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Derivatives

Controversial beginnings to a crucial market

The deluge may be yet to come, but some banks have already bitten the bullet. Banks have already printed Cocos, additional tier one and tier two capital that they expect to comply with the final CRD and EBA guidelines. But it hasn’t always been an easy ride. Will Caiger-Smith reports.

The CRD package was agreed in March this year, after numerous delays. Most banks are expected to wait for the rules to be officially published before they start printing additional tier one deals. That does not mean the market is unfamiliar with new-style loss absorbing capital issuance, however. 

Non-European issuers such VTB and Banco do Brasil have issued their own versions of Basel III-compliant additional tier one paper, and there have been several contingent capital deals from European banks, such as Rabobank, Credit Suisse and UBS. 

Most of those Cocos have used a tier two host instrument, however. The only CRD-compliant additional tier one trade from a European borrower so far is BBVA’s $1.5bn perpetual non-call five year trade, which was printed on April 30.

That deal was well received by the market, attracting over $9bn of orders, and performed well in the secondary market. 

But it was conservatively structured, effectively incorporating six different triggers for conversion, in order to satisfy BBVA’s home regulator, comply with the CRD package, and be counted as additional tier one capital in the stress tests the EBA will conduct next year.

Dangerous precedent?

This displeased some market participants, who felt it was a dangerous precedent to set. “If you solve for every single consideration, every trade would be awfully complex,” said a capital structurer away from the deal at the time. “It means you are structuring deals for every possible eventuality. This type of ‘all-in-one’ deal is not fair to investors. We have so many great precedents out of Switzerland in terms of simple, Basel III-compliant trades, and this one is just a massive outlier.”

Permanent write down tier two host Cocos, such as those issued by Barclays and KBC Bank, have also attracted criticism, particularly from investors, who see them as the least attractive option compared with equity conversion or temporary write down. 

Evening out

However, as the market develops, issuers, investors and bankers hope these securities will become less idiosyncratic and more homogeneous. 

Most new-style capital issues so far have been structured out of necessity, says Alex Menounos, head of European IG debt syndicate at Morgan Stanley, playing down concerns that these aggressive precedents could make issuers opt for less investor-friendly options going forward. 

“Several issuers clearly capitalised on very conducive markets and managed to place some ground-breaking structures.” he says. “There were no real alternatives to permanent write down available to issuers at the time when Barclays and KBC came to the market. Setting a precedent will be a significant stepping stone for many issuers, to bring further deals and to explore different currency alternatives. The market has demonstrated appetite for high trigger LT2-host Cocos and for AT1.” 

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