After the UniCredit Cashes concern, watch out for further challenges

The confusion over UniCredit’s Cashes notes is not a one-off. Uncertainty over regulatory capital eligibility affects the biggest banks in Europe, and it is unlikely to go away soon.

  • By Jasper Cox
  • 15 May 2018
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The Egyptian plover is known as the crocodile bird, on account of its supposed habit of picking the crocodile’s teeth free of parasites and warning it of approaching enemies.

This type of symbiotic relationship is the kind Caius Capital might like to describe when it explains its objective of scouring for bank capital instruments supposedly in breach of regulations and calling them out to the regulator.

The regulator is aided in its task of making sure banks’ securities are up to scratch and the hedge fund hopes to pick up some tasty returns on the way.

Its recent challenge to UniCredit was its highest profile bet so far.

UniCredit issued €2.98bn of convertible and subordinated hybrid equity-linked securities (Cashes) in 2009. All but €609m of this amount is counted as common equity tier one capital (CET1), the most loss-absorbing category of capital.

The hedge fund claimed that the Cashes should not count as CET1 under the EU’s Capital Regulations Requirement (CRR) and that in addition their presence meant that the Italian bank’s ordinary shares should not qualify either.

For its part, UniCredit said the instruments have been reviewed by all competent authorities (understood to mean the Bank of Italy and the European Central Bank) and that it foresees no impact on its CET1 ratio.

In response, Caius is requesting further details about whether the EBA itself reviewed the instrument, what exactly were the terms and conditions of the issue and what might lead to the conversion of the notes into ordinary shares.

We are now waiting for the European Banking Authority to give its view. It may indeed find that UniCredit is fully compliant.

The price of the Cashes fell from 75 before the letter to a low of 55, and has not fully recovered. This at least suggests either that there is some uncertainty over their compliance or that some bank investors do not really understand the rules (the Cashes are reserved for institutional investors).

Not just UniCredit

Caius was successful in a previous challenge, over West Bromwich Building Society. It said that the society’s profit participating deferred shares (PPDS) were incorrectly counting as CET1.

The hedge fund made money when West Brom subsequently instigated a liability management exercise to remove the PPDS, and it appears that it was right in its call.

This is hardly a scandal. Mark Carney and his counterparts in Europe are unlikely to lose much sleep over the seventh largest building society in the UK.

But larger institutions appear to have misunderstood the rules too, and this is not just a problem for bonds.

Crédit Agricole’s shareholders are set to vote on Wednesday to remove a loyalty dividend clause applying to 6% of ordinary shares. The scheme was set up in 2011, before CRR came into force in 2014.

The French bank announced at the end of last year that the EBA had ruled that the clause represented a preferential distribution in breach of CRR, and the ECB has told the bank to remove it by September 2018.

HSBC went the other way, announcing in its latest results that it judged 18 old bonds were in fact fully eligible as tier two. It is thought to have reassessed its original view on the basis of new legal advice, despite no change in the underlying regulations.

When the rules appear blurry for large banks years after their implementation, it is clear something is amiss in how legacy instruments have been reviewed.

Too toothless

One reason that some instruments have been allowed to fall through the gaps relates to the way legacy instruments were reviewed when CRR was introduced.

When the first list of CET1-compliant instruments was compiled, the EBA could only work on the basis of information provided by the competent authorities, without analysing instruments itself.

It was the Prudential Regulation Authority, for example, which put forward the PPDS instrument to be put on the list.

It has been suggested some of the reviewing work actually fell to issuers themselves.

The EBA’s work in this area has mostly been restricted to assessing new capital instruments. 

It has reviewed certain legacy instruments, like West Brom’s PPDS and Crédit Agricole’s shares, but even where it finds breaches it does not have the legal power to make the final ruling, which is left to the competent authority.

In May last year the body suggested in an opinion paper that it be given more teeth, for example in making explicit that it could remove existing instruments from the CET1 list.  

It has also embarked on a review of legacy capital instruments, concentrating particularly on the most widely used ones and the largest institutions. Based on information received before the UniCredit debate, GlobalCapital understands that the EBA expects to have a good view on the compliance of legacy instruments issued by the most important institutions by around spring next year.

This would be a while to wait, and it seems likely both that there will be other ineligible capital instruments lurking in banks’ CET1 buckets and that a crafty investor could find one before the regulator does.

Of course, in terms of the broader health of Europe’s banking sector, the odd technical breach does not matter too much.

One estimate is that without the ordinary shares or the Cashes counting as capital, UniCredit’s CET1 ratio would fall to an unhealthy level of below 5%. This ratio is often used in the market as a short-hand for how well capitalised a bank is, but the estimate demonstrates why the two are not the same thing.

UniCredit’s ordinary shares would still provide an ample capital buffer, in the real, economic sense, even if they did not qualify as regulatory CET1. And it would not be too hard to resolve the matter by removing the Cashes.

But for investors this topic matters. 

The crocodile’s teeth of legacy capital will remain an exciting place if you can pick off opportunities, or a dangerous one if you are left stranded in the wrong place.

  • By Jasper Cox
  • 15 May 2018

All International Bonds

Rank Lead Manager Amount $b No of issues Share %
  • Last updated
  • Today
1 JPMorgan 329.19 1505 8.44%
2 Citi 302.82 1293 7.76%
3 Bank of America Merrill Lynch 259.71 1092 6.66%
4 Barclays 235.37 968 6.03%
5 HSBC 192.36 1061 4.93%

Bookrunners of All Syndicated Loans EMEA

Rank Lead Manager Amount $b No of issues Share %
  • Last updated
  • Today
1 BNP Paribas 38.80 175 7.35%
2 Credit Agricole CIB 36.89 155 6.99%
3 JPMorgan 29.35 74 5.56%
4 UniCredit 24.81 134 4.70%
5 Bank of America Merrill Lynch 24.60 69 4.66%

Bookrunners of all EMEA ECM Issuance

Rank Lead Manager Amount $b No of issues Share %
  • Last updated
  • Today
1 JPMorgan 9.98 67 9.69%
2 Morgan Stanley 9.41 44 9.13%
3 Goldman Sachs 8.72 45 8.47%
4 Citi 6.91 54 6.71%
5 UBS 5.28 29 5.12%