Italy Puts Senior Bonds in Line for Losses Like Germany

Italy is set to put senior unsecured bank bonds in line for losses, following Germany’s lead with a law that facilitates writedowns to prevent taxpayer bailouts.

The Treasury in Rome will soon amend the order in which a failed lender’s capital will be written off, giving corporate and bank deposits preference over senior bonds, according to a new law implementing the European Union’s Bank Recovery and Resolution Directive. Senior bonds would be wiped out right after equity and subordinated debt, according to the law.

The 28-nation EU introduced rules requiring that bank creditors share the losses of failing banks instead of taxpayers who ended up as paymasters in the European debt crisis. Countries including Germany and Italy now have to amend local laws to remove practical obstacles that could stop them from making creditors take the hit should the time come.

“Changing the law would ensure the Italian banks’ bonds could be written down while deposits are protected,” said John Raymond, an analyst at CreditSights Inc. in London. “A German-style solution makes sense.”

The new Italian law was approved by the lower house July 2 and the Treasury will implement it by decree in the coming months. The German legislation has been under discussion in parliament since June.

Germany and Italy currently give senior bonds the same priority as deposits and other liabilities needed to carry out critical functions. That leaves regulators open to legal challenge if they impair senior bondholders while leaving depositors intact, which may hinder resolution.

Italy’s Approach

Italy’s law differs from the German draft in that it promotes deposits rather than subordinating the senior bonds. That might help it circumvent an objection the Bundesbank made to the German law, that subordination might make senior unsecured bonds ineligible for repurchase agreements with the European Central Bank, according to HSBC Holdings Plc analysts Frank Will and Ivan Zubo.

On top of EU rules, the world’s biggest banks will need to issue more instruments that can be written off to allow them to fail without needing public funds and without wrecking the financial system. The global Financial Stability Board proposed they have total loss-absorbing capacity, or TLAC, equivalent to as much as a fifth of their risk-weighted assets from 2019 at the earliest.

The cost of issuing new securities has prompted a search for alternatives, including ways of writing down senior notes outside of bankruptcy. Jurisdictions such as the U.K., the U.S. and Switzerland sidestep the problem by organizing their banks as holding companies that own a group of operating companies.

‘Structurally Subordinated’

Bonds issued by the holding companies are “structurally subordinated,” meaning they can take losses without involving the operating company. This avenue isn’t available for some continental banks like Deutsche Bank AG and UniCredit SpA, which could therefore benefit from the legislation in their home countries.

UniCredit’s Chief Executive Officer Federico Ghizzoni said the Italian law would make it easier for his bank to meet the FSB’s TLAC requirement.

“The government is working on a decree or proposal that should give preference to all deposits before senior bonds,” Ghizzoni said in an analyst call Aug. 5. “If this goes through -- there is already a consultation paper around so it’s not just an idea -- we would be in a very safe position.”

Still, as Italian banks often sell individual savers their senior bonds, the attempt to impair them is politically problematic, according to Stefano del Punta, chief financial officer of Intesa Sanpaolo SpA, Italy’s second-largest lender.

Even now, regulators are concerned that laws should be written in a way that avoids the possibility they might face legal challenge in dealing with a crippled bank.

International and European legislation “doesn’t clarify how other deposits rank with respect to senior unsecured bonds,” said Waleed El-Amir, UniCredit’s head of group strategic funding. “By failing to explicitly delineate, some parties believe that this could leave regulators open to legal challenge when they exercise the bail-in tool.”

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