Showing Preference

The Battle for an Orphaned Asset Class

Aviva has bowed to criticism, but that's not the end of the story.
Photographer: Jason Alden/Bloomberg
AVIVA PLC
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It looks a victory for aggrieved bondholders. Aviva Plc has had enough bad press and has kicked controversial plans to cancel its preference share class into the long grass.

The decision isn't entirely charitable. The British insurer may also have been influenced by the fact that likely cost of issuing new perpetual debt was beginning to tick up.

Funding Costs Rising

The yield on Aviva's most liquid Tier I perpetual bond has jumped 30 basis points this year

Source: Bloomberg

But this is far from the end of the story. Thanks to Solvency II, a set of European Union rules adopted two years ago, preference shares will have no purpose after 2026. They won't count as permanent capital, so insurers will want to cancel them.

Aviva is going to have to pay a higher price to do that than it looks it was hoping to get away with. Regulators aren't going to make a special U.K. exception for what is now an orphan asset class.

Upper Tier II non-callable cumulative dividend-paying perpetuals -- like those Aviva wanted to cancel -- are a relic in the age of bail-in additional Tier I capital. Regulators these days want bondholders to be at risk of losing their capital along with equity holders.

The private wealth managers who have been happily filling up pension and trust funds with high-coupon legacy bonds, in a world of very low interest rates, have done their clients a disservice.

After Lloyds Banking Group Plc won its legal battle to cancel its enhanced capital notes, the message should have been clear: if the coupon looks too good to be true, it probably is, at least for individual investors.

The Financial Conduct Authority has made sure that the new AT1 debt can't be sold to individuals. It should have acted on preference shares at the same time.

Aviva hasn't handled this well -- especially given it was going to set precedent for its peers in the insurance industry. Burying a landmine of this size in its annual results runs contrary to the lofty values the insurer espouses in its mission statement. All the more so when it looks like a naked attempt to grab 200 million pounds ($282 million) from one group of investors.

Bondholders Win

Aviva's preference shares have recouped most of the losses prompted by the threat to cancel them

Source: Bloomberg

Running up the white flag now won't save Aviva from lawsuits from aggrieved preference shareholders who sold their holdings in the rout after the insurer's initial announcement. Nor does it leave ordinary shareholders in a better situation: at some point the insurer will have to pay to cancel the securities.

In Aviva's defense, it was put in this position by its regulators, the Prudential Regulation Authority and the FCA. Both would have been told how Aviva was going to handle the retirement the preference shares, so there should have been no surprise. Their silence over how the replacement of these securities should be handled is deafening.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

    To contact the author of this story:
    Marcus Ashworth in London at mashworth4@bloomberg.net

    To contact the editor responsible for this story:
    Edward Evans at eevans3@bloomberg.net

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