S&P Says CoCo Investors Stuck in Gray Zone as Nordics Break Away

  • Rating company says regulators likely to police AT1 triggers
  • Local regulators will respond to specific circumstances: S&P

Standard and Poor’s says investors in the riskiest bank debt will have to learn to live with uncertainty after regulators in Scandinavia highlighted the lack of clear cross-border guidelines by breaking away from recommended European standards.

European rules for additional Tier 1 notes, which have only existed since 2013, don’t make clear how low capital can fall before coupon and dividend payments, as well as employee bonuses, are automatically restricted. The AT1 market went into a free fall earlier this year because investors were wrong-footed by European regulator attempts to clarify matters.

But investors can’t hope for a clear set of rules and should instead assume financial supervisory authorities will step in early enough to avert losses, according to Alexander Ekbom, a Stockholm-based S&P analyst. He says regulators will probably already intervene when capital declines rather than letting it fall to pre-set thresholds, because waiting that long “could create market nervousness.”

Nordea’s 5.25% CoCo -- AT1 investors got cold feet in February.
Nordea’s 5.25% CoCo -- AT1 investors got cold feet in February.

In fact, letting a bank breach capital triggers would unleash a string of very unwelcome outcomes, according to S&P. “A bank potentially wouldn’t be able to issue additional instruments and even more of their funding structure could be impacted,” Ekbom said.

Scandinavia excludes additional, local buffer requirements, known as Pillar 2 from the mix. That means banks can theoretically burn through more capital before being forced to limit investor payments tied to AT1s. The London-based European Banking Authority recommends including Pillar 2, which is a tougher standard.

The European Commission is reviewing how supervisors calibrate capital for the purpose of restricting payments, after the European Central Bank asked for clarification. The commission is considering splitting Pillar 2 demands so that some capital would be excluded when setting triggers.

In Sweden, authorities distinguish between formal orders, which result in Pillar 2 requirements being included, and guidelines, which exclude them. The Financial Supervisory Authority in Stockholm says their model gives them flexibility to guide a struggling bank.

S&P doesn’t “prefer any specific model,” according to Ekbom. “What we look at when we do an assessment is the risk of non-payment of coupons,” Ekbom said. He also says it’s hard to know how different regulators will act. “It will depend on the situation and the resolution plans and strategies and circumstances and the plans that banks present.”

In Sweden, for example, the FSA probably wouldn’t allow “a bank to burn through 500 basis points of capital before asking them to address the problem and stopping coupon payments,” he said.

“In the new world of bail-ins and new instruments, to have a fixed number is going to be difficult,” Ekbom said.

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