Senior non-preferred: Defining moments

The new market for senior non-preferred debt has developed quickly since its opening in December. European Commission plans for a common instrument and ECB interventions have meanwhile both helped and complicated progress. Here, market participants share their views on the new segment as its ultimate shape gradually becomes clear.

 

Participants:

Olivier Bélorgey, head of the financial management department, Crédit Agricole

Michael Benyaya, capital solutions, DCM, Crédit Agricole CIB

Doncho Donchev, capital solutions, DCM, Crédit Agricole CIB

Dr Norbert Dörr, head of capital management and funding, Commerzbank

Bernard du Boislouveau, FI DCM, Crédit Agricole CIB

Stéphane Herndl and Dung Anh Pham, senior banks analysts, credit research, Amundi Asset Management

Vincent Hoarau, head of financial institutions syndicate, Crédit Agricole CIB

Neel Shah, financials desk credit analyst, Crédit Agricole CIB

Olaf Struckmeier, functional head of research, financial regulation, corporate bonds, fixed income, Union Investment Privatfonds

Moderator: Neil Day, managing editor, Bank+Insurance Hybrid Capital (BIHC)

Neil Day, Bank+Insurance Hybrid Capital (BIHC): Has the early development of this new SNP segment gone smoothly and/or in line with expectations?

Vincent Hoarau, Crédit Agricole CIB: The development of the new asset class has been extremely smooth since December 2016 and the French SNP segment now amounts to some Eu15bn-equivalent. It is well established across the two core currencies, euro and US dollars, while all the French borrowers have also tapped niche currency markets, with issuance in Australian dollars, Japanese yen, Swiss franc or Swedish kroner in sub-benchmark or private placement-style formats. We expect the new format to be comparable across jurisdictions — even though there will be a crossover period with several types of structures.

Amundi: While the introduction into French law of the senior non-preferred took longer than initially expected, the opening of the senior non-preferred asset class has gone relatively smoothly. The French banking groups which have since then issued senior non-preferred instruments had well flagged their intention to do so, and their issuance plans for 2017 already incorporated such instruments.

Norbert Dörr, Commerzbank: The market received those French senior non-preferreds well. This indicates that investors understand the product and its purpose. Also, the documentation of those instruments contained the criteria that are in the CRR draft — it was good to see that there has not been a major issue with the inclusion of any provisions that are felt relevant from the perspective of the resolution authorities. So overall I think it went relatively smoothly.

Bernard du Boislouveau, Crédit Agricole CIB: This new segment is indeed benefitting from a warm investor reception, combining the appeal of a new debt format with the potential for yield on well-established signatures at a time when liquidity is abundant and markets globally are supportive, despite the first benchmark coming late, or even very late in the year.

From its inception, this new SNP debt format also benefitted n from the dynamics of the HoldCo debt sector, giving investors comfort and making for an easier benchmarking process among issuers.

On top of this, from January the primary market received a strong impetus from anticipated but by definition unpredictable external factors, such as the major elections awaited in Europe in 2017, which prompted an acceleration of issuance plans.

Olaf Struckmeier, Union Investment: So far it has gone smoothly, but there are still some outstanding questions, especially concerning the latest developments from the European Commission regarding harmonization across Europe. And legal questions concerning the structure of some bonds — UK banks’ acceleration or older KBC, for example.

Olivier Bélorgey, Crédit Agricole: Within a month of the French law being passed, the four large French banks had issued in senior non-preferred format, so clearly the start of this new asset class was very quick, and each issue went well and was appreciated by the market, which is positive for the whole asset class. So, firstly in terms of issuance and market appetite, it clearly went in line with our expectations.

And also in terms of pricing. We focused on what we have termed the bail-in cost — that is the difference between the senior non-preferred spread and the senior preferred spread, which we call the bail-in spread, and the difference between the Tier 2 and senior preferred spreads, which is the subordinated spread. The ratio was between 30% and 40%, which was perfectly in line with our expectations. So from our point of view things are starting well.

Day, BIHC: Crédit Agricole opened the segment at the end of 2016 with a quite aggressive approach, particularly in terms of timing. What was the rationale for this and the key takeaways from the inaugural trade?

Amundi (Dung Anh Pham pictured below): Crédit Agricole opening the market was indeed surprising; we would have expected other French peers to lead, given their greater needs for senior non-preferred issuance to comply with the forthcoming TLAC rules, for which the first deadline is as early as 2019. But this may well also be the very reason why Crédit Agricole sought to be the first to issue a senior non-preferred instrument: so as to ensure the pricing of their inaugural bond would reflect their own fundamentals and low issuance needs, rather than being influenced by the technicals (chiefly supply) of some peers.

Bélorgey, Crédit Agricole: First of all, this new asset class had been eagerly awaited. The announcement of its creation was made in December 2015, so a year beforehand, and there was a lot of anticipation in the market. It was therefore a good strategy to issue as soon as possible after the law was voted in order to meet the market’s expectations.

Secondly, market conditions at the end of last year were good. We know that the market right now is a windows market — some periods are good, some periods are closed — so it’s important to take advantage of good market windows, and mid-December was clearly one such time.

Thirdly, we had announced to the market that our plans in terms of TLAC debt, roughly speaking — senior non-preferred and/or Tier 2 — was around Eu3bn per year for 2016 up to 2019. We therefore thought that, if possible, it would be good to issue what we could in 2016 and not overstock 2017. So instead of issuing Eu3bn in each of 2016 and 2017, we issued Eu1.5bn in 2016 and have thus indicated to the market that we have Eu4.5bn to do in 2017, which is more balanced and avoids an excessive concentration of issuance in 2017.

Last, but not least, we considered Crédit Agricole to be a quite legitimate name to open this new asset class given the strength of our ratios. We felt that we were in a good position to anchor relatively good spreads for French issuers as a whole.

So these four points led to our decision to issue very quickly in December.

Du Boislouveau, CACIB: Crédit Agricole was indeed at the very forefront of developing this SNP format. It was logical to see them pioneer the market. Timing-wise, this inaugural issue was driven by the late in the year implementation for the so-called “Loi Sapin II” that came into effect on 10 December 2016 introducing “Non-Preferred Senior” as a new type of senior ranking below senior preferred bonds in a resolution scenario.

Among the key takeaways of this inaugural trade, we can mention the final order book, above Eu5bn, the 275 participating investors, and the final price: mid-swaps plus 115bp, i.e. circa 30% of the subordination cost (or bail-in premium), rather than the straightforwardly anticipated 50%, positioning the trade closer to senior preferred than Tier 2. For CACIB, it was also a milestone to introduce CASA in this new debt segment.

Part of the success also comes from the quite limited TLAC debt requirement of Crédit Agricole compared with its peers. This provoked additional interest in the venture, given the more limited issuance anticipated.

Hoarau, CACIB: We considered all options in terms of timing, but also the maturity and currency for the inaugural SNP benchmark of CASA. But after the global investor call in December everyone was screaming for a euro trade. Being a French bank, it was a little bit more natural to open up the domestic market before doing dollars, although feedback was extremely positive across the board and the pricing difference was marginal. Appetite for the long end was very clear after Draghi gave clarification mid-December on what was going to happen in terms of QE, so the ground was there for a good trade.

In terms of pricing, there was a strong feeling that the asset class should price one-third, or slightly less, of the distance between senior and Tier 2 — the “subordinated spread” as Olivier calls it. CASA paid ca. 30% of the distance, so it was an extremely good result. Very few investors had a strong view that this product should price closer to Tier 2 than senior. Price discovery was a topic back in December, but the asset in now very well established and it is all about relative value amongst peers in that format.

Day, BIHC: Was the announcement of the European Commission proposal helpful?

Bélorgey, Crédit Agricole: Yes, of course. The fact that the European Commission promotes what we can call the French solution is very good news for us and for the asset class as a whole. And it’s also very good news for the industry, because it anchored the fact that there will be a level playing field between banks with holding company and operating company structures, and banks without that kind of legal structure. It’s really something fair and good for everybody — investors and issuers.

Day, BIHC: How do you view the European Commission proposal to harmonize national approaches to creditor hierarchy (new Article 108 of BRRD2)?

Struckmeier, Union Investment: Why so late? They could have had that from the very start but decided to leave the door open for every country to do what best suited it. We appreciate the need for discussion, but it is now harder to harmonize and there will be the need for longer transition periods with even more instruments outstanding.

Amundi: The Commission’s endeavour to reduce heterogeneity and complexity in the EU banking insolvency frameworks is clearly welcome. It would enhance comparability, provide some standardization and ensure a level playing field, which are preconditions for a deep and sustainable market to develop for bail-in-able instruments. However, the EC’s proposed changes will still need to be transposed into the various EU member states’ national banking insolvency laws, which could limit the final level of convergence and standardization at an EU level. What’s more, even though the EC proposes to move swiftly, it will still take some time for the proposals to be transposed into national law, which reduces the TLAC/MREL compliance period for banks in many EU member states.

Dörr, Commerzbank (pictured below): I welcome the fact that there is harmonisation with respect to the credit hierarchy, because it increases transparency and thereby understanding of the product among investors. My understanding is that member states want agreement on the draft as soon as possible, in particular those states which — unlike France and Germany — don’t have in place a law that allows non-preferred instruments and would otherwise need to apply a contractual approach as Santander did. Hopefully things will be clarified soon.

Looking at the details of the current draft — and I refer there to the compromise text from the Maltese presidency — it gives every member state the option of migrating towards that harmonised framework, and without losing any existing instruments. For us in Germany, for instance, it is the common expectation that future senior non-preferred ranks pari passu with those instruments that are non-preferred under current KWG § 46f. Obviously we need to wait until we have the final text, but for the time being we have no concerns and I think there will be a smooth transition. BRRD 108 is one element, while the criteria under CRR 72b are another, and they both need to be addressed so that issuers have clarity on what they need to/can issue.

Day, BIHC: How do you assess the contractual SNP format (e.g. Santander Second Ranking SNP)? Do you differentiate between contractual and statutory SNP? Do you see any legal risk in the format?

Amundi: From a credit risk standpoint, the contractual and statutory non-preferred senior are identical because they rank pari passu, and would equally contribute to restoring a firm’s creditworthiness in resolution. Nonetheless, the issuance of contractual non-preferred senior instruments ahead of an expected change in insolvency law introduces a remote regulatory risk. This is because the contractual terms will need to be completely aligned with the updated Spanish banking insolvency law, which has not yet been drafted and will be highly influenced by ongoing discussions for a pan-European insolvency framework. Should the contractual terms fall short of the requirements under the updated Spanish insolvency law, the contractual non-preferred senior instruments would be exposed to a TLAC/MREL disqualification event which would allow the issuers to call the instrument at par — albeit these would still be bail-in-able in resolution.

Struckmeier, Union Investment: We do not differentiate between the two formats. We do not see risk in the Spanish format, even regarding the latest developments such as the disqualification event.

Dörr, Commerzbank: I’m not a friend of individual contractual terms. I prefer a transparent statutory framework. That is why I welcome a fast-tracking of Article 108 or giving jurisdictions the possibility to implement equivalent approaches in the meantime.

Hoarau, CACIB: Contractual or statutory, senior non-preferred debts rank pari passu after other “ordinary unsecured creditors” in the insolvency waterfall. In light of that, there are no tangible reasons why any differentiation should take place — while I don’t buy the risk of disqualification. Notwithstanding this, one shouldn’t underestimate the number of investors who only buy into debt backed by a legal framework and who are waiting for the law to be implemented, particularly in Spain where Santander pre-empted the move of the legislator.

More importantly, pricing is a function of supply/funding needs, credit profile, metrics and ratings. Supply is a key element in the pricing scheme, while we expect MREL to become much clearer in H2, providing full visibility of issuance needs across banks.

Day, BIHC: What is your view on the pricing rationale for Spanish issuers under the contractual format? What about the other issuers across Europe?

Struckmeier, Union Investment: Pricing for the Spanish and the French should be equal from a legal/structural perspective. Pricing differences are a function of credit quality.

Dörr, Commerzbank: In the long run, after the transition period, the drivers of pricing should be pretty similar, with the major difference being the type of issuer, the credit standing of the issuer — and obviously the lower you are in the hierarchy, the more you are potentially also affected by macro events that lead to a risk-off vs. risk-on.

Leaving that aside and looking at how things stand today: when French G-SIBs are issuing, the market knows they are the first non-preferreds, so the layer that is pari passu is not yet well populated — also that there is in particular for the large French banks more supply to come. Obviously that has an impact on initial pricing, and that is what we have seen — although there has been the specific issue of the French election and that has had an impact.

The question for me is whether the market will differentiate between operational MREL securities — as we have in the French and German cases — and HoldCo instruments, because obviously a HoldCo instrument is by definition built for MREL, whereas with an operational security it’s a mix of MREL and funding at the operational entity.

Day, BIHC: Do you expect other issuers to pre-empt the introduction of a legal framework and to tap the market as Santander did?

Amundi: Within the EU, global systemically important banks (G-SIBs) are those for which the issue of accumulating bail-in-able instruments is greatest. This reflects their generally higher requirement as well as their shorter compliance period, as the TLAC requirements will be implemented as early as 2019. However, with the exception of Spain, we believe that all other EU member states now have a framework that will allow the G-SIBs to comply with TLAC requirements by the deadline of January 2019.

At this juncture, we do not expect European domestic systemically important banks to massively start issuing senior non-preferred instruments — not least because the MREL rules are not yet finalised, in particular with regards to the quantum and subordination of bail-in-able instruments — unless the Single Resolution Board were to impose a short compliance period for the MREL.

Struckmeier, Union Investment (pictured below): Yes, we expect other issuers from Spain, such as CaixaBank. We do not expect issuers from Sweden, Norway or Finland yet.

Neel Shah, Crédit Agricole CIB: I do not expect other banks to pre-empt the legal framework to issue bail-in capital. Of the European banks which had the largest TLAC requirements, HSBC and BNP Paribas now have a framework for issuing bail-in capital. Santander, given its high issuance requirements, could not be on the back foot, so was left with little option but to pre-empt the legal framework and front-load issuance. For other European banks, issuance requirements are manageable and they will largely replace senior OpCo debt as it matures in the coming years.

Bélorgey, Crédit Agricole: It’s very good news that they have issued in this format because it widens the range of issuers.

Day, BIHC: In some countries (e.g. Belgium, the Netherlands) various resolutions strategies could coexist. Does that raise any concerns?

Struckmeier, Union Investment: Of course, a harmonized structure would be preferable, but there is already such a plethora of different bonds outstanding. So adding more to that is not great, but it’s OK. We understand the banks’ needs for different instruments (e.g. Rabobank vs. ING).

Amundi: Banking groups that can issue structurally subordinated bail-in-able instruments through their holding companies are not dependent on the evolution of national insolvency laws. This allows them to already issue bail-in-able instruments whilst other banks will need to wait for a pan-European insolvency framework introducing the statutory senior non-preferred debt class. From a credit loss point of view, the co-existence of several resolution strategies does not raise any concerns, as long as the investor community is provided with the appropriate data to assess the risk of the various instruments under each resolution strategy and for each resolution group.

Day, BIHC: How does the lack of acceleration rights outside insolvency, the waiver of set-off, and the bail-in acknowledgment affect the credit assessment of the SNP product?

Bélorgey, Crédit Agricole: The lack of acceleration rights outside insolvency is something that impacts the spread of the product. It could potentially disadvantage European issuers — I say potentially because, at least for G-SIBs, if you do not pay your coupon for 30 days the probability that the resolution entity will step in and trigger resolution is rather high. So, economically, I think any difference is really small.

Regarding the waiver of set-off, our legal counsel’s opinion is that under French law set-off is anyway not at all obvious and that it would be very difficult for investors to claim for set-off. They therefore told us that this clause is not really essential because under French law it was already implicitly the case.

As for bail-in acknowledgement, again, if an investor was under New York law, for example, buying a note that is economically for us as an issuer a bail-in-able instrument, but was trying to count on the fact that they could have a claim and so on… It’s not in the spirit of the product. So for us the waiver of set-off and the bail-in acknowledgement clauses are rather self-evident.

Struckmeier, Union Investment: We assume no recovery in the event of default, but have done that since January 2015. So no change from that perspective. The only thing we look at is whether we assume MREL eligibility in the future, and hence the call probability.

Day, BIHC: Under US TLAC rules, the inclusion of the acceleration right in case of non-payment for at least 30 days is permitted. Do you think that the proposed European rules put European banks at a significant disadvantage?

Michael Benyaya, Crédit Agricole CIB: It’s a question of adherence to the original criteria set out in the TLAC term sheet, as the proposed criteria in CRR 2 go beyond the TLAC term sheet in terms of acceleration rights. That said, acceleration provisions provide investors with little protection. In the event that a bank stops paying coupons on an MREL bond, the bank would be in a very difficult liquidity position and would likely be close to resolution. Even if the acceleration right is used by the investor at that time, it will not stop the bail-in tool to be implemented.

Doncho Donchev, Crédit Agricole CIB: I am aligned with the view of other participants, that in theory it matters. But in practice? Not so much.

There is no situation imaginable where a G-SIB or a D-SIB would be in payment default (even within the grace period) without there being a front page headline on the FT or Bloomberg. And what would be the result? If the bank does not correct the payment default immediately, then the insolvency will occur in matter of days, as you would have a combination of a bank run and no new business.

Maybe this is why the market does not differentiate that much between US and European banks on this matter. But the fact that we are talking about it means that at least in theory there is some consideration. From a level playing field point of view, there should be no such consideration, so ideally we will see alignment of the event of default provisions, with long periods leading to acceleration.

Also, we need to ask ourselves why the authorities are even looking at events of default. They do so because it represents a contractually-sanctioned run on the bank. This is clearly a big concern for regulators. What it means is that we are likely to see lengthy periods prior to acceleration kicking in. Some issuers, notably in peripheral Europe, also have acceleration and cross-default clauses — this is definitely out as it represents a bank run at exponential power.

Day, BIHC: What is your view on the latest ECB opinion on the SNP format, notably in terms of comparison with the statutory (German) and structural subordination? And how do you see the three formats from PD/LGD and spread perspective?

Amundi: While it supports the EC’s proposal for a convergence of European banking insolvency regimes, the ECB also stresses that this initiative should not undermine the effectiveness of actions taken until now by EU member states to update their insolvency regimes. In particular, it suggests that outstanding senior unsecured debt that had been statutorily subordinated — as has been the case for German banks since early 2016 — should rank pari passu with senior non-preferred instruments. The ECB’s comments would effectively ensure that German banks’ outstanding “plain vanilla” senior unsecured debt remains eligible for TLAC and MREL in the future.

The probability of the instruments being written down or converted into equity are arguably similar under the statutory, structural and contractual subordination approaches. This is because these instruments rank pari passu and would be subject to losses only in resolution (they would not be automatically subject to burden-sharing under a precautionary recapitalisation as they are not regulatory capital instruments). Similarly, senior non-preferred and German statutorily subordinated debt instruments face the same risk of being written down or converted into equity, which essentially reflects the risk of a bank entering resolution, in our view.

Conversely, the various approaches have a significant bearing on the loss severity in resolution. This is because approaches designed thus far (German and Italian statutory subordination, French and EC’s senior non-preferred, UK’s holding company senior unsecured debt) have changed the relative ranking and respective volumes of debt instruments. Following the change in German insolvency law in 2016, the quantum of bail-in-able instruments is now large and allows for a greater dispersion of losses amongst investors. Conversely, banks that have just started to issue senior non-preferred or holding company senior unsecured debt still have a smaller layer of bail-in-able instruments, which results in a higher loss severity, ceteris paribus.

We also caution, though, that in the case of structurally subordinated bail-in-able instruments, the seniority of the internal loan funded by the holding company senior debt weighs heavily on the ultimate waterfall in resolution, and hence on loss severity. This adds another variable compared to other structures, in our view.

In the medium term, the higher quantum of bail-in-able instruments issued in the ramp-up period should translate into a greater spread differential between senior non-preferred and Tier 2 instruments — albeit spreads will also be highly influenced by technicals, notably for banks with a high level of senior non-preferred supply by 2019, which the market must be able to absorb.

Struckmeier, Union Investment: We embrace the opinion, assuming it will bring about grandfathering and long transition periods. From a PD/LGD perspective we do not see a difference. The same applies to pricing.

Bélorgey, Crédit Agricole (pictured below): My understanding is that the ECB is in favour of both the SNP format and also in favour of the HoldCo/OpCo structure. The ECB has perfectly understood that these two products are economically the same. And clearly given the European Commission proposal, the German solution is in fact or should be a transitional situation — that is, if the European Commission proposal is put in place, the German solution at the end of the day will converge towards the French solution.

Donchev, CACIB: I agree with everything the other participants have said.

In terms of ratings, there could be a negative impact due to Moody’s LGF methodology. Since we are talking about investment grade instruments here, the rating does matter to key investor categories (banks, insurers) and it also matters whether it is A or BBB. So, from cost a perspective this is not ideal.

But of course the macro factor of financial stability and effectively solving the NCWOL issue might prevail.

Day, BIHC: What is your best guess/expectation with respect to the evolution of the regulatory framework in Germany? How do you see the ECB Opinion proposal in this respect, i.e. grandfather the existing senior subordinated stock and then start issuing in EU SNP format, once the product becomes legally available?

Dörr, Commerzbank: If you read Article 108 carefully, and consider the German legal framework, you can come to the conclusion that the current legal framework is entirely compatible with Article 108. Article 108 merely says that you should have a non-preferred layer — and, by the way, that in that layer there should not be any derivative features. This is excluded in Germany by such structured instruments automatically being preferred. In addition, our documentation already refers to the statutory resolution framework and discloses that, given KWG § 46f, the instruments are non-preferred — as required by Article 108. In contrast, Article 108 does not explicitly require anywhere that we need to be able to issue plain vanilla preferred senior — which, however, are relevant instruments for those banks that have higher unsecured funding needs.

My expectation from all that I hear and see is that everybody also agrees that instruments issued before a certain cut-off date that are MREL-eligible under the current legal framework will remain MREL-eligible until their individual maturity, which is important for creating a smooth transition.

Struckmeier, Union Investment: We expect it to follow the EU opinion, including a grandfathering period until 2022.

Bélorgey, Crédit Agricole: Having a grandfathering of the actual statutory German solution is a welcome move— it allows everybody to follow at their own pace. It effectively relieves pressure on certain German players, which is rather positive because — even if you can benefit when your competitors are in trouble — we also want to avoid any renewed crisis. So allowing the German solution and smooth convergence towards a more stable situation in Europe is a good thing.

Day, BIHC: What are your views on the ECB repo eligibility of the product? Do you expect loss of repo eligibility for SNP and how will this influence your expectations about market depth/pricing? And what about Senior HoldCo debt that is currently ECB repo-eligible and without signs of potential loss of such repo-eligibility?

Struckmeier, Union Investment: That is a problem. It clearly benefits the HoldCo approach, which is in contrast to EU opinion. They will need to get that fixed before banks are fully convinced to do SNP instead of HoldCo.

Bélorgey, Crédit Agricole: I think that the ECB’s idea concerning repo eligibility is to remove repo eligibility from any bail-in-able instrument. Once again, they are being rather pragmatic in order not to destabilise the German market. It is used to repo eligibility for senior debt and the change in the nature of German senior debt also has to be managed smoothly. So that explains what they have done, but I think that the idea is to align everybody on non-eligibility for bail-in-able instruments.

I am totally in favour of a pragmatic attitude, I am totally in favour of a smooth transition. But I would react very strongly if at the end of the day they introduce an unfair playing field.

Benyaya, CACIB: Regarding the eligibility as collateral for Eurosystem credit operations, the ECB noted in its opinion the potential implications of subordinating instruments, but it did not provide any new elements. The non-preferred format is viewed as a form of contractual subordination as opposed to statutory subordination, as applied, for example, in Germany. This distinction between the two formats is debatable at this stage, but, longer term, a level playing field is critical and it would sound reasonable to me that all forms of subordination are not eligible as ECB collateral.

Day, BIHC: Again on the ECB Opinion, how do you see the proposed introduction of general depositor preference to affect you from an issuer/investor perspective? Do you expect a rating impact? Do you think general depositor preference will require higher spreads? On the other hand, do you think that improved resolvability might result in lower MREL components (whether requirements or guidance)?

Struckmeier, Union Investment: Since January 2015 we have assumed full subordination to depositors in our analysis — although it is not fully legally in place, it would economically have been the case in an event of intervention.

Bélorgey, Crédit Agricole: I’m not totally in line with the proposal, because it introduces some moral hazard. If you create that kind of hierarchy, you clearly indicate to corporates that they can make their deposits in any bank, whatever its strength and quality, and should the bank start getting into trouble, if they pay a little more, the corporate can make more deposits in this bank knowing that at the end of the day they won’t be bailed in — which could also cause more problems in resolving the bank. So ultimately it encourages some risky behaviour and I don’t think that’s a good idea.

Amundi (Stéphane Herndl pictured below): Looking at the recent past, we reckon the European authorities have been reluctant to activate the bail-in tool, especially because it would have potentially impacted liabilities that were seen as critical for the financial stability of the region (e.g. retail subordinated bonds, senior unsecured debt ranking pari passu with depositors).

The proposed introduction of a general depositor preference should theoretically be negative for senior (preferred) bondholders. On the one hand, this would remove the risk of legal challenge stemming from the BRRD’s “no creditor worse off” (NCWO) principle, and render senior (preferred) debt more easily bail-in-able. On the other hand, it would also materially increase the loss severity in resolution for senior (preferred) bondholders, as they would no longer be pari passu with depositors, which typically account for a large portion of banks’ liabilities.

The spread impact should, however, be at least partially compensated by the accumulation of more junior instruments (e.g. statutory, contractually or structurally subordinated senior notes) which will reduce the loss potential for senior preferred. Spreads should also be positively influenced by the increasing scarcity of senior (preferred)/operating company senior notes, going forward.

Day, BIHC: What are your expectations in terms of MREL and the subordination requirement? Do you expect to see it extended to D-SIBs? If not, do you have level playing field concerns?

Struckmeier, Union Investment: We do not expect it to be rolled out to D-SIBs soon — how should these tap the market? Smaller SIBs are already struggling to do so. Of course that means no level playing field. It is not wanted by Germany, for example, with the strong savings and coop banking sectors.

Amundi: We expect the MREL requirements to converge towards those of the global TLAC rules, albeit they will potentially lead to higher requirements, overall. Over the long run, we see the potential for European authorities to require some subordination for bail-in-instruments, not least to avoid legal challenges that may arise because of the BRRD’s NCWO principle. MREL requirements are also likely to be extended to D-SIBs, albeit to a lesser extent, commensurate with their systemic importance for the bloc.

A decision to impose a materially lower MREL requirement for D-SIBs would have negative implications for the resolvability of these institutions, which we see as a greater concern.

Bélorgey, Crédit Agricole: What the resolution authorities have already outlined is that, at least for G-SIBs, MREL requirements will be as a percentage of RWAs, so they will align it with the TLAC calculation. The MREL requirements are expected to be calibrated at a level that more or less doubles the actual Pillar 1 and Pillar 2R regulatory requirements. But this MREL requirement should include as the numerator the whole amount of preferred senior debt with a remaining maturity over one year. In other words, the MREL requirement may appear greater than TLAC in terms of ratio, but — the numerator perimeter being wider — we do not expect the effective constraint to be very different.

I don’t know if they will extend the subordination requirement to D-SIBs. If they don’t, then there will be level playing field concerns, because the difference between the requirements for G-SIBs and D-SIBs could potentially be very high. And as G-SIBs, and especially French G-SIBs, are in a sense over-contributing to resolution funds, it would be unfair to at the same face much higher requirements than D-SIBs.

It also creates a potential cliff effect. For the G-SIB definition you rank banks according to their size — their interaction with the financial system and so on. But the list is not definitive and forever; it is dynamic. So one day you can be a G-SIB; one day you can be a D-SIB. And if the difference in regulatory requirement between G-SIB and D-SIB is so great, you can be in trouble.

So I hope that there will be, perhaps not exactly the same target, but a target ratio for bail-in-able instruments in terms of MREL for D-SIBs.

Benyaya, CACIB (pictured below): Both the EBA and the SRB seem to support the extension of a Pillar 1 MREL requirement to D-SIBs, notably to ensure an improved resolvability of those institutions. It’s also a question of level playing field in certain countries between G-SIBs and large D-SIBs. In any event, I expect that investors will require D-SIBs to operate with a buffer of loss-absorbing debt. Some D-SIBs may be willing to start building up loss absorbing capacity ahead of full clarity over MREL needs and hence need to find a way to communicate on potential needs to prepare investors for upcoming supply.

Donchev, CACIB: From a bank-neutral perspective, both should be aligned (TLAC and MREL) with MREL Pillar 1 along the lines of the interim TLAC requirement for D-SIBs (i.e. 16% RWA, etc.). Also, a D-SIB in Slovenia is not the same as a D-SIB in Germany or Spain. Hence, perhaps an EU SIB framework may be worth considering.

Day, BIHC: Although the SRB has been relatively quiet on the required period for full MREL implementation, particularly with respect to the subordination requirement, other jurisdictions are more vocal, generally aligning with the TLAC ramp-up period (2019-2022). What would be your expectations?

Amundi: The Single Resolution Board is expected to provide G-SIBs, under its remit, with their final MREL levels by end-2017. Following this, we would expect it to adopt a phase-in period until 2019 and full implementation in 2022, i.e. in line with the TLAC timeline agreed by the Financial Stability Board in November 2015. However, given that banks will be informed of the final MREL requirement only by end-2017 and that MREL requirements could end up higher than those of TLAC, it would be sensible to adopt a longer phase-in period.

Struckmeier, Union Investment: We expect alignment with the TLAC period, especially regarding a potential grandfathering period for the German banks, for example.

Dörr, Commerzbank: The SRB faces a moving target with respect to the applicable legal and regulatory framework. First, the ECB has adapted its approach on Pillar 2, and now we have the EU Commission drafts for CRR2 and BRRD2. Both may be going in an expected direction, but for setting legally binding requirements for MREL the SRB has to operate within the current framework. That is one issue.

The other issue is how far along SRB is in compiling individual resolution plans. Their plan is to communicate legally binding group requirements later this year, and at resolution entity level in 2018. So that all gets delayed a little bit.

The fact that in certain jurisdictions — naturally more in the periphery — some issuers are not ready to ramp up a quite substantial MREL requirement any time soon might be taken into account. You can’t push issuers into a problem because of something you want to have in place if there really is a problem.

That obviously makes things a little bit more difficult for other banks like us, because we don’t have full clarity what amount of MREL and in what format will eventually be required and when.

At the same time, the market should be a little bit more relaxed about the announcement of the ultimate requirements. Obviously, once there is an agreed regulation or directive being published, various stakeholders will immediately do some calculations and work out what the shortfall of Issuer A or Issuer B is, and where the supply should be coming from. That is only natural. But we are talking about instruments that will be used in resolution — and prior to resolution we have an existing apparatus of regulatory measures that are there to prevent anything like that happening in the first place.

Day, BIHC: What is your view on the depth of market and the evolution of the demand for SNP, particularly in Germany?

Struckmeier, Union Investment: The structure itself is not much of a problem. Non-inclusion in Barclays benchmarks limits some funds from participation, as do cross-over or high yield ratings.

Dörr, Commerzbank: I don’t really have an insight into how German investors have participated in issues from other countries. As a general comment I would note that, for German issuers, senior paper has traditionally been a product placed at tighter levels within Germany, often not in benchmark format but more private placements. I expect that to continue, but depending on the requirements of individual issuers, there may well be the need to diversify, and that’s what’s happening.

Day, BIHC: Index eligibility for SNP: What is your expectation, but also your preference in this context? A separate index including all statutory, contractual and structural solutions?

Bélorgey, Crédit Agricole: It would improve clarity around the asset class for everybody if there is an index for all bail-in-able instruments — not subordinated, but bail-in-able instruments — that includes — because economically they are exactly the same — senior holding company issuance, senior non-preferred under French law, and the current German statutory solution. So I am clearly in favour of the creation of an index for this asset class.

Amundi: For the time being, senior non-preferred instruments are not included in the senior index, which includes senior debt instruments issued by some holding companies, which puts senior non-preferred debt at a disadvantage. However, given the increasing outstandings of “senior subordinated” instruments (be it structurally, statutorily or contractually) we are of the opinion that the introduction of a new index should be explored, as the risks associated with these instruments do not match those of a pure funding senior instrument.

Struckmeier, Union Investment: It would be nice, of course, but is not a necessity. As long as broad indices (the Merrill Lynch ER00, for example) include such instruments, that’s fine for us.

Shah, CACIB: Markit announced at the beginning of the year and has since implemented a Senior Bail-in index, which is a sub category of Senior Financials. The Senior Bail-in index accommodates all statutory, structurally and contractually subordinated senior unsecured bonds. As the number of constituents in the Senior Preferred index dwindles, the Senior Bail-in index will gather more interest.

Day, BIHC: CDS with HoldCo/SNP deliverable: Do you expect the development of such a CDS and how do you expect it to influence the market?

Bélorgey, Crédit Agricole: It would be clearer if there were a new CDS for this asset class. It does not occupy the same place in the hierarchy, so it’s fair to have a dedicated instrument for it. But I’m neither a buyer nor a seller of CDS for this instrument, and it will depend on supply and demand.

Struckmeier, Union Investment: I’m not sure. CDS are becoming less and less important, in my view. So even if such an instrument were developed, personally I think it would be a very illiquid market.

Day, BIHC: In terms of issuance currency, how do you expect the breakdown to develop, particularly between EUR and USD? What expectations do you have for other currencies? How would issuers decide on what currency to issue SNP in?

Shah, CACIB: For European banks in 2016, we saw around 70% of senior bail-in debt issued in US dollars, 20% in euros, and the remaining 10% in other currencies. The dominance of dollar issuance follows investors previously comfortable owning US bank debt issued out of the HoldCo in dollars. The natural extension was for UK and Swiss banks to issue HoldCo debt in dollars. I would expect dollars to remain the dominant issuing currency, especially as investors look to lock in higher dollar yields. I would expect euro issuance to increase to around 30% as European investors get more comfortable with the asset class and with the refinancing of maturing senior preferred bonds into senior bail-in bonds.

Struckmeier, Union Investment: Clearly US dollars and euros will be the dominant currencies (maybe some Scandi currencies and sterling or Swiss francs). I think issuers will use as many currencies as possible, especially those with large buckets to be filled, like BNP Paribas.

Bélorgey, Crédit Agricole: Our second deal, in January, was denominated in dollars, and there the market appetite proved to be very good as well — we were able to do a triple-tranche issue, including a floater — and we learned that the range of investors is very broad. In this trade we had some investors coming from the senior preferred bucket and some coming from the Tier 2 world, so clearly this asset class is able to gather interest from both sides, which is very really key. We had a very wide range of investors including real money, so we are really confident in the future of this asset class.

So we did the Eu1.5bn in December and $2.3bn in January, and we issued another Eu1.5bn, in floating rate format, in April. This last deal was a little more defensive, being a five year floater, but it was before the French election. Clearly there was still some euro appetite and we printed the deal at a spread that was still rather interesting — the floater format allowed this — but at that time the appetite from, for example, Anglo-Saxon investors was clearly smaller. Actually, the deal shows that even in more difficult market conditions this asset class is able to attract the attention of investors and that deals are possible.

Du Boislouveau, CACIB: Globally, we can pencil in that this market, TLAC-related debt, will grow to reach Eu150bn of outstandings by 2019. Obviously US dollars and euros will take the lion’s share, but for issuers keen to raise significant amounts, diversification will play a great part. For benchmarking purposes, the leading markets will remain euros and US dollars, but we will continue to see niche markets offering funding opportunities, not only from an arbitrage angle but also from an investor diversification standpoint.

If we now consider senior non-preferred debt from a relative yield perspective, i.e. as a cheap Tier 2 or an enriched senior preferred, the relative performance of both senior preferred and Tier 2 in a given market can lead to genuine opportunities from a relative spread positioning perspective. This will also be a driver in the decision-making process.