Bank capital harmonisation has been left for dead

When BBVA unveiled the structure of the first ever CRD IV compliant additional tier one trade in April 2013, there was an outcry.

Bankers and investors were dismayed that the nascent market’s first deal was so complex, and they feared it would lead others to pursue a similar tactic of using numerous triggers to satisfy a multiplicity of regulatory goals.

“We might just end up seeing some idiosyncratic twists to each deal,” said one capital solutions banker at the time.

How right he was. Fast forward two years and two consecutive AT1 trades are rarely the same. We have equity conversion, permanent write-down and temporary write-down, all at different trigger levels, and non-call periods jump between five and seven years.

And investors lap it up. The order books may not be as big as the early days, but they are now dominated by big institutional investors that have put a lot of time and effort into gaining comfort with the new risks attached to post-crisis bank capital.

And now with regulators implementing new loss-absorbency rules in a bid to end ‘too big to fail’ once and for all, they will have to do so all over again.

Further up the capital structure, national discretion is set to create idiosyncrasies that will further muddy the waters in the coming years.

The Financial Stability Board’s total loss absorbing capacity (TLAC) proposals, which require global systemically important banks to hold loss absorbing capital equivalent to 16%-20% of their risk weighted assets, are a global standard that have drawn very local reaction in Europe.

Germany is planning to make all senior debt TLAC eligible, while Spain will give its banks the option of issuing a new contractually bail-inable ‘tier three’ layer of debt. Other jurisdictions, such as France and the Netherlands, have to decide which way they prefer to help their banks comply.

TLAC will be finalised in November. From January, we could have some banks issuing a completely new capital instrument, others trying to buffer their newly bail-inable senior debt with increased tier two and still more simply meeting the minimum 2% tier two requirement and increasing the thickness of their senior debt layer. It will depend on the institution and how much they value the immediate availability of senior funding.

On Friday, the European Banking Authority released final technical standards for its own "minimum requirement for own funds and eligible liabilities" (MREL), a TLAC equivalent for all European banks, large and small.

The EBA stopped short of detailing how much extra capital banks will be required to hold. But like TLAC, it will be roughly double the minimum capital requirement under Basel III, the idea being that a failing bank could bail-in half those liabilities on a Friday and be raring to go the following Monday with the other half.

What MREL does do is put even more power in the hands of national regulators. They will be allowed to adjust the amount of MREL held by individual lenders based on business model, risk profile and systemic risk.

Banks have to look after themselves. Regulators have imposed huge capital burdens on them. Their job is to comply with those regulations as cheaply as they possibly can.

But investors’ jobs are also being made harder with each new regulation. Anecdotally, buyers in Asia and the US are baffled by the system Europe has created post-crisis.

One head of capital management at a European-based bank recently told GlobalCapital he sympathised with investors’ calls for more harmonisation and disclosure, and continued to hear them on roadshows, but confessed he was staggered not to see them acting together and using the media to amplify their objections.

AT1 bonds are already barely comparable across Europe because of the variety of structures that have been allowed. The same could well be about to happen with tier two and even senior debt.

On limited information, bank capital buyers have to make investment decisions largely based on how they believe each national regulator would react when presented with a situation where a bail-in of creditors could be a solution.

You could say that is the job of credit analysts. Many investors revel in the market inconsistencies, because they can make gains when products are incorrectly valued.

But it could be detrimental to the market at some point down the line. A true test of appetite in the market, such as the first time an institution is unable to pay a coupon on an AT1 bond, or a first bail-in at a large cross-border institution, would reveal how many of the investor base really has the stomach for this nuanced risk.

The investor base is vital to any market, but particularly so in bank capital at the moment. They are the ones who have had to very quickly become experts on structures that present much more principal and coupon risk than anything available pre-crisis, and will need to take on much more of them.

Early estimates of the extra capital banks will have to issue over the next four years because of TLAC were in the region of €500bn. Investors will be needed to turn up for transactions year round as banks build their total capital ratios before implementation in 2019.

But the unilateral actions of Germany and Spain suggest they aren’t waiting around to find a unified European solution.

Investors will need to shout very loud very quickly if they don’t want their jobs to be made even harder.