Photographer: Simon Dawson/Bloomberg

European Secrecy Makes Banks Guessing Game for Investors

The secrecy surrounding Europe’s new capital targets is unsettling some investors and analysts who say they’re being kept in the dark about the health of the region’s banks.

The European Central Bank in March approved the last batch of Pillar 2 requirements, completing its first such exercise as supervisor of the region’s biggest banks. The figures, which refer to the second prong of an international accord known as the Basel standards, define how much capital a lender should hold as a buffer against economic shocks. In Italy, the stock-market watchdog deems the levels so crucial it urged banks to disclose them. Elsewhere, lenders have remained silent.

“Italy has been more transparent,” said Karim Bertoni, who helps manage 6 billion euros for the Swiss-based firm Bellevue Asset Management AG. “It’s odd that other countries didn’t do the same considering that they are under the same supervision.”

The targets, tailored for each institution, would shed light on which banks are under regulator scrutiny and help investors decipher and compare balance sheets. Rebuilding confidence in the region’s disparate bank industry by creating a common approach was among the objectives of introducing the ECB as a single regulator. Measures like the Banking Recovery and Resolution Directive, which allows regulators to impose losses on shareholders and creditors of lenders deemed beyond repair, are prompting demands for yet more information about bank finances.

‘Bail-in World’

“This new bail-in world of BRRD, where you have to assume that the European Commission really will force countries to ask bondholders to pay when there’s trouble, means that the investor has to receive more detailed information in return,” said Michael Huenseler, who helps manage over 14 billion euros ($15 billion), including European banking shares and bonds at Assenagon Asset Management SA in Munich. “Otherwise it’s an unequal game. The regulator knows a lot, the investor knows little.”

The annual requirements cover risks not captured in the minimum requirements spelled out under the first pillar of the Basel accord. Examples range from risks inherent in a bank’s business model to outside pressures such as an overheated real estate market. Disclosure isn’t required under European rules but national regulators can force banks to publish the targets.

Investors and rating agencies can’t ignore Pillar 2 requirements, said Alexandre Birry, director of Standard & Poor’s European financial services team in London. “It can give us greater confidence in our ability to apprehend and understand the various risks the bank is facing.”

No Incentive

In the euro area, Pillar 2 targets are expressed as core equity capital compared with risk-weighted assets, or the common equity Tier 1 ratio. Italy’s Banca Monte dei Paschi di Siena SpA and Banca Carige SpA in February expanded their plans to raise capital after receiving their Pillar 2 targets. Carige said the ECB is asking the lender to hold a minimum 11.5 percent CET1 ratio, the highest for an Italian lender.

Banco Santander SA raised 7.5 billion euros in a share sale in January. The bank at the time said the sale wasn’t related to tougher ECB requirements. A spokeswoman for Spain’s central bank said the regulator had no comment.

Without laws obligating banks to divulge supplementary capital requirements, the incentive to come forward is often missing, said Ross Levine, a professor at the University of California at Berkeley’s Haas School of Business and co-author of “Guardians of Finance: Making Regulators Work for Us.”

Market Discipline

Some banks shy away from transparency that could signal weakness compared with peers, while regulators worry that exposing problems at a fragile bank could disrupt markets, Levine said in an e-mailed response to questions. Giving markets too much information could make it harder for regulators to mitigate risk and stabilize a troubled firm.

And yet it’s “impossible to have effective private market governance of banks if private investors are unable to assess the quality of banks,” he said. “Lack of transparency can harm private market discipline of banks and hence the functioning of the banking system.”

Fitch Ratings published a statement on March 6 highlighting the importance of Pillar 2 disclosure for holders of contingent convertible bonds, or CoCos. HSBC Holdings Plc, Deutsche Bank AG, Credit Agricole SA and Santander have issued these high-risk securities to meet capital requirements that have steadily increased since the 2008 financial crisis. Some call CoCos sudden-death bonds because if a bank’s capital ratio dips below pre-defined levels, the bonds convert to equity or lose their value altogether. What’s more, interest payments are optional, allowing a bank to suspend them when it runs into trouble.

Coupon Trigger

Standard Chartered Plc, which sold $2 billion of additional Tier 1 CoCos last week, told investors it has a capital ratio of

10.7 percent. It must maintain at least 8.7 percent, giving it a $6.8 billion cushion, taking account of Pillar 2.

If the money is used up, say by a loss or fine, the bank will have to rebuild the buffer. It can retain capital by passing up dividends, shrinking the bonus pool or stopping coupon payments.

“How this will all work isn’t clear, because we’ve never had the situation and because regulators haven’t ruled on it,” said Mark Holman, chief executive officer of London-based Twentyfour Asset Management. “What is clear is that if your Pillar 2 requirement goes up, the trigger for you to lose your coupons gets closer.”

CoCo Concerns

Robert Kendrick, credit analyst at Schroder Investment Management Ltd in London, said it’s “pretty frustrating” to think regulators expect investors to buy these instruments without knowing at what level the bank would be forced to stop paying the coupon.

Olaf Struckmeier, a Frankfurt-based fund manager at Union Investment Privatfonds GmbH, which manages 232 billion euros, said Pillar 2 targets would help CoCo investors compare debt instruments from banks in different countries. Struckmeier manages UniInstitutional CoCo Bonds, a fund created in August for institutional investors with a volume of about 65 million euros that invests primarily in CoCos.

Danish Example

Beyond the euro area, Sweden decided last year to follow its Danish counterpart and start publishing banks’ individual capital requirements, putting Nordic banks ahead of the pack in continental Europe. In the U.K., six major banks have disclosed add-ons to the country’s Pillar 2B requirements, a U.K.-specific regulatory buffer that remains under wraps, Fitch said in its comments on March 6.

Ulrik Noedgaard, director general of the Danish Financial Supervisory Authority, said disclosure has improved the dialogue between supervisors and banks in his country.

“The impact of our supervisory actions is amplified by making them public. It is clear there is a lot more attention from top management concerning what kinds of instructions and orders we’re giving,” he said. “I can only recommend it for other countries.”

National Differences

Investors have complained that national regulators don’t use the same method for calculating a bank’s capital needs. As a result, even if information is disclosed, investors find it hard to digest and compare across banks from different countries, they say. The ECB plans to begin standardizing the targets next year.

Europe needs more harmonization of bank regulations, including a common definition of capital, Daniele Nouy, head of the ECB’s supervisory arm, told the European parliament on March


Last year, in the midst of the ECB’s region-wide review of bank assets, Greece, Portugal, Italy and Spain decided to allow their banks to shore up capital with tax credits, even though this runs counter to the European Union’s drive to untangle the finances of lenders and states.

Regional differences make “life extremely difficult for investors,” said Patrick Lemmens, who helps oversee about 10 billion euros in global financial services stocks at Orix Corp.’s Robeco Groep NV in Rotterdam. “It’s difficult to really know what’s going on.”

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