Taxing AT1 interest is the start of a debate, not the end of the world

Additional tier one will not die out in Europe if governments remove tax deductions on interest payments, but the latest debate about their fiscal status shines another light on an asset class in a state of confusion.

  • By Tyler Davies
  • 10 Jul 2018
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Banks were a little dismayed to learn of last week’s news that the Netherlands was planning to get rid of tax deductions for AT1 coupons, following a stern warning about state aid from the European Commission.

Part of the argument against the decision centres on the belief that it is simply not right to tell banks to maintain high levels of capital and then turn around and tax them for doing it.

There is an element of truth in this of course, especially given that a large number of tax decisions are political choices.

But the argument is also a little misleading.

Banks do not have to raise AT1 at all. In fact, the asset class essentially functions like a discount for the costlier types of capital that do actually form the basis of a bank’s regulatory requirements.

This discount will remain therefore effective as long as issuing AT1 remains cheaper than issuing common equity — and removing tax deductibility on coupon payments is unlikely to tip the balance in a meaningful way.

But we should not pretend that European tax regimes resemble anything like a level playing field.

So it was interesting to see that the Dutch government has taken some courage in the idea that its banks will not be disadvantaged versus other European institutions because the European Commission will be addressing its concerns about the tax treatment of AT1s in other member states.

A letter-writing campaign from the Commission is hardly likely to bring us any closer to a state of fiscal union in Europe.

But the EU body’s due diligence has shone another light on a debate about AT1 that has been raging since its inception — what even is it?

At the heart of the Commission’s recent concerns is the question of whether or not affording special tax treatment to capital instruments issued by financial institutions can constitute an illegal dose of state aid.

In other words, why should AT1s and insurance tier ones be afforded a cushier ride, with tax treatment as debt securities, if very similar hybrid instruments issued by corporates are taxed as though they are equity?

Five years on from the first issuance of a Basel III compliant AT1 and debate about the design and purpose of the asset class has not subsided.

If anything, the discussions have only intensified since the resolution of Banco Popular raised troubling questions about AT1’s ability to absorb losses on a going concern basis.

Any move to tax the interest paid on these instruments will simply not carry enough economic consequence to kill the market stone dead.

But reopening a debate about the accounting and tax status of AT1 instruments could add fuel to the fire for a re-examination of the product’s essential qualities.

  • By Tyler Davies
  • 10 Jul 2018

All International Bonds

Rank Lead Manager Amount $m No of issues Share %
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1 Citi 66,398.25 210 8.43%
2 JPMorgan 62,989.04 222 8.00%
3 Barclays 53,876.84 175 6.84%
4 Bank of America Merrill Lynch 44,675.83 159 5.67%
5 Deutsche Bank 42,359.23 156 5.38%

Bookrunners of All Syndicated Loans EMEA

Rank Lead Manager Amount $m No of issues Share %
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1 Bank of America Merrill Lynch 6,160.68 5 15.90%
2 Deutsche Bank 3,400.72 4 8.77%
3 Commerzbank Group 2,532.05 5 6.53%
4 Citi 2,513.95 6 6.49%
5 BNP Paribas 1,742.18 7 4.49%

Bookrunners of all EMEA ECM Issuance

Rank Lead Manager Amount $m No of issues Share %
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1 UBS 998.25 3 13.32%
2 Citi 693.55 2 9.26%
3 Morgan Stanley 572.72 3 7.64%
4 Bank of America Merrill Lynch 509.34 3 6.80%
5 Jefferies LLC 409.89 4 5.47%