Progress achieved despite quirks

  • 17 Jan 2006
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Regulators in the CEEMEA region are being encouraged to move towards capital frameworks based on the guidance of the Basel Committee. The speed of their progress depends very much on local peculiarities, however, and banks' lobbying efforts have met with varying degrees of success.

East of the European Union, Kazakhstan is the only country in the CEEMEA region to have taken large steps towards the Basel framework, with its banks now able to take advantage of issuing lower tier two and tier one capital.

Even in Kazakhstan, constraints remain on issuers similar to those in other countries in the region, as the national regulator, the Financial Markets Supervisory Agency (FMSA), does not recognise the difference between lower tier two and upper tier two capital.

This situation is typical of jurisdictions across the region. In Russia, the Central Bank of the Russian Federation's (CBR) closest equivalent category to tier two is "additional capital". But as in Kazakhstan, there is no distinction between different layers within this category.

Such restrictions had been placed on many issuers in the former accession states of the EU, but as they have become members their regulatory frameworks have been brought into line with western European practices and the Basel guidelines.

But even EU membership is no guarantee that capital instruments will automatically become available to those wishing to use them.

Hungary's OTP Bank, for example, launched the first lower tier two transaction from the country via JP Morgan in March as a bullet 10 year transaction rather than the typical 10 year non-call five structure. "According to Hungarian law, a 10 year non-call five transaction only has a five year maturity, rather than 10 years," says Dóra Losteiner, head of the corporate finance department at OTP in Bucharest.

And before this year OTP and its fellow banks could not take advantage of issuing hybrid tier one securities. "Under our law governing regulatory capital there was previously no provision for issuing tier one bonds and as it would cost much more to sell such a transaction there was no point in doing one," says Losteiner. "This was a disadvantage for the Hungarian banking sector."

As of January 1, new regulations have been introduced in Hungary allowing the issuance of tier one, lower tier two and upper tier two securities, along similar lines to international standards. However, as there are differences in the way that step-ups and early redemption clauses will be treated it remains to be seen whether Hungarian banks will be able to issue securities on a par with their foreign peers.

The case for Basel

The lobbying of national regulators by their domestic banks, usually supported by international investment banks, has been one of the key drivers of the progress that has been made on the regulatory front in the past couple of years.

"The push has really come from the issuers," says Igor Hordiyevych, director, CEMEA debt capital markets at UBS in London. "Clearly, regulators will listen to their local banks and the bigger ones in particular if they come to them and explain that they have a need to raise these forms of capital.

"That is why previously there was little movement on the regulatory side: it was only really in 2004 that the larger banks have grown to the extent that they were looking at new ways of raising capital and approached their national regulators seeking to issue subordinated bonds."

It is not just banks themselves that can benefit from the adoption of state-of-the-art regulatory frameworks. The introduction of international regulatory standards is often part and parcel of the creation of a modern economy.

Rachel Hatfield, a partner at White & Case in London, says that Russia, for example, would benefit from introducing the Basel framework as part of a broader move to improve its financial sector.

"If you look at Russia, the banking industry has been systemically weak for a very long time," she says. "The number of commercial banks pre-crisis was double what it is now, so some steps have been taken since 1998 to address that systemic weakness by driving consolidation and eliminating banks that failed in the crisis.

"However, the sector is still quite weak for an economy of that size and a financial centre of that import. From a commercial perspective, allowing for the proper development of bank capital in a more sophisticated way would be a good step for the central bank to take."

The move towards an internationally accepted framework for bank capital also makes sense for countries of more modest size. A treasury official in one new EU member state says that commercially, banks in smaller countries have little choice but to adapt to the standards required by international investors, but that they can only properly do this if their national regulatory framework moves in the same direction.

As long as domestic regulations are out of synch with the Basel guidelines, many banks will continue to report two sets of figures. "They report ratios according to local capital adequacy standards," says one emerging markets DCM official, "but they are also very keen to report internationally acknowledged and accepted BIS ratios."

Finally, there are also the rating agencies to please.

When Ukreximbank launched the only subordinated debt issue from the Ukraine in February, a $40m lower tier two deal via Dresdner Kleinwort Wasserstein and UBS, local regulations dictated that the coupons were deferrable in certain circumstances. This quirk of Ukrainian bank capital regulations meant that Fitch rated the sub debt two notches lower than Ukreximbank's senior rating instead of the usual one for lower tier two capital.

Nikolay Udovichenko, deputy chairman of Ukreximbank in Kiev, says that he hopes this will not be an issue again. "We believe that in the future there will be improvements to legislation to bring it in line with market practice in this field and that any such change will be treated positively by the rating agencies," he says.

Encouraging experience

The experience of banks and their advisers in dealing with national regulators suggests that central banks and other financial authorities are open to being persuaded of the advantages of adopting internationally accepted capital standards.

"The central bank was very co-operative," says Damjana Lavric, area manager, financial institutions and international industrialised countries at Nova Ljubljanska Bank, which in June launched the first hybrid tier one issue in Slovenia. "It could have taken perhaps one year for them to implement the necessary changes to the regulations, but they tried to help us as much as they could and moved much faster than that."

Bankers that worked on the first hybrid tier one issue in the CIS, Kazkommertsbank's $100m deal in October via ING, JP Morgan and UBS, were also pleased with the regulator's approach.

"I was very impressed with how short the chain of command was at the Kazakh regulator," says one banker in London involved in the trade, "how quick the decision making process was and how practical they were. We started the process in around mid-June and I remember reviewing a late draft of the documentation over the August bank holiday weekend, then the process was finalised by the necessary authorities some time in September.

"So it took only around 2-1/2 months for them to go from nothing to everything being agreed upon."

This does not, however, mean that the process of changing regulations is without its potential for bureaucracy in even the most sympathetic of jurisdictions.

"In Kazakhstan, the regulations are published in draft form and then sent by the financial regulator to the ministry of justice to be registered, and they do not come into effect until they are published in the official gazette," says one observer. "If the ministry of justice, when it receives the regulations, decides that it doesn't like them then it can get back to the sponsoring agency and say that it wants to make various changes.

"That is a process that could take a long time, but in KKB's case the financial regulator was very confident that the regulations would be adopted."

In other cases, which should have been easier, the processes were more protracted. "It was not until we sent a third set of documentation to them that the central bank approved our lower tier two transaction," says an official at one Russian bank in Moscow.

Bankers add that what has undoubtedly helped many of the issuers hoping to open new markets is that they have been state-owned, in some cases by the very entity, the central bank, which is responsible for regulations.

Not quite a blank slate

When banks, their advisers and regulators move towards introducing new regulatory frameworks and new instruments under these, they have both the advantages and disadvantages of being faced with something of a clean slate.

Issuers looking to raise lower tier two capital, for example, may be able to do so under existing frameworks allowing for 'additional capital' or 'supplementary capital', but be free to create instruments that are also acceptable on an international stage.

"There may be local quirks," says one DCM banker in London, "but you can still work out how to get to a lower tier two structure that meets international standards. There is no point creating an instrument that is not going to qualify as capital for BIS ratios if that is one of the measures that you are managing your capital to."

Bankers therefore typically look to western European models when structuring instruments — which also has its advantages when approaching the investor base.

"Given that these instruments have not been issued in these countries it makes sense to draw guidance from the instruments that have been used elsewhere, provided they are alligned with the local regulatory and corporate law framework," says Prasad Gollakota of the capital securities team at UBS in London. "So even though there might not have been specific guidance in relation to a certain feature of the terms of an instrument, it is reasonable to stick with what investors have accepted in the past."

As in Hungary, where OTP structured its lower tier two issue as a 10 year bullet, the regulations in several jurisdictions rule that 10 year non-call five issues are treated as having a 10 year maturity. But while OTP kept within the statutes of its national regulator, other banks have pushed to use the internationally accepted callable structure.

The first ever Russian lower tier two issue to hit the market, Vneshtorgbank's (VTB) $750m trade led by Barclays Capital, Deutsche Bank, HSBC and JP Morgan, was a 10 year non-call five issue even though this went against domestic regulations.

"The definition of subordinated debt says that it is a debt that should have a minimum maturity of not less than five years, should be subordinate to senior creditors in the case of bankruptcy, should be priced at a market level, and — which is a very important feature — a debt that cannot be prepaid, says Nataly Loginova, head of financial institutions at VTB. "This is the most difficult regulatory issue. Because even if everybody understands that a 10 year non-call five structure for lower tier two is market practice, it was not allowed under the regulations."

However, VTB was allowed to proceed after receiving a waiver from the central bank. "The deal did not completely fall within the regulations that exist for additional capital, so we had to see what the central bank's reaction would be," says Loginova. "Their reaction was very positive as they understood the reasons behind the deal and took a pro-active approach."

Teething problems

The difficulties of working in a framework that is not fully developed and where apparent changes to regulations have not been set in stone were made apparent by the experience of Russian Standard Bank when it launched its inaugural lower tier two issue in December.

The deal followed a successful $225m lower tier two issue led by Barclays and UBS for Alfa Bank, the first for a privately owned bank in Russia. Russian Standard Bank had planned to come with $200m issue via Barclays employing the same 10 year non-call five structure.

But its issue was delayed slightly when it had to modify the step-up in the coupon.

Until then the central bank had given the green light to two step-up structures. One was a step-up of 150bp if the deal is not called in year five, while the other — which Alfa Bank had used and Russian Standard was planning to include — was a step-up to a margin 50% higher than the initial re-offer margin paid over the prevailing five year Treasury.

While the deal was being prepared, the central bank signalled a shift in stance when its supervisory committee hinted that it would be more comfortable with a straight 150bp step-up structure for lower tier two debt issued by non-state owned banks. Russian Standard therefore switched to the 150bp step-up.

One reason for the central bank's move, say observers, is probably the fact that, like most regulators and also the rating agencies, too large a step-up is considered to imply too high a likelihood that the transaction will be called, with the result that the issue should be viewed more as having a five than a 10 year maturity.

The 150bp step-up is in line with step-ups accepted in western Europe, and when Sberbank employed the more complex formula for its $1bn lower tier two issue in February the central bank was happy with the structure after being presented with forecasts that the formula would result in a step-up of around 150bp if it is not called.

But with lower rated private banks paying higher initial margins and more vulnerable to market volatility, the absolute coupon that they might have to pay were they not to call their deals in five years is harder to predict and almost certainly higher.

The next steps

Some market participants say that the discussion surrounding coupon step-ups is merely symptomatic of Russia's progress towards a more modern regulatory framework. "The point here is that although the deals are being done and they all look very similar, there is still no fundamental clarity of some of the more technical points, like the coupon step-up," says one DCM banker in London, "and that is something that still clearly needs to be defined."

Others say that the regulator appears to be getting cold feet. "Once the state-sponsored banks have had their structures approved, the quandary for the central bank is that while it may be suitable for the state-owned banks, the same structures will be used for the private banks as well," says one emerging markets banker in London, "and that might not be what they originally had in mind."

This opinion is backed up by the experiences of those that have been involved in the markets' evolution. "We are concerned that they are getting nervous," says one observer. "The approval process for the first deals for the state-owned banks were relatively straightforward. But the process to get the more recent deals done has been slower, while in a way it should have got easier.

"They are getting much more focused on certain terms and conditions, documentation and precedents. Their body language displays a certain nervousness at the speed with which this product is developing and at the appetite that is being shown in it by some of the smaller banks in Russia."

This uncertainty is being reflected in the nature of regulatory calls that are being included in the documentation of Russian lower tier two issues. Whereas regulatory calls typically allow an issuer to call a subordinated transaction if changes to regulations during its life mean that it is no longer treated as regulatory capital, Russian regulatory calls allow banks to call their issues if they are not classified by the central bank as subordinated debt during the 30 day approval period after launch.

Russian banks, like those in other CEEMEA countries, are now looking at the possibility of issuing upper tier two bonds and hybrid tier one securities. But while a waiver from the central bank was sufficient for banks to achieve their lower tier two ambitions, it will take legislative changes to open the door to further tiers of capital.

"We have talked to clients about the possibility of structuring a hybrid deal and in theory you can do one in Russia," says Hatfield at White & Case. "However, you would have to rely on contractual subordination because there is no regulatory vehicle for you to cast that through, and contractual subordination may well not be enforceable in Russia." 

Regulation of Bank Capital in Central and eastern europe and the CIS
Lower tier two
Recognition of LT2YYYNY2YYY
Min maturity LT25 years5 years2 years-2 years5 years5 years5 years
Callable featuresYYY*-Y*-Y*Y
Step-up limitation1Varies150%Varies-Varies-Varies4-
Upper tier two
Recognition of UT2YYYNY3NNN
First call-date10 years10 years5 years-5 years---
Step-up limitation1Varies150bpVaries-Varies---
Ranking in liquidationSub toSub toSub to-Sub to---
senior andsenior andsenior andsenior and
Hybrid tier one
Recognition of Hybrid T1YYNNNNNN
Max HT1 as % of total T1Varies-----15%
First call date5 years-----15 years
First step-up date10 years-----10 years
Step-up limitation1Varies100bp or 50%------
- Not specified1 As % of initial spread or additional bp
N Not approved2 Known as "Tier 3" capital
* With consent of the regulator3 Known as "Tier 3" capital — can be called only if bank meets capital adequacy ratios and
regulator consents
4 150% of initial spread or additional 150bp; recent preference for latter
Source: UBS, White & Case
  • 17 Jan 2006

All International Bonds

Rank Lead Manager Amount $m No of issues Share %
  • Last updated
  • Today
1 Citi 417,761.51 1606 9.02%
2 JPMorgan 380,362.89 1737 8.21%
3 Bank of America Merrill Lynch 364,928.71 1322 7.88%
4 Goldman Sachs 269,252.76 932 5.82%
5 Barclays 267,252.43 1082 5.77%

Bookrunners of All Syndicated Loans EMEA

Rank Lead Manager Amount $m No of issues Share %
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1 HSBC 45,449.36 196 6.56%
2 BNP Paribas 38,734.80 217 5.59%
3 Deutsche Bank 37,615.10 139 5.43%
4 JPMorgan 34,724.19 118 5.01%
5 Bank of America Merrill Lynch 33,835.53 112 4.88%

Bookrunners of all EMEA ECM Issuance

Rank Lead Manager Amount $m No of issues Share %
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1 JPMorgan 22,475.46 105 8.65%
2 Morgan Stanley 19,057.00 101 7.34%
3 Citi 17,812.08 111 6.86%
4 UBS 17,693.89 71 6.81%
5 Goldman Sachs 17,333.10 99 6.67%