Banks under threat as EU group proposes holdings restrictions

By Helene Durand

LONDON, Oct 2 (IFR) - Banks' ability to access the wholesale funding markets could be hampered if proposals submitted by an EU advisory group are adopted by the European Commission, dealing them a further blow at an already difficult time.

In a report published on Tuesday , a high-level expert group on bank structural reforms set up in November 2011 by the European Commission suggested a number of amendments to the use of bail-in instruments as a resolution tool, including possible restrictions on who could hold them.

"In order to limit interconnectedness within the banking system and increase the likelihood that the authorities are eventually able to apply the bail-in requirements in the event of a systemic crisis, it is preferable that the bail-in instruments should not be held within the banking sector," the report said.

"This would be best accomplished by restricting holdings of such instruments to non-bank institutional investors (eg investment funds and life insurance companies)."

If the Commission were to adopt this proposal, it would mark a further blow to banks which have seen their access to capital markets and real money investor demand for their bonds diminish as a result of the financial and sovereign crises.

So-called real money investors, such as asset managers and pension funds, have instead turned their focus to the corporate bond market, where order books for new issues are multiple times oversubscribed, whereas banks sometimes struggle to even reach full subscription on a deal.

While the role of banks in buying each other's bonds has diminished over recent years, they still form a key part of issue distribution. Recent examples of senior bank debt issues show that the proportion of paper sold into banks' hands can vary anything between high double digits to almost 60%, in the case of a recent five-year sold by Morgan Stanley.

While banks' roles in subordinated debt distribution has dwindled dramatically, they also play a part and would have to be replaced. A Tier 2 benchmark sold by Rabobank in September had a 29% placement with banks. However, this is at the higher end of distribution statistics. A EUR500m Tier 2 sold by Austrian lender Erste Group Bank only had 10% placed with banks.

Cutting off this investor base could also force banks to rely further on their retail networks to raise funding, a potentially dangerous move, as highlighted by what is happening in Spain.

Spanish banks have sold billions of euros of subordinated and senior debt through their retail networks, which is making any burden-sharing a lot more difficult to enforce at a time when they are in dire need of capital.

MORE PREDICTABLE

As well as potentially limiting holdings of bail-in bonds outside the banking sector, the expert group suggested further developments to the framework put forward by the European Commission in the Crisis Management Directive in June this year so as to improve the predictability of the use of the bail-in instrument.

"Specifically, the Group is of the opinion that the bail-in requirement ought to be applied explicitly to a certain category of debt instruments, the requirement for which should be phased in over an extended period of time," the report said. "This avoids congestion in the new issues market and allows the primary and the secondary markets to grow smoothly."

The draft of the Crisis Management Directive (CMD) did leave the door open for a new layer of debt that would absorb losses after regulatory capital but before senior when it was published in June, and the group's suggestion could push the Commission to be more specific on it .

The report also suggested that banks should be allowed to satisfy any requirement to issue bail-inable debt instruments with common equity if they prefer to do so. "This could be especially useful for smaller institutions, whose bail-in instruments could face particularly narrow markets," the report said.

The report also said a clear definition would clarify the position of bail-in instruments within the hierarchy of debt commitments in a bank's balance sheet and allow investors to know the eventual treatment of the respective instruments in case of resolution.

This would likely be warmly welcomed by investors who fear that the CMD has left some grey areas that could potentially see them absorb losses while shareholders' holdings are not completely wiped out, thereby reversing the creditor hierarchy.

"Detailing the characteristics of the bail-in instruments in this way would greatly increase marketability of both new bail-inable securities and other debt instruments and facilitate the valuation and pricing of these instruments," the report said.

(Reporting by Helene Durand, Editing by Philip Wright, Julian Baker)

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Keywords: EU BANKS/LIIKANEN