Europe: Barclays’ CoCo

The UK bank’s debut AT1 was a breakthrough for the budding European market. It also foreshadowed the UK regulator’s tough approach to bank capital

Barclays' issue of fixed-rate, perpetual subordinated contingent convertible bonds (CoCos) last November was widely heralded. The $2 billion deal was the first Additional Tier 1 (AT1) capital issuance by a UK banking institution to target the US market. It was also the first public benchmark issuance by a UK bank under the EU's Capital Requirements Directive (CRD) IV.

When the deal was being negotiated during the course of 2013, regulators, issuers and investors had only just started grappling with the nascent asset class. Twelve months on and the market has come a long way. And it's in no small part due to the benchmarks set by this deal.

The 8.25% bonds will convert into equity if Barclays' fully loaded Common Equity Tier 1 (CET1) ratio falls below seven percent. In addition to satisfying the UK's gold-plated trigger requirements, the deal had to be structured in line with then-new EU rules that mandated, inter alia, an interest cancellation mechanism.

"It was interesting to see that shareholders placed so much value in the clawback"

The fact it was registered with the US Securities and Exchange Commission (SEC), and could have been purchased by US retail investors, added to what deal counsel describe as "regulators' intimate involvement" in the deal. The Prudential Regulation Authority's (PRA) scrutiny and input lengthened the structuring period. Reflecting on the deal, Sarah Crouch – then a director in the bank's general counsel office – offered some practical advice for executing regulatory capital issuances. "The Prudential Regulation Authority became very involved in the detailed review of documents with us, and the Financial Conduct Authority is obviously very interested in disclosure and who the securities will be sold to," she said at IFLR's Bank Capital Seminar earlier this year. "So you need sensible deal timetables that give you enough lead-time to discuss and agree matters with different regulators." CRD IV allows a phased in approach to risk weighting and deductions with regard to capital ratios. These transitional provisions benefit banks when calculating, for instance, their CET1 in the context of AT1 triggers. The PRA, however, required Barclays to calculate its trigger as if CRD IV was in full effect, without applying any transitional relief. This tough stance made Barclays' AT1 a rare and early example of a fully-loaded trigger, and cemented the regulator's reputation for taking a tough approach to bank capital.

As the notes were issued off an SEC-registered shelf, they were subject to New York law. The subordination and waiver of set-off provisions of the supplemental indenture were governed by English law, but there were still conflict of law issues to be worked through and the PRA needed to be convinced of how enforcement would occur in practice.

In addition to the regulatory-imposed structural novelties, the deal included two other new features that drew praise from the market. The first is a mechanism whereby Barclays has the discretion to offer any converted shares to its ordinary shareholders before being delivered to the holders of the converted notes. Some significant structuring was required to accommodate this feature, which was a condition of Barclays' shareholders' approval of the AT1 deal. It gives shareholders a way to avoid dilution – a potential downside of the equity conversion loss-absorbing mechanism.

"It was interesting to see that shareholders placed so much value in the clawback," said Crouch. "We will be interested to see if this remains the equity market view but we remain a huge supporter of keeping these instruments consistent – these are perpetual notes and we want them to be part of as uniform an asset class as possible," she added.

"The Prudential Regulation Authority became very involved in the detailed review of documents"

The bank also had to manage, and meet, the expectations of fixed-income investors. To do this, Barclays devised the second structural novelty – a tradable receipt feature. This means that while any converted notes are being offered to shareholders as shares, the debt can be traded – as receipts – before the shares settle. This meant working with the trustees to ensure the process would work in practice, and continue to be cleared in clearing system. Debt investors also had the benefit of seeing the bank's dividend policy. These two features were testament to the high premium Barclays places on its relationship with fixed-income and equity investors. They required significant structuring, but seemed to pay off. The deal – which was underwritten by Barclays, Citigroup, Deutsche Bank, Goldman Sachs, SMBC Nikko, UBS and Wells Fargo – was many times oversubscribed.

While it wasn't the world's first AT1, it was a significant moment in the asset class's maturation. A transaction of its size, complexity and depth being successfully sold into the US showed that there was a broader market for such subordinated bank debt. It was a positive development not only for the banks that need to issue these instruments to meet post-crisis capital requirements, but also for broader efforts aimed at strengthening the global financial system as a whole.

Tear sheet

• Clifford Chance – Barclays • Emmet Marvin & Martin – BNY as trustee • Linklaters – Underwriters • Niederer Kraft & Frey – Barclays • Sullivan & Cromwell – Barclays

Barclays' decision to focus on the US market also foreshadowed American investors' appetite for AT1. An increasing number of European and now Asian banks issue dollar-denominated tranches, to capitalise on demand from the country's institutional investors. IFLR also understands that in the months following Barclays' deal, the European Banking Authority suggested other banks look at the UK deal for guidance on how to structure an AT1 deal that meets EU requirements.