Asia’s Basel III Tier 2 bond evolution continues

Author: Ashley Lee | Published: 18 Mar 2014
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  • Asia’s Tier 2 market has developed quickly following the first offering in October;
  • Banks in Hong Kong and Singapore have sold US dollar-denominated Tier 2s. In India and Malaysia institutions have issued in their local currencies;
  • Partial and sequential write-downs have been seen in different offerings, but their inclusion depends on local regulators’ preferences;
  • More banks are expected to sell US dollar-denominated Tier 2s, and sources are expected to see more deals across the region.

Recent Tier 2 offerings prove that Asia’s regulatory capital market is growing, but the evolution of write-down features common elsewhere depends on local regulations.

Most Asian regulators have now finalised their Basel III regulations. This has unlocked the Tier 2 market, and more deals are now expected across the region, including Japan and Korea.

But each jurisdiction’s Basel III regime differs slightly, which will affect how the market develops. "Specific features are likely to be driven by regulatory frameworks in each jurisdiction," said Mark Young, head of Asia-Pacific financial institutions at Fitch Ratings.

Tier 2 so far

Asia’s Tier 2 market has evolved since ICBC Asia’s October 2013 offering – the first Tier 2 from an Asian ex-Australian) bank. It counted as regulatory capital for both the Hong Kong subsidiary and its China parent, but investors were concerned that both Hong Kong and Chinese regulators were able to write down the bonds.

Subsequent US dollar offerings, such as those in Hong Kong by China CITIC Bank and Dah Sing Bank, and in Singapore by UOB, have performed well. China CITIC’s bonds included a partial write-down, while UOB included a sequential write-down so that its Tier 1 bonds would be written off before its Tier 2s. This month Mizuho announced a Tier 2 offering, marking the first Basel III deal by a Japanese bank.

Banks testing Basel III structures are also issuing in local currency; and those offerings are usually Tier 2 bonds. Last September, CIMB opened Malaysia’s regulatory capital market with a $229 million Tier 2 offering, while State Bank of India sold $323 million of Tier 2s in January.

Issuers from these jurisdictions may look to the US dollar market next. "Asian regulatory capital is evolving – as it has in Europe – to become more of an established asset class," said Young.

Write-downs

The inclusion of partial and sequential write-downs depends on the preferences of domestic regulators. For example, China’s regulations prohibited ICBC Asia from including a partial write-down in its Tier 2 bonds.

Sequential write-downs are a newer feature in Asia. The Monetary Authority of Singapore permitted sequential write-downs in both UOB’s Additional Tier 1 (AT1) offering and its latest Tier 2 bond, although regulators in other jurisdictions in Asia are hesitant. "This is still a developing area," said Allen & Overy partner John Lee.

Young compared the Asian regulatory capital market to that of Europe, noting that in Europe, many markets initially required full write-offs. But some investors are increasingly pushing for conversion into equity or partial write-downs.

If regulators will allow them, they will be featured in more deals, he added.

But contingent convertibles (CoCos) are not expected in most Asian jurisdictions, where contractual write-downs have featured in all completed deals. The exception is in Australia, where most Basel III offerings have included equity conversions.

That’s not likely to change. "Conversion into equity at the point of non-viability is rarely discussed in detail for Tier 2s," Lee said.

What to expect

Young believes that there will be more Tier 2 bonds. Chinese issuers are waiting for the country’s authorities sign off on partial write-downs and Japanese banks as well as others throughout the region are thought to be preparing. As legacy instruments mature and become less effective from a capital perspective, banks will seek to refinance.

And the growing Tier 2 market might pave the way for AT1s, with Lee hoping to to see them this year. "To have depth in the Asian regulatory capital markets, we need AT1s as well as Tier 2s," he said.

Related links

ICBC Asia’s USD Basel III-compliant Tier 2 bond first explained

China CITIC’s Tier 2 first explained

Australia’s first Basel III-compliant Tier 2 hybrid explained