EBA: AT1 monitor

The European Banking Authority is playing a lead role in the evolution of hybrid capital, most recently with the publication of an AT1 monitoring report. Here, Delphine Reymondon, head of unit, capital and asset/liability management at the EBA, discusses how the regulator would like to see instruments develop and a planned initiative on standardised T&Cs.

You published the AT1 monitoring report in early October — what was the background to that?

EBA is charged with monitoring the quality of capital, and if we notice a deterioration in the quality of capital then we should report immediately to the European Commission. Until now, we have very much been focused on the regulatory side, on the drafting of the technical standards. We have issued roughly 20 technical standards on capital, so this aspect is now done.

What we want to do now is to move to the implementation and the peer review, and see exactly how these technical standards and the CRR provisions are applied by EU banks. And so we are now focused on more practical issues, such as the terms and conditions of the issuances themselves.

This is within the context of different types of monitoring. We are doing one for CET1 instruments and there published a list of existing instruments in the EU a few months ago that we will update regularly. And we will not add anything to the list without a prior assessment by EBA and peer review, and confirmation that the instrument is compliant with the rules.

Concerning Tier 2, we have so far been less involved, partly because we consider it a little bit more straightforward, and partly for reasons of resources. In some cases we did have a look at some of the provisions. This was the case, for example, with the RAC Tier 2 in particular, where we expressed a specific opinion on the link between the Tier 2 coupons and the AT1. But we have to an extent set aside Tier 2 for the time being as it is less the priority.

So we have really focused on these AT1 issuances. It’s preliminary work and based on a limited number of issuances, but there were not so many available. We are continuing the work at the moment and are having a look at more recent issuances. We had a roundtable with some issuers to share our views, for example. And the work is not only on the issuances themselves, because in some cases we realised that there are some interpretational issues with the CRR regarding the triggers, the link between the solo level and the consolidated level, for example. So we need to think a little more about all these types of issues.

What is important is that we wanted to go out very quickly with the report to give initial guidance and really send a signal to issuers and investors that we are monitoring what is happening and that we will not let these issuances go in the wrong direction — the wrong direction being for us far too complex types of engineering, questionable terms and conditions, or doubts on the effectiveness of the loss absorption mechanisms, etc. That is why we wanted to give guidance on this.

Do you have any mandates outstanding in this regard? Will there be a second monitoring report?

Contrary to the vast majority of the reports that we are delivering, this one was an own-initiative report — it was not mandated by the EC or any other body. And yes, we intend to do a follow-up. There are a lot of points in this report that are still open, so we will need to give some clarity on these and confirm our interpretation. In some cases we have reservations about specific terms and conditions and are still reflecting on them, while we have also asked some market participants for some written feedback on certain topics. For example, we asked some roundtable participants about a very specific topic, namely the contingent clause mechanism.

I cannot say exactly when an updated report will come out or what the format will be, but we should not wait too long and it could be around the end of the first quarter. As I said, it’s a continuous, ongoing task, so ideally the objective would be to give regular feedback on these issuances.

You also need to bear in mind that there are other work-streams and reports going out on the consumer protection side. For us, as regulators, it is very important to keep the terms and conditions as simple as possible. It’s already a complex product, so we would not like to see increased complexity.

Contrary to other authorities, we consider that the investors in these products are well informed investors — it cannot be retail, of course — so we consider that they know the risks, but again there are different views. For example, if you take coupon flexibility, we as regulators wanted this, we are very happy with this full flexibility of coupon, and this is something that is very important for us. Market regulators, for example, may say, yes, but this full flexibility of coupon payments creates a lot of uncertainty for the investors, so this is not something we like because it is complex and the risks are not properly assessed. So this is something important to have in mind for these issuances, that in some cases there may be different views. But what is certain, again, is that simplicity and standardisation of these issuances is key.

How do you coordinate within the EBA and with external authorities on consumer protection-type issues?

There is of course a coordination with the work we published in July, not under the EBA name but jointly with the other two European Supervisory Authorities, on self-placement, and the consumer protection requirements that firms have to fulfil. Then we also of course discussed with ESMA when they published their report on CoCos. As I mentioned, there are different perspectives because we are coming from different sides — the consumer protection or investor side not being the banking regulatory side.

You say that you like simplicity — are you actually trying to achieve standardisation, and do you think that the monitoring reports that you are doing will lead to that kind of standardisation?

Yes. There are two different ways in which it will do this. The first is that through this report and the follow-up report we can show the direction that we want to go in — the fact that we don’t like complex terms and conditions, that we don’t like certain types of clause because they raise uncertainty, etc.

But then what we will also do next year, but which is not mentioned in the report, is work on standardised terms and conditions for AT1 issuances. We did it in the past on the recap exercise, with the Buffer Convertible Capital Securities (BCCS) term sheet. The idea is really to provide institutions and competent authorities with standardised terms and conditions, especially for the smaller institutions and competent authorities. The idea would be that if a bank were to use these terms and conditions then it would be guaranteed that the issuance is compliant with CRR and the technical standards. It would be an option, it would not be compulsory, but if a bank is doing it then it would definitely be deemed compliant. The issue that could be raised with some of these AT1 issuances is that if the peer review is made on an ex post basis, then some banks and their supervisors will have to take their own risks in terms of compliance with the regulatory provisions. What we are always telling our members is that if you have any doubt or if you have a new clause please come to the EBA to discuss this first, because if you decide on your own you take the risk that at the end the peer review we don’t like this clause or have reservations, and then what will you do? When you need to change terms and conditions afterwards it is always extremely difficult. So we will work for these standardised terms and conditions — probably some with write-down, some with conversion, etc.

Is this something you came up with or was it requested?

It is a bit of both. When we discussed this in the past, there was a little more reluctance from some competent authorities about doing this — it is not new from the EBA side, I would say. But there has been clearly a shift in the mood of some of the competent authorities towards these standardised templates. And indeed it has always been an expectation from competent authorities of a smaller size that may have less expertise when institutions in their jurisdictions do not use a lot of these instruments. In the same vein, when you are a small bank and you are not in a cross-border situation, standardised terms and conditions can be really helpful. Some large supervisors are also very interested in getting these standardised terms and conditions because their view is that there should be only one template in a national market – why should there be different templates? We will see how this drives issuances in the future.

Back in February the chairman of the board of supervisor noted that there had been little AT1 issuance in spite of favourable market condition, and you had few issuances to consider for your report. Are you disappointed that there hasn’t been more AT1 issuance?

We do not make this kind of judgement. What was maybe a little bit surprising was that for a while it seemed as if there was always something more or less holding back issuance: the CRR was not finalised, then the EBA technical standards were not finalised, then when they had been it was because EBA did not give any guidance on some Q&As, or it was because the fiscal treatment in some countries had not been finalised.

But it was not that we have been disappointed — we just noted this. And now we have seen that there are more issuances, that the market has reopened, and that is why we are getting on with this work.

Under the new ECB supervision, how will the process for approving the structure of upcoming AT1 work? How will the national regulator, the ECB and the EBA work on the approval process?

This is a very good question, and we do not have the answer yet. We will see in the coming weeks and months. It is completely new for the competent authorities themselves, so this is a process that we need to discuss with them and the ECB and that will have to be structured. Let’s also see how the ECB will structure itself but I don’t see them challenging the work that is currently being done.

What is the likelihood of the EBA considering a potential revision of the maximum write-up formula for AT1 instruments in the medium term, ideally shortening the reinstatement process upon an institution’s full return to financial health? Given their potential going-concern loss absorption capacity, could a different formula apply at least to high trigger (7% CET1 or higher) instruments?

We have already had this question a few times and we said, no, not for the time being, we will not change this. This was something that was heavily debated when we finalised the technical standards, so we know that market participants were not happy with this because of course the length of the write-up can be quite long. But to be very honest with you — also keeping in mind all the other streams that I mentioned outside the pure regulatory side and the reservations about these instruments for different types of reasons — I do not think it would be appropriate to change this now. This is definitely not our intention, so for the time being it is not at all on the table.