Denmark may be forced to amend its policy on how much hybrid debt banks can use to meet capital requirements after European regulators recommended limits.
The European Banking Authority in London is proposing that contingent convertible debt make up no more than 44 percent of the additional capital that national regulators tell the banks they oversee to hold. The so-called Pillar 2 capital is used to address risks not covered by minimum European Union requirements.
The Financial Supervisory Authority in Copenhagen is now awaiting the EBA’s final proposal before deciding how to proceed, Kristian Vie Madsen, deputy director at the agency, said in an e-mailed response to questions. “The guidelines are in consultation,” he said. “We will first evaluate the situation when the guidelines are finished.”
As global regulators try to specify the details of rules first envisioned after the financial crisis, banks and national watchdogs are struggling to adapt their frameworks. The uncertainty over how freely Danish banks will be able to use CoCos comes after the nation’s two biggest lenders -- Danske Bank A/S and Nykredit Realkredit A/S -- issued the securities this year.
Denmark sets no official limit on how much contingent convertible debt banks can use in their individual capital requirements, or Pillar 2 buffers. The policy mirrors that in most other countries, according to Moody’s Investors Service.
Most Danish banks probably hold enough equity to meet their Pillar 2 requirements under the EBA’s proposal, though the FSA doesn’t compile data on this, Madsen said.
“If we did the calculation, I am sure that it would show that the vast majority of the banks have sufficient CET1 to also cover their Pillar 2 add-on, that is, without using CoCos to cover part of it,” he said.
Nykredit said in May it expected its 600 million-euro ($805 million) Tier 2 CoCo to be eligible for use as both Pillar 1 and Pillar 2 capital. The lender said at the time it “may be tempted to sell more” following investor demand. The bond, which has a coupon of 4 percent, yielded 3.63 percent today in Copenhagen trading, little changed from yesterday.
Danske sold a 750 million-euro Additional Tier 1 note in March with the intention that the security could be used to meet Pillar 2 requirements, Claus Jensen, the bank’s chief investor relations officer, said by phone. The 5.75 percent note yielded 5.32 percent today, versus 5.33 percent yesterday.
Danske sold its AT1 in part to refinance a 24 billion-krone hybrid owned by the Danish state, which was called in April, Jensen said. While Danske currently meets its individual solvency requirement of 10.6 percent with common equity Tier 1, having the CoCo gives the bank a buffer “in case our capital ratio comes down and common equity makes up less than 10.6 percent,” he said.
“Part of our capital planning is, of course, to deal with stressed scenarios,” Jensen said.
The EBA proposed last month that at least 56 percent of banks’ Pillar 2 capital be comprised of common equity Tier 1 and that at least 75 percent be Tier 1 capital.
Most national regulators let their banks use debt to help meet Pillar 2 requirements, though some are becoming more restrictive and demanding that equity make up at least 56 percent, Moody’s said. These include the U.K., Sweden and Hong Kong, according to the ratings company.
“Jurisdictions have inconsistent application of Pillar 2 additional capital assessments as well as inconsistent disclosure,” Moody’s said in a report yesterday.
The Danish FSA told banks last year they could use contingent convertible debt instruments to meet individual requirements as long as the notes convert to equity or are written down before a mandatory minimum required buffer of 8 percent of risk-weighted assets is breached. The agency allowed lenders to build in triggers tied either to their individual solvency requirements or their core capital.
“Our starting point is that the Pillar 2 requirement should be met with CET1,” Madsen said. “However, Tier 1 or Tier 2 instruments that trigger sufficiently early to be converted or written down in a going-concern can also be used.”
Regulatory oversight powers vary across borders. The EBA’s proposal is among dozens of recommendations the agency has put forward as part of an effort to harmonize procedures as Europe moves toward a single banking union.
Pillar 2 policies “differ significantly” and are “very untransparent,” Johan Eriksson, senior adviser for bank policy at Sweden’s Financial Supervisory Authority, said by phone. The Stockholm-based agency will next year start publishing Swedish banks’ individual capital needs to provide greater transparency to investors. Denmark already discloses Pillar 2 requirements.
Europe’s banks argue the industry needs the same standards across the region. The European Banking Federation said as far back as 2009 that a level playing field, with similar criteria and disclosure requirements, was “a main concern for banks.”
The Brussels-based EBF is consulting its members to prepare a response to the EBA’s proposals, Mathilde Poncelet, a spokeswoman, said in an e-mailed response to questions.
To contact the reporter on this story: Frances Schwartzkopff in Copenhagen at email@example.com