Bankers Challenging CoCo Payment Rules Begin to Get Their Reward

  • ECB's Nouy seeks `certainty, clarity' for the market
  • One lawmaker warns it might open a legal `Pandora's box'

Lobbying by European banks for a relaxation of rules that affect their ability to service their riskiest debt is starting to pay off.

Six months ago, nine of the euro region’s largest lenders privately appealed to the European Central Bank for a loosening of the constraints on their ability to pay coupons on contingent convertible debt, or CoCos. They said that some of the capital requirements tailored for banks should be adjusted to shield investors who bought the bonds.

In doing so, it would “limit harmful and counter-effective reactions from the markets,” the bank chiefs, including Deutsche Bank AG’s John Cryan, wrote in a Sept. 16 letter to ECB President Mario Draghi and Daniele Nouy, head of the central bank’s supervisory arm. It would also “partially remedy the divergence” between euro-area banks and their competitors in the U.S. and U.K., they wrote.

Their message has penetrated the policy-making bastions in Brussels and Frankfurt, even if it may face opposition among some European Union lawmakers.

The European Commission, the EU’s executive arm, is now considering how to give “particular protection” against missed payments to investors in certain securities. They include CoCos, which were invented after the 2008 financial crisis as an extra layer of capital and are the first debt securities to take losses should a bank run into trouble.

Nouy said on Wednesday that the ECB had sought clarification from the commission to “deliver certainty, clarity, transparency to the market.”

Under the framework set by the Basel Committee on Banking Supervision, a bank’s capital is divided into two basic categories plus a series of buffers.

Pillar 1 requirements are one-size-fits-all and set out the minimum levels all lenders must meet to be considered solvent. Pillar 2 is defined by supervisors for each bank individually, to cover risks that may not be addressed by Pillar 1.

Once losses pierce the capital level defined by the two pillars and the combined buffers, the affected lender must prevent money from leaving the business: dividends, bonuses and coupons on CoCos are capped by the so-called maximum distributable amount, or MDA. Nouy said this week the EU should set out the revised calculation of the MDA in law.

If such payments are threatened, “it sends fear through the credit market,” HSBC Holdings Plc analysts Robin Down and Ivan Zubo wrote in a note.

In their letter, the banks demanded the ECB be “proportionate and reasonable” in setting the triggers for the coupon restrictions. They welcomed ECB plans to split Pillar 2 requirements that would exempt part of it and potentially lower the MDA trigger. The commission is now considering introducing this split, according to documents obtained by Bloomberg.

At the same time, the paper trail of bank lobbying leading to the commission’s plan may generate opposition in the European Parliament, which would have to approve any changes to European Union law.

“Instead of imposing the highest standards in Europe, the ECB and EU Commission are lowering the payout restrictions for banks,” said Sven Giegold, a Green lawmaker who’s a member of the parliament’s Economic and Monetary Affairs Committee. “This opens a Pandora’s box on a doubtful legal basis. To prevent future crises, banks need to hold capital according to their risks. We cannot accept any special treatment, not for systemically important banks or holders of CoCo bonds.”

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