IFLR Bank Capital Seminar: the highlights

Author: | Published: 3 Mar 2014
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Basel III implementation

  • Basel III implementation is 80% harmonised across Europe. This will greatly improve in four years time, once the Banking Union is fully implemented;
  • Investor appetite, rather than tax or legal regimes, will determine which jurisdictions issue the most bank capital this year;
  • European Additional Tier 1 (AT1) issuance is tipped to reach €30 billion ($41.2 billion) this year. Investors' shift in focus from capital ratios to also include leverage ratios will encourage this dealflow. The outcome of the European Central Bank's asset quality reviews is not likely to be important;
  • AT1's core investor base has migrated from Asian private banks to institutional investors – particularly London-based multi-strategy hedge funds;
  • Equity-linked loss-absorption mechanisms give issuers greater scope to tailor AT1 deals as compared to non-dilutive mechanisms;
  • Banks are not intending to innovate for the sake of innovating. Capital instruments should be consistent and comparable, so they can be quickly understood (and if necessary converted) in times of stress.

AT1 and contingent convertible: the design variables

  • This is the year that contingent convertible bonds will become mainstream;
  • 2013/14 can be compared to 2000 when banks first gained the ability to issue innovative securities. The sector could be on the cusp of new possibilities to innovate;
  • Regulatory developments regarding single point of entry is a major structuring consideration for issuers;
  • In many ways AT1 is similar to pre-Basel III bank securities, although it is more equity-like;
  • The European ban on dividend stoppers means, at some level, bank bonds rest on a moral contract between investors and issuers;
  • For investors, the issuer and trajectory of capital is more important than the bond’s structure;
  • Rating agencies are more interested in the possibility of coupon payment cancellation rather than the trigger point.

Tier 2: a new lease of life?

  • Tier 2 capital is intended to absorb losses on a gone-concern basis. However, a role for Tier 2 securities as going concern capital seems to be developing;
  • Variation and substitution is an important issue when rating AT1 and Tier 2 securities and Moody's expects such language to have sufficient investor protections. This includes prohibitions of a change in the terms and conditions that would have a material negative impact on investors, as supported by the opinion of an unrelated third party;
  • Contrary to its original stance, Moody's will now rate contingent capital securities – but only when a trigger is based on something that is credit-related;
  • Both Tier 1 and Tier 2 instruments must now contain the ability to be written down or converted into equity at the point of non-viability. Although the Basel Committee has defined 'point of non-viability', there are different interpretations as to what exactly this means.

Tax treatment

  • Tax deductibility for Tier 2 should not be in question, but the position is less clear for AT1;
  • UK regulators are now comfortable with the tax deductibility of AT1, which has allowed for new deals;
  • Spain is comfortable with the deductibility of AT1 because the division between debt and equity is determined by accounting treatment;
  • Germany sits at the other end of the spectrum, with no special rules and several features of AT1 that have proven problematic;
  • UK regulations may cover AT1 issuance by any EU bank, raising the possibility of issuance out of a London branch if the local tax position is not settled.


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