markets

Triple Whammy Shows New Risks for Old Paper in Europe Bank Rules

  • UniCredit is latest to see aging notes hit by uncertainty
  • Europe financials have $74 billion of pre-crisis junior debt

Europe’s overhaul of finance-industry regulations is opening unexpected trapdoors under aging bank securities.

Three times recently notes have suffered sharp selloffs partly because of differing expectations about how new rules will affect old debt. The slumps rattled investors who thought they understood the risks in instruments that have traded for as long as three decades, and raised questions about what other surprises may be hiding among at least $74 billion of pre-crisis subordinated debt sold by European banks and insurers.

“There is a certain degree of uncertainty,” said Simon Adamson, a financial services analyst at CreditSights. “In many cases, grandfathering rules are not entirely clear and you can even have lawyers disagreeing.”

UniCredit SpA hybrid notes called Cashes were the latest victims of the uncertainty, tumbling almost 20 percent in two days last week amid questions about their regulatory treatment. The rout followed earlier collapses for 1980s perpetual notes and U.K. preference shares, which were both sparked by issuers surprising investors in their response to rule changes.

Hedge-Fund Campaign

The UniCredit slump was the result of Caius Capital LLC querying the eligibility of the Cashes notes, issued in early 2009, under updated capital rules. The hedge fund pursued a similar regulatory-led strategy last year at West Bromwich Building Society, which eventually resulted in the U.K. lender undertaking a debt swap.

Caius’s actions may spur others to try similar campaigns targeting other notes issued before capital rules were overhauled, according to Vaclav Vacikar, an analyst at Rabobank. Still, regulators are unlikely to reverse their decision on the Cashes notes as they will want to avoid spreading uncertainty, he wrote in a note to clients on May 9.

HSBC Holdings Plc triggered a perpetuals slump earlier this month by reclassifying notes issued in the 1980s ahead of a looming update of the European Union’s Capital Requirements Regulation. The change dashed hopes that the bonds would be retired at a premium, causing a selloff that spread to similar Nordea Bank AB and BNP Paribas SA securities.

U.K. insurer Aviva Plc prompted a preference-share rout in March with a suggestion that it would cancel “irredeemable” notes at par ahead of the end of Solvency II grandfathering rules. The proposal hammered preference shares across the U.K., including notes from Lloyds Banking Group Plc, Royal Bank of Scotland Group Plc and Standard Chartered Plc. The securities have failed to recoup all of the losses, even though Aviva has ruled out its original proposal.

Across the bank-capital market, “there is more volatility,” said Richard Thomson, a credit analyst at Janus Henderson. “Regulatory changes mean there are risks due to the uncertainty.”

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