China needs to get going on TLAC bonds
Crédit Agricole bagged a total loss-absorbing capacity eligible senior preferred Panda bond in China last week — the first of its kind onshore. But the confusion it created shines a light on a market that is still in dire need of education around these new structures. With Chinese banks set to come under pressure soon to issue their own TLAC-eligible bonds onshore, rapid change is needed before time runs out.
French bankCrédit Ag broke new ground in Mainland China last week by selling a Rmb1bn ($142m) TLAC-eligible senior preferred bond — the first in the onshore market.
The tight pricing and a well-covered book surprised many onshore DCM bankers, who initially thought the deal would be a hard sell.
The transaction was a senior preferred bond with write-down and equity conversion clauses, making the note TLAC-eligible, although Crédit Ag explicitly told investors it wasn’t going to treat the deal as a TLAC instrument for its regulatory ratios.
Nevertheless, such a combination was completely new for onshore Chinese banks.
Before the bond was priced, some onshore bankers said they were confused about whether to treat it as a capital instrument or a senior bond. Others said that even if it is treated as a senior bond, many banks’ treasuries would be unable to buy it because of the bail-in language.
This concern among both banks and investors in China needs to be fixed — and fixed quickly.
The scope of existing tools for Chinese banks to raise TLAC securities is very limited, despite the fact that the big four banks will also need to comply with TLAC requirements in the near future.
At the moment, there are mainly two existing tools for Chinese banks to raise TLAC capital: selling tier two and perpetual bonds onshore and selling additional tier one bonds in the offshore dollar market.
Onshore perpetual bonds were only introduced by the People’s Bank of China and the China Banking and Insurance Regulatory Commission in January this year. So far, 15 banks have sold Rmb549.6bn of perps with coupon rates ranging from 4.2% to 5.4%, Wind data shows.
But the perp issuers have mostly been large state-owned banks or joint-stock commercial banks, while perp buyers are mainly the wealth management subsidiaries of these state-owned or joint-stock commercial banks, GlobalRMB understands. That effectively keeps the risks within the country’s banking system, defeating the very purpose of raising TLAC capital, which is to enable banks to deal with their own failures independently.
The same scenario exists when Chinese bank issuers sell AT1 bonds in the dollar market, GlobalCapital Asia, GlobalRMB’s sister publication, reported previously.
That explains why offshore AT1s issued by smaller Chinese banks are often priced at tighter levels than their international peers with much higher credit quality.
But the G-SIBs in China — Agricultural Bank of China, Bank of China, China Construction Bank and Industrial and Commercial Bank of China — still have a huge amount of work to do to meet their looming TLAC requirements.
Moody’s estimates that the big four will have to sell more than $467bn of TLAC securities by 2023 or 2025 — depending on whether China’s outstanding credit bonds surpass 55% of the country’s GDP or not. To put this number in perspective, so far this year, all Chinese commercial banks have collectively issued just $52bn of senior financial bonds and $162bn in subordinated bonds, Wind data shows.
That makes it crucial for China’s regulators to come up with innovative funding tools for TLAC, which will inevitably need to be placed onshore as well as offshore, and among a greater variety of investors.
Moody’s reckons that the type of securities banks will mainly use in the future will be senior non-preferred bonds — untested by Chinese banks but common among European banks.
The TLAC-eligible senior preferred bond issued in China by CréditAg showed that domestic investors still need to get their heads around the different levels of risk posed by these new and different layers of debt on a bank's balance sheet.
CréditAg’s deal was ultimately a success but, at Rmb1bn, it was tiny in size compared with what the Chinese banks will need to issue in the coming years.
The Chinese regulator needs to act fast to get investors up to speed with how these new types of senior bonds will work in the onshore market. This can be either through putting together official guidelines around TLAC instruments, or by organising roadshows and meetings to educate investors about the product.
Only then will these deals have a stable runway from which to take off.