* EC seeks to end too-big-too fail with new framework
* Proposals cater for diverse European banking landscape
* Questions linger on what will happen in Germany
By Alice Gledhill and Helene Durand
LONDON, Nov 25 (IFR) - The European Commission this week proposed a new form of loss-absorbing debt for the region’s banks, providing a much-needed solution to the growing fragmentation in national regulations.
The EC thinks that so-called “unpreferred” senior unsecured debt, which would sit beneath existing senior debt, is the most cost-effective way for banks to comply with the subordination requirement of the total loss-absorbing capacity standard for global systemically important institutions.
The EC said harmonising rules on the treatment of bank creditors in resolution would also limit the risk of competition being distorted in the internal market.
The proposal leaves Europe facing a multi-track senior unsecured market, with most institutions issuing a combination of unpreferred and preferred senior debt; similar to the route favoured by the French. UK and Swiss banks, however, will continue to issue at the holding company level to achieve the requisite subordination.
Even so, bankers believe the proposal represents Europe’s best shot at harmonisation.
“Given the range of circumstances, you can’t have a one-size-fits-all,” said Simon McGeary, head of European new products at Citigroup.
“It needed to cater for all, from banks that have large deposit bases to those that are heavily reliant on wholesale funding. It is not completely harmonised and there will still be some divergence in Europe, but it does get everyone a bit more on the same page.”
Those issuers that have been hamstrung by the lack of certainty welcomed the new standard.
“We love the non-preferred senior solution,” said Isabel Rijpkema, director capital - treasury, at Rabobank. “We’ve been quite vocal in favour of the French solution and we expect the Dutch will follow and implement it.”
There are also clear attractions for investors.
“A new format of instrument tends to offer new opportunities for relative value across banks,” said Gildas Surry, a senior analyst at Axiom Alternative Investments. “The first deals to come are expected to offer a generous premium, and we will look at them.”
The new asset class should be absorbed easily. Issuance of unpreferred senior could hit 550bn in the next four to five years, according to Morgan Stanley, but some 770bn of senior debt is due to mature during that period.
But describing this instrument as a “senior” bond is potentially misleading, said Laurent Frings, global head of credit research at Aberdeen Asset Management.
“I don’t believe they are senior per se,” he said. “As long as there is loss absorption, you can call them what you want but you can still take losses there, and you need to be careful how you think about them.”
This is unlikely to curtail demand from French insurance companies for non-preferred senior from domestic banks, an appetite that threatens to drive spreads to excessively tight levels, Frings added.
Some argue the new asset class should offer as little as 25% of the spread between preferred senior and Tier 2. Others warn against a blanket approach given spreads should vary depending on an individual bank’s capital stack, issuance targets and credit fundamentals.
“It’s very important how the market behaves towards the thickness of the tranches,” Frings said. “To what extent will the market do its homework properly? I hope to see more differentiation going forward.”
The proposal was not received positively in all quarters, particularly in Germany, which struck out on its own last year by subordinating senior bonds to other senior liabilities. The country may now need to change tack.
“It would be interesting to see whether Germany will once again tweak the bank creditor hierarchy in order to give German banks a choice between MREL-eligible ‘non-preferred’ senior and non-MREL eligible ‘preferred’ senior,” said Emil Petrov, managing director within global finance solutions at Nomura, referring to the minimum requirement for own funds and eligible liabilities, a European rule-set similar to TLAC that requires banks to build up buffers of loss absorbing debt.
“In any case, we are fairly confident that the German authorities will do whatever it takes to at least grandfather outstanding senior debt as MREL-eligible for a certain transitional period.”
The projected timeline could also prove a hurdle. The EC has provisionally indicated a June 2017 deadline for the amendments, but the changes will also need to be written into local law.
“The best case for issuance is Q3 or Q4 next year, unless you’re in a jurisdiction which is acting unilaterally like France,” said a FIG DCM banker.
“TLAC issuers who have a 2019 initial deadline may feel a little bit pinched, depending on how big their need is.” (Reporting by Alice Gledhill, Helene Durand, editing by Alex Chambers)