Rules governing the riskiest bonds that banks can issue are hard to grasp, even for regulators.
The securities in question are additional Tier 1 notes. The bonds feature a conversion button should the issuing bank run into trouble. Post-conversion, some AT1s turn into equity while others are written down. But before that drastic step, banks whose capital reserves sink below pre-set thresholds must limit coupon payment as well as dividend and bonus payments.
What regulators appear to disagree on is when payment restrictions are triggered. In Scandinavia, the view is that capital can fall to minimum Pillar 1 requirements plus additional safeguards such as capital conservation buffers, before investors incur losses. Additional capital requirements ordered by national watchdogs, known as Pillar 2, shouldn’t be included in the mix, or so say regulators in Sweden and Norway.
“If the sum of the Pillar 1 and Pillar 2 is breached, this does not trigger automatic restrictions under CRD IV, even if the Pillar 2 requirements have the force of an order, according to the Ministry of Finance’s interpretation of the law,” Emil Steffensen, deputy director general at the Norwegian Financial Supervisory Authority, told Bloomberg by e-mail.
The European Banking Authority and the European Central Bank say payments should be restricted when capital slips below the combined pillar requirements and the additional safeguards. In other words, tougher rules than those proposed in Scandinavia.
The situation can only be characterized as “a mess,” according to Lars Holm, a credit analyst at Danske Bank in Copenhagen.
European regulators argue that investor payments need to be halted to allow an issuing bank to rebuild capital buffers if they sink too low. But in Scandinavia, the theory is that banks will have a harder time tapping markets to raise capital after angering investors by deferring payments. Regulators in the region say they’re only doing what their governments instruct them to do.
Denmark has yet to communicate its position on investor payments and Pillar 2 to the market. The Financial Supervisory Authority in Copenhagen is waiting for the Business Ministry to announce its opinion, Soeren Moeller Christensen, the FSA’s head of communications, said by phone.
The ECB acknowledges that there is some confusion. Daniele Nouy, its supervisory head, has spoken of a “lack of clarity” in European regulations. “Markets don’t understand whether the coupons” on AT1 instruments will be paid on time, she said.
Holm at Danske says investors are likely to be more comfortable with the Scandinavian model. Leaving Pillar 2 out of the equation “makes a huge difference when comparing Nordic banks and also when comparing them to other jurisdictions,” he said.
But Sweden and Norway’s regulators warn that investors shouldn’t assume they’re shielded. Steffensen says the Norwegian FSA still has the power to “impose restrictions on individual banks, pursuant to national legislation, in the case where the total requirements are breached.”
Sweden’s supervisor says it has the power to switch its Pillar 2 assessments from a recommendation to an order, which would result in automatic restrictions when buffers are breached.
“Investors shouldn’t count on us not taking formal legal decisions if that becomes necessary,” Uldis Cerps, executive director for banking at the Stockholm-based Financial Supervisory Authority, said on Thursday.
More banks in Norway have issued additional Tier 1 debt than lenders in any other country, according to data compiled by Bloomberg. It’s also worth noting that capital requirements in Norway and Sweden are among Europe’s toughest.
Stockholm-based Nordea Bank AB, Scandinavia’s biggest lender, had 21.6 percent in regulatory capital relative to its risk-weighted assets at the end of the fourth quarter, the FSA said on Thursday. Swedbank AB, Sweden’s biggest mortgage lender, had 30.3 percent in reported capital.
“The Nordic supervisors generally believe the Nordic banks are well capitalized, whereas the ECB may want to use this to force the banks to increase their capitalization,” Holm said. “The Nordics are also very dependent on the wholesale market, so the regulators want to maintain the banks’ good position.”