For many of us who have been working from homes connected only virtually to the world of work, this heralds a gradual return back out into the wider world. In parallel, Bank+Insurance Hybrid Capital is returning in print for the first time since the onset of the pandemic — we hope you have in the meantime found our timely online BIHC Briefings valuable.

As we tentatively emerge into the light, there is a widespread feeling that the post-pandemic world can and should be different: better, fairer, greener.

Fortunately, the financial sector was in ways primed for such an evolution through the growing emphasis on ESG factors ahead of the crisis, not least in the development of green, social and sustainability bonds in the capital markets.

And 2021 has seen a surge in the proportion of issuance in these formats, not least as senior non-preferred and Tier 2 bonds. In this edition, we look at the latest developments in this field and hear from issuers who are embracing these trends, such as BayernLB and Raiffeisen Bank International.

Our partner Crédit Agricole CIB continues to be at the heart of ESG-related innovations such as sustainability-linked bonds, and global head of financing and funding solutions Arnaud D’Intignano shares his insights into how the wider market and the corporate and investment bank are positioned for the second half of the year.

The recovery from the pandemic will see significant fiscal and monetary support programmes falling away in the coming months. Representatives of CACIB’s syndicate, DCM solutions, and economics teams discuss the potential timing and impact of any such moves on either side of the Atlantic, and the likely impact on rates and spreads.

However the remainder of the year plays out, it is safe to say, the world will never be the same again.

Neil Day,
Managing Editor, Bank+Insurance Hybrid Capital

Fortunately, the debt capital markets give more cause for hope. Generali and CNP Assurances brought the green bond concept to the European insurance industry in subordinated format, and we spoke to them about their motivations and strategies, as well as banks taking the market in new SDG-impactful directions, such as ANZ, Rabobank and RBS.

As well as assisting in many key transactions, Crédit Agricole itself in October took its green bond issuance into the senior non-preferred market, then in November launched an inaugural CA Home Loan SFH green covered bond while Crédit Agricole CIB sold a ground-breaking “transition bond” to AXA.

“Starting in 2009, Crédit Agricole has made significant progress to identify and promote green and sustainable financings within its ‘distribute to originate’ business model,” said the bank. “We are proud that AXA Group recognizes this expertise and partners with us to finance the environmental transition projects of some of our key clients.”

Incoming ECB president Christine Lagarde has already shown an openness to sustainability being increasingly integrated into the institution’s mission, but “time for action” could have been the rallying cry of Mario Draghi, in light of his regular exhortations to EU leaders to make structural changes and, latterly, to use fiscal policy more forcefully. CACIB Eurozone economist Louis Harreau gives his verdict on the central bank’s impact in this issue.

Finally, will the New Year be a time for action in the primary market? Boris Johnson’s victory in the UK general election as Bank+Insurance Hybrid Capital was going to press removes one uncertainty but potentially creates others, while who knows whether or not Donald Trump’s positive turn in the trade war saga will persist? In his primary market outlook, CACIB FI syndicate head Vincent Hoarau warns against complacency, but sees reasons to hope for a strong start to 2020.

Was CRD IV actually worth the wait? And do we really need another Basel?

But like its Avengers namesake, “Infinity QE”, as more than one critic has dubbed the ECB’s stance, is perhaps inevitable — and equally certain to deliver a powerful performance. Sure, there are those who complain of diminishing returns, but give the market what it wants! And while renewed bond buying may come after the departure of the franchise’s leading man, Europe is following (Captain) Marvel’s lead in casting Christine Lagarde in the starring role.

Not allowing the ECB to steal the limelight — think Star-Lord and Thor — the Fed delivered its first rate cut in a decade in a post-credits, stop the press scene for Bank+Insurance Hybrid Capital.

In this edition of BIHC, we look at the story so far and ask what can be expected from the premier of QE2.

Meanwhile, capital needs and structures continue to face their latest iterations around the globe.

Hitting screens across the Atlantic was the Australian version of TLAC, as Westpac sold a blockbuster US$2.25bn Tier 2 to meet ALAC needs. BIHC went behind the scenes with the bank’s funding team to discuss how they are responding to the latest APRA requirements.

Changes to S&P Global’s insurance criteria come against the backdrop of the sector’s most famous sequel, Solvency 2. With hybrid methodology changes at the same time affecting insurers most, S&P insurance sector lead Dennis Sugrue has an interesting tale to tell.

One Disney Pixar sequel that looks unlikely to reach production is WALL-E 2. However, the bond markets are at least acting to help save the planet from humanity’s excesses, as part of what Matthew Dong Seok Gim, head of Kookmin Bank’s treasury team, sees as a megatrend that must be followed. While the Korean issuer chose to make its AT1 debut under a sustainability banner, the senior non-preferred segment has seen several issuers return with green bonds and Standard Chartered take the ESG show into new markets with a debut sustainability bond.

Neil Day, Managing Editor

Photo: ECB Luminale 2016; Credit: ECB/Flickr

Just how tight can the market get?

Following some nasty surprises in 2016, markets were at the start of the year nervous about political and geopolitical events bringing an end to the rally in credit markets by causing collateral economic damage. But as 2017 has developed, potential crises have either been averted or proved to be less harmful than expected.

Most recently, Spain’s banks showed that even a relatively unanticipated development such as the tensions around Catalan independence could be overridden. Even the sum of all fears, nuclear tensions in the Korean peninsula, today leave markets unruffled — indeed, the Vix “fear index” is at historic lows.

Have mainstream markets taken leave of their senses?

Underlying the rally in credit and other markets is what economists have increasingly been perceiving as a Goldilocks scenario, with growth more assured than had been considered likely at the start of the year, and central banks showing greater patience and largesse than had been guaranteed, against a backdrop of a benign inflationary outlook.

The subordinated debt markets have not only benefited from this optimistic scenario; they have contributed to it, by enabling the new regulatory framework aimed at creating a safer system to come into being. Witness, for example, the expansion of the senior non-preferred asset class this year beyond France into Spain and Belgium. And the anticipated growth of the asset class in countries such as the Netherlands and Italy equally promises gains on both sides.

It is therefore no surprise that — despite some brief wobbles — the strength of demand has enabled new tights to be set across currencies and asset classes, most notably Nordea setting a coupon low of 3.5% on a EUR750m AT1 benchmark.

So while prices may oblige one to ask whether this is irrational exuberance, it’s hard to find a reason to act otherwise.

Neil Day, Managing Editor

It is, however, something of a shock that Banco Popular hasn’t closed the market.

The write-down of the bank’s AT1 might have been expected to result in the kind of turmoil witnessed when rumours about Deutsche Bank and speculation about coupon deferrals roiled the market. But prices were largely steady in the face of the losses being imposed on Popular’s sub debt holders.

The most direct beneficiary of the episode is the taxpayer.

If there were ever a time for bankers to shout about the social value they can bring to society, then this is it. Politicians please take note of how such complicated financial instruments can help them avoid the dreaded “bail-out”.

Regulators can meanwhile draw satisfaction from the smooth resolution process. Anyone remember those maze-like flow charts casting doubt on the EU authorities’ ability to act quickly? They can be put in the circular filing cabinet.

Positives for debt holders are perhaps harder to find.

As feared, the point of non-viability (PoNV) has been shown to be the great unknown in the AT1 equation. Investors clearly miscalculated the likelihood of this point approaching given cash prices of around 50 immediately before the ECB/SRB acted.

Yet the resilience of other AT1 shows that investors still have faith in the product, or at least consider the risk-reward to be worth their while.

Will senior unsecured bondholders be so steadfast if the next resolution sees them bailed in, too? With any luck, better management and the rise of senior non-preferred will forever leave that question unanswered.

Neil Day, Managing Editor

Read more on Banco Popular here.

Dutch prime minister Mark Rutte’s hyperbole can be understood given the heated atmosphere in the European Parliament where he was addressing UK MEPs including Brexiteer Nigel Farage. But — for the sake of its own citizens — the diminished EU would be better advised to reflect on its own future.

Indeed, the UK’s decision to leave the EU has acted as something of a mirror for remaining member states, where support for the union enjoyed a bounce in opinion polls conducted in the immediate aftermath of the Brexit vote, possibly as electorates saw the chaotic financial aftermath of the surprise referendum result.

How will EU leaders themselves respond? The head of the liberal group in the parliament, former Belgian prime minister Guy Verhofstadt, characterised the European Council’s attitude as “we shouldn’t change anything, just implement existing European policies” — which he condemned as “shocking and irresponsible”.

An early and portentous test will be whether, and if so how, the problems of Italy’s banking system are addressed. Here, “national specificities” — to borrow a Brussels euphemism — clash with a Bank Recovery & Resolution Directive that has been placed at the centre of the EU’s post-crisis financial architecture.

What will be sacrificed: principle, or Italian retail investors’ savings?

Perhaps compromise is in the air: a European Banking Authority decision on 1 July to split Pillar 2 and thereby ease coupon payment concerns in the AT1 market looks like nothing less than a U-turn, albeit dressed up in face-saving language.

Can Europe’s leaders perform a similar trick? With Italy’s own referendum — on constitutional reform — due by November, the clock is ticking.

Neil Day, Managing Editor

Photo: Guy Verhofstadt, Source: European Parliament 2016 – European Parliament

Events in the Additional Tier 1 market made for a perfect storm of journalistic clichés in the opening months of the year, and for once their use was justified.

Maybe prices didn’t literally fall off a cliff, but AT1 were left in a critical condition.

At the turn of the year few would have predicted the horrendous collection of factors that afflicted markets barely a week into 2016: negative news on oil, China and bank earnings — combined with bewildering regulatory pointers from the “competent” authorities.

AT1 found itself centre stage for all the wrong reasons, with issuers’ earnings falling short of expectations just as the bar for distributions was being bumped up — while a lack of understanding of the instruments amplified the negative sentiment being fed back into the broader markets.

Value hunters put a bottom under the market after others had capitulated, but a substantial recovery in the sector had to await the latest instalment of Mario magic — leading to round two of cliché bingo: bazookas, game-changers, etc.

Again, these did not overstate the impact of the ECB’s actions; after disappointing at its December meeting, the Governing Council overdelivered in March, paving the way for UBS to reopen AT1 issuance.

However, while the cutting of rates and boosting of QE undoubtedly stole the headlines, it was Draghi’s footnote regarding Pillar 2 that could ultimately prove the most important for the AT1 market, drawing attention to a European Commission review of the aspects of the instrument that had been the most contentious during the volatility.

The ECB has arguably bought time for the authorities to sort things out and provide the clarity the market desperately needs.

Will they get it right? No comment.

I have a rather bizarre memory of some guy with a penchant for Burberry scarves threatening to implode the Eurozone. Then there was something about big trouble in big China.

And that guy in Frankfurt… He couldn’t have cared less. Get used to it? Thanks for nothing, Mario. The less said about regulators the better.

Seriously, did we really make it through all that?

It appears so.

Indeed when it comes to hybrid capital, not only did we survive, but we came out alive and kicking.

Who can argue with AT1 achieving the best returns in the credit markets? Those who braved the subordinated markets in 2015 can be pleased with their call.

Supply may have disappointed, but this at least eased pressure on spreads and allowed the maturing asset class of AT1 to find a better equilibrium, while Tier 2 avoided a potentially dangerous deluge.

Are we home and dry?

Not quite, Dorothy.

Federal Reserve chair Janet Yellen is not the Wicked Witch of the West and is cognisant of the tornado that rising US rates could unleash on the financial markets, but they may prove to be forces beyond her control.

Regulators, meanwhile, will continue to pull the levers behind the curtain, but can they be trusted? The final TLAC terms sheet released in November sprung no nasty surprises. However, we may yet be humbugged as further details emerge on MREL, Pillar 2, RWA floors and the like.

Those looking for some place where there isn’t any trouble might therefore wish to search elsewhere.

When the Greek government late on Friday, 26 June announced it would hold a referendum on any potential debt agreement, it capped a second quarter many fixed income investors would rather forget. For even before the talks collapsed bond markets had moved into uncharted and hostile territory.

The end of the QE rally in mid-April and the severity of the reversal caught almost everyone off guard. But even Super Mario could not come to the rescue on this occasion — indeed, Draghi told everyone to “get used to periods of higher volatility”. A renewed back-up in yields and more pain ensued.

Many issuers chose to give the primary market a wide berth, and several of those who did venture out with new issues — whether covered, senior or subordinated — failed to live up to expectations.

But if we are entering a new era of volatility, it has already been shown that issuers can survive and even thrive in the sub space.

Witness an almost brazen Eu1.5bn 10 year non-call five Tier 2 issue for ABN Amro on 23 June that attracted Eu8bn of demand. Given the circumstances, a new issue premium of 35bp seems a small price to pay. And two weeks earlier the financial institution that most successfully issued into an almost as hostile market was none other than Bank of Ireland with an inaugural AT1.

Complementing these encouraging signs has been a relatively stable performance from bank capital instruments that has certainly not gone unnoticed on the buy-side. “This has gone a long way to making investors more comfortable about the asset class,” says one.

So perhaps it is not all doom and gloom, for bank capital, at least. Tom Ranger, director of funding and collateral management at Santander UK, perhaps captured the mood of the times best after an inaugural £750m HoldCo AT1 for the UK group.

“I guess the very interesting thing, which goes against everything you learnt at school, is that in such volatile markets, the less volatile product is the higher risk product,” he says. “To a certain extent, I would probably have more faith in issuing a hybrid capital instrument today than a triple-A covered bond, which makes no sense from everything I learnt, but that is the life we’re in.”

On the supply side, forecasts are only increasing. While the AT1 market may be off its highs, hybrid issuance remains economically efficient for financial institutions seeking to optimise their capital structure. 2014 may have seen several jurisdictions opening up and many issuers debuting, but there is much more to come.

On top of this, the launch of the Financial Stability Board’s Total Loss Absorbing Capital (TLAC) consultation on 10 November raised the prospect of multiple billions more of subordinated instruments hitting the market over the coming months. Already, issuers are gearing up to hit the market with Tier 2 deals in January.

They will be joining the most active issuers in the year-end market: insurers. Having avoided the worst of the volatility suffered by banks, insurance companies have taken advantage of market windows to launch deals designed to optimise capital structures ahead of and going into the implementation of Solvency II — while next year will see the first hybrids purely based on the new framework.

Meanwhile on the demand side it is clear that the investor base for AT1 is thinning. Many private bank and hedge fund accounts have either exited the market or cut down their tickets, while those remaining committed to the asset class can afford to be selective — and are taking advantage of that.

Tier 2 investors also suffered a knock in December when Erste Group announced that — as it had warned it might — it would be skipping coupons on outstanding Upper Tier 2 and Tier 1 instruments. And all that goes without mentioning the slew of postponements of senior unsecured and covered bonds in late November.

Yet the market does not appear to have priced in these ominous trends, let alone some potentially unpleasant negative macro headlines. When it begins to — as it surely must when supply resumes in January — the last thing issuers should expect is a happy New Year.