How sustainable is that? Does anyone have a view on how big is that pool of demand for bank capital?
SEAN CHANG, BARING AM: Maybe I can have a go at that. I think one of the things is the market liquidity has definitely got twisted by the central banks injecting liquidity into the system. In this region, people investing into bank capital, probably like Mark just mentioned, go for the name and probably the rating. And they are rather more longer-term investing and the instrument is taken to buy and hold. This is the typical Asian characteristic of investing in bank capital. Because of these elements these instruments start to become illiquid and when you want to get it in the market, it’s rather difficult. On top of that, now those instruments have different jurisdictions and rules and that makes the differentiation even more challenged than before.
So for investors like us, obviously, valuation, pricing is one thing, but we also have to consider whether these instruments are liquid enough for us, you know, in case we need to meet some liquidity requirements – not necessarily to get rid of the bond itself, but also for other operational purposes.
So with these new introductions definitely it has become less liquid as compared to 10 years ago, for instance.
IFR ASIA: How sensitive are these securities to rates?
SEAN CHANG, BARING AM: I think the impact of interest rates will come filtering through with all the systematic risk. But it also depends on the profitability of those banks and financial institutions, right? And at the end of the day, whether the banks are viable or not viable is a test of whether they can make money or not make money. In Asia, you know, most banks are still making money, and if you look at the net interest margins, you know, you are talking about 3%, 2% compared to below 1% or close to 0% in Europe, because of negative interest rate environment.
So it’s getting tough for banks in the developed world. And if you just simply generalise it, in the US, in Europe, in Japan, they have to deal with zero interest rates or negative interest rates. In Asia the net interest rate margins are still providing some buffer to those banks’ profitability.
IFR ASIA: Yes, they seem to be popular. And here of course, there it’s a big private bank market right? It’s a big high-net worth market. The ANZ tier 1 we talked about before I think was quite a high proportion that went into private banks?
JOHN BARRY, NAB: I believe that’s true of the Asian component. I think the majority would have been sold into US asset managers. But within the portion that went to Asia, a lot of that was private bank interest I suspect.
IFR ASIA: What’s the view on local currencies? We just touched on this quickly, but we’ve seen some of the global banks coming to Asia to raise capital recently, in Singapore dollars or in Taiwan. How big is that potential market?
SEAN MCNELIS, HSBC: I think it’s a very relevant market segment. You’re right that we’re seeing the European, Australian and the global banks looking at Asian investors in most formats for both AT1 and Tier 2 capital. The Australian banks have been quite active across some of those local currency markets in recent years, particularly in the Tier 2 product.
Local currencies offer global banks an opportunity to diversify away from their domestic and G3 investor base with a view to being able to access multiple markets to satisfy future TLAC and bank capital requirements, whilst also achieving potential pricing arbitrage. So it works for both issuer and investor, of course, and can give some of those banks another way of meeting their TLAC, Tier 2 and, potentially, AT1 funding needs.
We have also seen the Chinese banks, for their inaugural offshore AT1 and Tier 2 issuances in 2014 and 2015 elect to issue most of that in the US dollar and euro markets. There were a few exceptions, but generally they issued large sizes into the G3 markets. On the other hand, we have seen the large European banks, the Australian banks being active in these markets for Tier 2 in particular. Those banks tend to be largely neutral between currency, as they will typically swap back to their home currency or to US dollars.
That theme has been ongoing for about three years, and we expect it will continue with the advent of TLAC alongside Tier 2 as banks need to diversify their funding needs. We will also see those banks accessing new markets for capital in due course. So yes, local currencies continue to have a big role to play in funding TLAC and bank capital needs of the international banks.
IFR ASIA: But Taiwan has come up, for instance.
SEAN MCNELIS, HSBC: Absolutely yes, Taiwan has become important. This investor base has been active in bank capital across a few different currencies. The Formosa market and its relevance for bank capital has been an interesting development. Subordinated debt issuance in that market is now permitted for banks that have previously issued senior debt in the market but is currently limited to Tier 2 (and Tier 3) only.
IFR ASIA: Sean, do you look at Singapore dollars? What’s your view on where those things price?
SEAN CHANG, BARING AM: When we look at the local currency, obviously, we have to take into account the currency view. But apart from that the Singapore capital markets are very well developed and their banks are very strong. People are really familiar with the operations, and they’re not that sophisticated. And I think the Sing market could also offer us the diversification from Asia. So Singapore banks could be one of our top choices.
IFR ASIA: The pricing there seems to depend on how many private banks are buying them, doesn’t it?
SEAN CHANG, BARING AM: Yes, that’s true. I mean in terms of their performance, but I think for us, because if the portfolio is big enough then they might well fit into some part of the picture.
IFR ASIA: Okay. Fair enough.
BRIAN WEINTRAUB, DEUTSCHE BANK: I’ll just pick up on a few general points. First and foremost diversification, if I go back a year or two ago, nobody was talking about currency from a diversification perspective, it was all from a funding arbitrage perspective. Whereas fast forward through today and this enters the TLAC discussion a bit. People are more worried about supply side concerns and domestic capacity in the example of ANZ’s Tier 1 issue.
In Australia there is a huge domestic market for this, as we know, with a whole bunch of Aussie dollar deals up around the same time, so ANZ in US dollars is actually a diversified currency. In this case, it’s not a niche currency. But I’m willing to pay whatever basis points more on a like-for-like basis to do something that diversifies my ability to access different markets. So that’s really great for people entering these markets.
For the local banks in those markets, so take the Singapore banks, it’s a negative for them to have offshore issuers entering Singapore.
IFR ASIA: Because it drains the capital, do you mean?
BRIAN WEINTRAUB, DEUTSCHE BANK: Precisely. And this is a ready source of cheap capital for local banks. It is cheaper to do it domestically, you can just look that up. So that’s a concern. So whether we’re talking Sing dollars or any other local currency, issues arise there.
And then the other theme I would put in is subsidiarisation. Take the rupiah market, for instance. A local regulator would prefer, arguably, a subsidiary of a Malaysian bank, or a Singaporean bank, to raise local Rupiah Tier 2, so that will drive some of that local currency issuance. And we get into all sorts of issues around, well, they’ve raised the currency locally, does that match with their local RWAs, or how does that translate back to the parent balance sheet, do they get capital recognition at the parent? If they raise it in Indonesia, it doesn’t necessarily count back in Malaysia for example.
So there’s all kinds of issues that come up with that, but that’s another theme or key driver around some of these more left-field local currencies.
SEAN MCNELIS, HSBC: The Australian banks benefit from having a deep and sophisticated local currency investor base for AT1 and Tier 2. The Singaporean banks also have deep markets where they can access AT1 and Tier 2 at attractive levels. Certainly, if you look in some other jurisdictions in Asia you could argue that some of those banks will eventually come into the dollar market even though it’s often more expensive to do so.
So I think it’s likely that in Korea and India and other jurisdictions banks see the merit in accessing not only the local market but also the offshore markets. So, yes, I think we will see more offshore issuance – it won’t only be about investor diversification, it will be about size requirements to get their efficient level of AT1 and Tier 2 on their balance sheet.
IFR ASIA: Price is still a sticking point though isn’t it? Asia can be a very price-sensitive place.
SEAN MCNELIS, HSBC: Which is why in some cases banks have so far elected to issue primarily in their onshore markets rather than in G3 or other international local currencies. For example we haven’t yet seen a benchmark offshore AT1 or Tier 2 from India and we’ve seen a limited number of offshore deals out of each of Korea, Malaysia and Thailand. However, I think over time what we’d expect is those banks to look increasingly offshore (in G3 and local currencies) as well as onshore across AT1 and Tier 2.
IFR ASIA: Yes. So deadlines are approaching. Let’s move on to TLAC then – the total loss-absorbing capacity requirements for the world’s biggest banks.
Mark I’ll ask you to start with this one. How do you look at loss-absorbing senior bonds, and what’s the playing field look like across Asia?
MARK YOUNG, FITCH RATINGS: At the moment TLAC is confined to the G-SIFIs (global systemically important financial institutions), which means Japan, China and possibly those G-SIFIs who are operating in Asia if they have multiple points of entry. There is talk of the next stage where other regulators embrace TLAC for their domestically important banks in markets like Australia.
IFR ASIA: Is there any progress on that? That’s not there yet, is it?
MARK YOUNG, FITCH RATINGS: Most regulators outside Japan in this region are taking a wait-and-see approach on how things progress on that front. Whenever we’re talking to the Australian banks they all recognise it’s likely to come, but each have their own perspective of the likely format. So it’s clearly a case of wait and see. I understand that the regulator probably is moving in that direction, but up until recently the regulator in Australia was of the view that anything sort of bail-in was a bad idea for Australia.
Importantly, the nature and structure of different financial groups across Asia vary. For Japan you’ve got the holdco-opco structure, while in China and Australia you don’t. As a result this may ultimately influence the type of instruments that may come out of some of these markets. It’s possible we may get variations of what has come – or is potentially coming – out of Europe.
IFR ASIA: So in this part of the world so far it’s been Japan. Have you looked at those securities?
MARK YOUNG, FITCH RATINGS: Yes, as mentioned Japan’s mega banks have the opco-holdco structure and the banks have been moving their issuance into the holdco to qualify as TLAC. We’re not differentiating between the credit risk of the holdco or opco given the way the authorities look at Japanese banks and expect to resolve banks if and when one of them were to get into trouble.
As a result the ratings assigned to holdco senior debt is aligned with opco senior debt. In terms of the size and amount that’s likely to come out of Japan, we think those banks are relatively well positioned for TLAC and we don’t think there’s major pressure points in terms of the amount required. It will be a very different picture in China.
BRIAN WEINTRAUB, DEUTSCHE BANK: Can I just ask you a question around Japan? Do you view what they’re doing as TLAC? And I say that in more of the spirit of what they’re doing as opposed to technically what they’re doing.
MARK YOUNG, FITCH RATINGS: Well these instruments are senior and structurally subordinated to the operating bank. So yes, it’s TLAC in the sense that these can be loss-absorbing while protecting the operating bank.
BRIAN WEINTRAUB, DEUTSCHE BANK: It’s a loaded question. Is there a feasible scenario where the senior debt issued out of a holdco will be bailed-in?
MARK YOUNG, FITCH RATINGS: Theoretically, yes it is feasible. However, we think the authorities may prevent that type of situation. What is interesting is that for the debt that has already been issued, while in foreign currencies and issued to foreign investors, has now found its way back into the local markets with domestic investors. So if you’re going to impose losses, you’re going to be imposing losses on your own investors. As a result in our view the authorities are unlikely to change their stance with regards to being pre-emptive with regards to supporting their mega banks.
IFR ASIA: I’m picking up a bit of scepticism from you there, Brian.
BRIAN WEINTRAUB, DEUTSCHE BANK: What makes you think that? Yes, in the letter of what they’ve done, yes, it’s TLAC of course. I mean they’ve got a term sheet that ticks a bunch of boxes that says it’s TLAC. To me, in the spirit of what it’s accomplished, it’s moved senior issuance from opco to holdco. And, you know, perhaps there is an additional spread that gets paid for that for some structural subordination, depending upon any rating differential, which you have described.
And if there is any deemed incremental risk associated with that debt in the way the resolution regime is set up. I mean, arguably, there is no difference. Holdco and opco are treated one and the same. What exactly has changed? A whole bunch of nothing. And that’s okay. It ticks the boxes and now they’ve done TLAC. But it’s a fundamentally different discussion than if we’re talking about European banks. And then it’s a fundamentally different discussion if we can hypothesise about what China is going to do to meet that requirement.
But, for me, TLAC is literally half of what we talk about right now with clients. But it’s a whole lot of nothing right now. So aside from Japan – and we can talk about China at length – but in every other country, to me, it’s beyond wait and see. Even Singapore has come out and stated they won’t extend this to senior debt, and frankly from a policy point of view I don’t see any reason why they should.
Separate from that though is how does this look from an investor relations’ point of view. So if I have a bank in country X and I comp myself to all these European banks when I go and do a senior deal, a Tier 2, AT1, or even how my equity investors view me, they want to know what my buffers are and what my total loss absorbing capacity is. And all of a sudden I only go up to 15 and all my peers are at 22. All of a sudden you’re at a huge disadvantage – just the headline really hurts. Even for banks that are not directly affected, how are they going to articulate their capital strategy? You can’t just continuously say, “Oh, we’re different because we’re Malaysian. We’re Singapore. We’re Indonesia. We’re China.”
So those are some of the issues that I worry about. That’s more of where I guess the sceptical comment comes from. It’s what is all this for as it relates to Asia? Does it really matter other than a perception issue, an investor issue? Do we really need this to make the system safer here? I’m not a policy expert by any means, but that’s what I question.
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