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Oi! Regulators! — leave those hybrids alone

As the chatter intensifies around how banks’ capital bases should look in the future, so do the voices of those who think that hybrids within it has no future.

If one listens to the anti-hybrid bond mob, one of the reasons why so many financial institutions are in such a mess is that banks did not have enough genuine loss absorbing capital and that too many hybrids failed to act as they were supposed to.

However, the opponents of hybrid capital are wrong: not only is the role of hybrids and other forms of subordinated debt within a bank’s capital structure still very relevant, but more to the point, they have absorbed losses.

It is true that they have not absorbed losses in the way that had been expected — through a straight writedown or non-coupon payment (although this has happened on occasion) — but they have done through liability management.

Indeed, according to UBS figures, as many as 115 securities have been targeted by financial institutions whereby they have offered to buy the bonds back from investors at a deep discount to par.

In some cases, bonds have been bought back in the 20s. According to the same data compiled by UBS, the average tender/exchange price so far has been 60.

While in a lot of cases investors did get the opportunity to move up the capital structure by selling the hybrids back to the financial institution and getting more senior instruments in return, it is still the case that they had to take a loss. While this might not be how these instruments were designed, this is how they have ended up working.

Perhaps more important is the fact that through the liability management process these securities have also led to the creation of core tier one capital.

Again according to UBS, the core tier one gain through liability management for EMEA banks since the beginning of the year has been Eu12.1bn. Core tier one is the holy grail for some and this, they say, should be the only capital in a bank. Yet, hybrids have allowed for the creation of this core tier one, so surely they have a very meaningful role in times of crises.

The Eu12.1bn figure compares to the Eu29.5bn of equity raised by banks over the same time period (this figure includes the HSBC’s Eu14.5bn rights issue).

So while hybrids might not have been perfect, they have behaved in such manner that should cement their standing and regulators across the globe should remember this as they draw the map for future bank regulation.

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