Polonius' admonition to son Laertes came long before investors in financial institutions began to contemplate the full import of regulatory initiatives that require bail-in mechanisms or give banking authorities considerable discretion to convert bondholders into equity holders.
In the aftermath of the financial crisis, regulators have undertaken extensive rulemaking efforts designed to ensure that we avert a similar financial crisis in the future.
However, it might be sensible to pause and conduct an impact assessment of sorts to evaluate the likely effects of the many measures that have been adopted. Specifically, if one were to take a close look at the capital markets and consider the financing horizon for financial institutions, one can't help but wonder whether financial institutions will be able to issue any true debt securities.
Even using Wikipedia's definition of debt one would have difficulty characterising a bond that morphs over its term to an equity claim as debt-like. The same might be said of a bond, a portion of the principal of which is written down upon a trigger breach or by regulatory fiat. Perhaps one could conclude that if, in the first instance, a bondholder agrees to purchase one of those securities, it has come to terms with their possible change in status.
However, what about some of the current proposals that grant regulators discretion to haircut bondholders? Or grant discretion to convert a portion of a debt claim to equity? Is this consistent with basic contract law principles?
Imagine the reaction of financial institutions' existing equity holders upon learning that their stake has been diluted. All in all, these new measures, when looked at in their totality, suggest a new paradigm-possibly one with very limited notions of debt insofar as financial institutions' capital structures are concerned.
Will this all lead to more robust balance sheets? Or scare away investors?
© 2021 Euromoney Institutional Investor PLC. For help please see our FAQs.