• ECB's Nouy says EU rules on payment restrictions are unclear
  • `Inflexible' law isn't what ECB oversight arm needs, Nouy says

Daniele Nouy, head of the European Central Bank’s supervisory arm, is caught in a quandary that could rock the $117 billion market in contingent convertible bonds.

Nouy said it’s unclear how much the additional capital requirements she can impose on banks in the euro region will affect their ability to pay coupons on additional Tier 1 debt, known as CoCos. “This is a problem that we discovered recently,”  she said in an Oct. 22 interview in London. “I have questions now, not necessarily all the responses.”

Since debuting in April 2013, CoCos burgeoned into the fastest-growing public debt market and it’s still less than half the size analysts say it will eventually reach. A bank failing to pay a coupon would focus attention on the riskiness of the debt and, at the very least, push up the cost and scale back the pace of sales.

“This is a new class of instrument that regulators invented for a particular purpose,” said Robert Montague,  a credit analyst at ECM Asset Management in London. “If a regulator forced a major European bank to miss a coupon at such an early stage of the market’s development, this would be a significant setback for the AT1 market as a whole. That would be cutting off your nose to spite your face.”

Capital Rules

The uncertainty arises from European Union capital rules, which set limits on banks’ payment of dividends, bonuses and AT1 coupons when they eat into their capital buffers. These restrictions are tied to a combined buffer requirement, or the total common equity Tier 1 capital -- common stock and retained earnings -- needed for the various cushions that can be imposed by regulators. The limits are intended to conserve capital, helping struggling institutions to regain a solid footing.

When a bank fails to meet the requirement, it must calculate the so-called maximum distributable amount, or MDA, which determines restrictions on payments including CoCo coupons. The problem Nouy found is that the EU law, known as CRD IV, doesn’t specify if the calculation should factor in her bank-specific, Pillar 2 capital charges, or not.

An indication of the impact of an issuer failing to pay a coupon came on Oct. 8, when Deutsche Bank AG said it would pass its dividend and cut bonuses. That cast doubt on whether the regulator would allow the optional AT1 payment to be made.

The Frankfurt-based lender’s 1.75 billion euros ($1.9 billion) of 6 percent CoCos slumped as much as a record 4 cents to 92.65 cents on the euro during trading that day, data compiled by Bloomberg show. The securities were at 95 cents on Tuesday.


If additional capital requirements set under the Supervisory Review and Evaluation Process, or SREP, have to be met before the combined buffer requirement, this would divert capital that could be used to fill buffers, making a breach and possible cancellation of a coupon payment more likely.

“We have discovered, -- and that was confirmed by the discussion we had with the European Commission -- that there are different ways of understanding the text of the directive,” Nouy said. “It can be in or it can be out, and the place of Pillar 2 vis-à-vis the buffer can be different.”

A spokeswoman for the commission declined to comment.

With rules on the maximum distributable amount coming into force on Jan. 1, the uncertainty may also fuel the clamor for the ECB to make public the capital requirements it imposes on banks.

Disclosing Numbers

“I don’t see how they can keep the SREP numbers secret if they are going to make them part of the MDA calculation,” said John Raymond, an analyst at CreditSights in London. “If they said that this is a binding Pillar 2 requirement before meeting the combined buffer requirement, they would have to make it public. Otherwise it would be a completely unknown risk and I don’t see the AT1 market accepting that.”

Some countries have stepped in to provide clarity for investors. Swedish regulators said Pillar 2 capital requirements don’t affect “the level at which the automatic restrictions on distributions linked to the combined buffer requirement come into effect.” In the U.K., by contrast, the Prudential Regulation Authority decided that the combined buffer requirement must be met with common equity Tier 1 capital that isn’t used to satisfy minimum and additional requirements.

Nouy said that for reining in dividends and bonuses, the ECB doesn’t need the maximum distributable amount, because it’s issuing guidance to the banks under its supervision that are even tougher. In any case, she’d like to change the “inflexible” rule, and that could mean a lobbying effort in Brussels.

“We would like to use the coming months to get a better understanding of what exactly the directive implies, and if it needs be to evolved, to have a different interpretation of the maximum distributable amount, maybe less inflexible” on “the role that this concept is playing for example for other Tier 1 instruments,” Nouy said.

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