Richard Johnson of Credit Suisse Group discusses
expectations for capital structuring and product development in
the coming 12 months.
Credit Suisse Group is well-placed to comment on emerging
trends in products that are aimed at meeting capital
requirements, particularly under the Swiss regime. Here,
Richard Johnson, head of the EMEA debt capital markets,
transaction management group, provides the reasoning behind his
views on the outlook for product adoption and emergence, having
much expertise in regulatory capital.
He also provides an overview of the key European regulatory
themes to affect the sector in the coming year to watch out
for, particularly in relation to Contingent Convertibles
Switzerland has long pioneered Contingent Convertibles
(CoCos) as a way of solving bank capital shortfalls
post-crisis. Do you see the asset class growing in
CoCos have now been embedded as a permanent part of banks'
capital structures for a while in many regulatory regimes,
e.g., the CRD4 European Additional Tier 1 (AT1s), which are
required to be CoCos. As such, I would expect this asset class
to continue to grow as banks transition their capital
structures to the new rules. Additionally, as resolution
regimes come online with point of non-viability (PONV) loss
absorption and bail-in, it will become clearer that CoCo-like
features and risks are embedded in instruments throughout
banks' capital structures.
What product developments do you expect to see within AT1
instruments over the next year?
While in many jurisdictions a degree of standardisation is
taking place, I expect to see continued use of different
trigger levels to reflect different institutions' economic and
regulatory capital requirements. I would also expect a
continued evolution of the loss absorption mechanisms available
to banks, with temporary write-down becoming available in more
Do you expect a degree of homogeneity ultimately creeping
into AT1 documentation as the market develops?
Compared to the world of Basel II, the level of
standardisation in Basel III AT1 instruments has increased
because the minimum requirements are set out in pan-European
legislation, and are no longer set at national level as before.
However, the wide range of ownership structures, business
models, home jurisdiction requirements, etc., still require
issuers to keep some flexibility in order to adapt the
structure to their own and to their regulator's needs,
particularly with regard to trigger levels, loss absorption
mechanism, call options, and to the class of investors who may
buy. For instance, several regulators have concerns around
sales to retail investors. Also, the documentation will have to
continue to reflect variation in corporate and tax law
frameworks across the different jurisdictions, ultimately
limiting the degree to which true homogeneity can be achieved.
Nevertheless, the European Banking Authority, (EBA), has a
clear aim to increase the homogeneity of AT1 terms where
possible, and systems such as the Single Supervisory Mechanism
should help further in that respect.
Post stress tests, do you imagine a new type of more
peripheral southern European issuer of AT1 emerge?
Stress tests may potentially accelerate the issuance, but
those in need of capital so far have generally preferred to
respond by increasing their Common Equity Tier 1 (CET1), in one
way or another. Ultimately, all banks are motivated to have AT1
in their capital structure unless they choose to meet this
requirement with expensive equity, so while stress tests may
impact timing of issuance, they are unlikely to have a material
impact on the ultimate issuer universe.
What, if anything, needs to be clarified from a regulatory
perspective to encourage the development of AT1s and Tier
In most jurisdictions there is now sufficient clarity to
allow issuance. Key areas for development mainly focus around
tax, with some jurisdictions yet to confirm deductibility, and
there is still some variability around Europe in the approach
to tax issues arising from a write-down. On other structuring
issues there remains some variation across jurisdictions, which
is not necessarily a bad thing in as much as it reflects
national specificities. However it is certainly the case that
while there is one rulebook in Europe, it is implemented
differently around Europe, with some jurisdictions and bodies
applying a principles/policy filter to the basic rules.
At the time of writing, the total loss absorbing capacity
(TLAC) proposals are in their consultation phase. What is your
view on these proposals?
The aim of TLAC to provide a consistent and credible
framework to ensure bail-in is adequately resourced is welcome.
The proposals on external TLAC seem broadly appropriate,
although some of the rules on qualifying instruments look tough
(e.g., maturity cut-offs and exclusion of all structured
notes). The decision to impose internal TLAC on material legal
entities, represents the first time the Financial Stability
Board (FSB) has sought to regulate the distribution of capital
within a group. The final rules should ideally be more flexible
to better facilitate a proportional distribution of external
TLAC to avoid instances of trapped capital and liquidity. It
will be interesting to observe how the proposals are applied
across a broad range of different banking models, e.g., HoldCo
banks vs OpCo banks, and whether this will lead to further
changes to statutory legislation or insolvency regimes in
certain jurisdictions. UK banks have already started to
incorporate contractual recognition of some of the statutory
tools into the documentation of their recent issuances, a
process we would expect to continue and evolve.
The Swiss Financial Market Supervisory Authority (Finma)
has directly implemented Basel III and has been ahead of the
curve in terms of post-crisis legislation. Has this pro-active
approach surprised you?
No. Switzerland has always taken a pro-active approach to
bank regulation, informed in part by the importance of the
banking sector to the Swiss economy. As such the Swiss approach
to Basel III is best seen as a continuation of its longstanding
approach to bank regulation.
What can other countries learn from the Swiss approach to
bank capital rule making?
Switzerland has benefited from a clear and transparent
process of designing and implementing rules, with an efficient,
What regulatory developments do you expect to have the
biggest impact on your sector in the coming 12 months?
A couple of themes spring to mind, particularly in financial
services regulation where the reform to strengthen and update
the EU market abuse regime, which has been in place since 2004,
is likely to have a big impact. Also, we have seen various
regulators including the European Securities and Markets
Authority (Esma), the UK Financial Conduct Authority (FCA), the
German Federal Financial Supervisory Authority (BaFin), Danish
Finanstilsynet (FSA), Italian Securities and Exchange
Commission (Consob) and the Securities and Futures Commission
of Hong Kong (SFC) issuing guidance and statements on the
distribution of CoCo instruments.
"It will become clearer that
CoCo-like features and risks are embedded in
instruments throughout banks’ capital
On the first point, most of the provisions of the Market
Abuse Regulation (MAR) will come into effect in the middle of
2016, introducing a single directly applicable rulebook
governing market abuse. It is broadly the direct replacement to
the Market Abuse Directive (MAD), which has been in effect
since October 2004, and is intended to reduce regulatory
complexity. Among the changes relevant to the sector are the
scope (MAR will apply to a wider range of securities and
derivatives than MAD) and market soundings. With respect to the
latter, MAR does usefully recognise that inside information can
be legitimately disclosed to potential investors to gauge
interest in a potential transaction or its potential size or
pricing. Indeed, MAR will regulate market soundings in some
detail, for example by requiring certain steps to be taken
prior to conducting a sounding and by imposing detailed
record-keeping requirements. In addition, Esma (in a
consultation paper on draft technical standards for MAR) has
proposed arrangements and procedures for those making the
soundings, including rules on who to speak to and when, and the
contents of scripts, and they will be separately issuing
guidelines for the investors receiving the soundings.
Regarding the discussion on restrictions on the retail
distribution of regulatory capital instruments, the major
development impacting the markets has been the UK FCA's product
intervention, coming hot on the heels of the Esma statement in
August 2014. Essentially, the regulators are voicing concern
that investors may not have fully considered the risks of CoCos
before investing in them and that investors cannot or do not
properly understand or evaluate the complexities of, and risks
associated with investing in, CoCos. Esma set the details of
some of these risks in its statement and, in particular, the
unusual features of CoCos that differ from other regulatory
capital instruments, whilst the FCA stated that it does not
believe that CoCos are appropriate for distribution to the mass
retail market: i.e., retail clients who, amongst other
criteria, are neither sophisticated nor high-net-worth. These
were not unanticipated – for instance, the UK FCA
first outlined its concerns in June 2013 and then worked
closely with UK issuers to ensure their new capital securities
were marketed in a way that minimises the risk of inappropriate
investment by ordinary retail investors, largely through
voluntary agreement by issuers to issue with high minimum
denominations. In light of the continuing regulatory scrutiny,
there is ongoing work across the market (via industry bodies,
for instance) to ensure that there continues to be a diverse
pool of investors for these products, allowing the
stabilisation of performance in times of volatility and, hence,
continuing to allow banks to raise capital efficiently.
Director, Head of EMEA DCM Transaction Management,
Richard Johnson is a lawyer and director in the
investment banking division of Credit Suisse. He is
based in London, and joined in 2014 to head of EMEA DCM
transaction management group. He leads teams and
advises on debt capital markets and structured finance
transactions, with a particular emphasis on regulatory
capital and financial institutions issues.
Prior to joining Credit Suisse, Johnson previously
worked for Barclays, Allen & Overy and Norton Rose
and has over 10 years in managing bond issues for
financial institutions and global corporate issuers,
bringing them to both the European and US markets.