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BBVA’s AT1 blowout was big and clever — but it’s not what Basel intended

How complex is too complex? The market was left wondering just that after last week’s additional tier one trade from BBVA, which ticked every regulatory box imaginable. It might have suited the bank, but it may also have made it tougher for others.

BBVA’s CRD-compliant additional tier one (AT1) capital trade, printed last week, heralded the birth of a new market. But while it has performed well, the complicated structure wasn’t exactly what the Basel Committee must have been hoping for when it set out its plans for new-style bank capital three years ago.

The issuer, and the investment banks that structured BBVA’s deal, were quick to defend the transaction from criticisms that its multiple trigger structure was unnecessary and had set a complex precedent for what — according to CRD IV and CRR — is supposed to be a fairly simple instrument.

BBVA’s argument was that when one is paying 9% for $1.5bn of capital, one wants value for money. And that means satisfying as many regulatory requirements as possible.

Hence the deal’s four triggers for equity conversion: a common equity tier one ratio of 5.125%; a Spanish capital principal ratio of less than 7%; an EBA core tier one ratio of less than 7%; and a tier one capital ratio of less than 6% when the bank has reported losses over four consecutive quarters.

That the lead managers felt it necessary to wall-cross investors in the week before the deal was announced was testament to the complexity of this structure. And there’s no question that the effort paid off: the deal attracted $10bn of orders, mostly from European institutional accounts — who had previously been some of the most vociferous opponents of such aggressive loss-absorbing instruments.

But not all of these triggers were strictly necessary. The 7% EBA core tier one trigger, for example, was not requested by the EBA — it was included at the behest of the issuer, to ensure it was covering all regulatory bases in what it called “a transitional phase of regulation”.

But where does this carpet bombing of regulatory requirements leave the wider market?

If additional tier one is to become a deep and liquid market — and one would hope it is, given the amount of capital banks need to raise to comply with the CRD package — it is not possible to expect issuers to go through the arduous process of wall-crossing and explaining a bespoke basket of conversion triggers every time they want to print a deal.

By the same token, investors are going to get tired of this level of complexity if it continues. One of the missions of Basel III was to simplify the bank capital market, as well as strengthen it. Structures like the one used for BBVA’s trade do not do that.

Sure, there are regulators in a couple of other European countries that would require issuers to bolt on extra conditions to their AT1 deals — Italy and Denmark, for example. But in most cases, the definition of additional tier one capital under the CRD package is enough to satisfy national supervisors. A 5.125% common equity tier one trigger for equity conversion should do just fine.

Let’s hope the next AT1 deal is more in keeping with the spirit of Basel III, rather than a multi-purpose tool designed to deliver maximum value for money for the issuer, at the expense of what is best for the wider market.

Complex deals like BBVA’s give the issuer value for money in the short term. But they are not easily repeated. It is to the long term benefit of both issuers and investors — and regulators — that these securities are easily marketable and executable.

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