A German proposal to recategorise swathes of bank senior debt as eligible for TLAC (total loss absorbing capacity) and MREL (minimum requirement for own funds and eligible liabilities) could be a blueprint for other banks across Europe to meet their own requirements.
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The German banking sector is very unrepresentative of the rest of Europe Marcus Schulte, |
The German government released the draft legislation, SRM Anpassungsgesetz, on March 10. It amended section 46f of the German Banking Act so that all senior unsecured securities of all German banks with a full banking licence become subordinated to the bank’s other senior unsecured liabilities in insolvency.
The change gets around the problem of bailing in senior debt that ranks pari passu with other large blocks of senior liabilities. The Bank Recovery and Resolution Directive (BRRD) enshrines the principle that no creditor should be worse off than another and requires the resolution authority to work out the net insolvency set off position of all pari passu senior creditors.
The German proposal deals with the problem by subordinating senior debt to other senior liabilities.
“The proposed German law would create a huge stack of debt that would be subordinated to deposits,” says Matthias Ogg, a director in the EMEA credit structuring team at Credit Suisse in London. “This would mean that German banks would have solved TLAC and MREL straight away. But it rolls the cost of subordination to the senior bondholders.”
N-bonds
Under the first iteration of the proposal in March the type of bond itself was to determine whether it would be subordinated: senior debt in the form of bearer bonds was to be bail-inable, but registered bonds (uniquely German instruments called Namensschuldverschreibungen or N-bonds) and Schuldscheine were exempt. A second proposal was, however, issued on April 30, which determined that all forms of senior debt would be subordinated.
“If Schuldscheine were not bail-inable there would be a significant distortion potentially in favour of a larger and rather untransparent Schuldschein market,” says Marcus Schulte, head of EMEA financial institutions DCM at Credit Suisse in London. “It makes sense to put Schuldscheine on the same level as other senior unsecured debt to broaden the amount of available bail-in mass further and to avoid creating a significant distortion in favour of one peculiar product.”
The decision to include all senior debt in the proposal calmed investor reaction. “Investors appreciate that German senior bonds will be subordinated to other liabilities,” says Schulte. “Spreads on German bank paper widened on news of the law but, once the German government revised it to include Schuldscheine, they tightened again.”
With a stroke of a pen, they are saying that all senior debt is loss-absorbing in resolution and therefore TLAC-eligible Piers Ronan, Credit Suisse |
The senior spread differential when the proposal was announced was between 10 basis points to 15bp but it has settled back to 5bp to 10bp.
“With a stroke of a pen, they are saying that all senior debt is loss-absorbing in resolution and therefore TLAC-eligible,” says Piers Ronan, a director on the syndicate desk at Credit Suisse. “However, the impact of the change in the law is less than 10bp as investors still view this as senior debt and the quantifiable increase in expected loss is negligible because the probability of failure is so low and the thickness of the layer is so large.”
The proposal needs to pass into law by the end of the year for the rule to be implemented under BRRD. It is expected to pass sooner rather than later, and there are rumours that the German government is liaising with other EU member states about implementing a similar rule elsewhere.
“It appears there’s at least a reasonable possibility that this law gets enacted and if it were to be, we expect much of Europe would follow suit,” says Greg Case, European bank analyst at Morgan Stanley.
However, this one-size-fits-all approach could be difficult to implement. “Something similar to the proposed German law might potentially help to foster bank resolution in other EU member states, as well,” Bernd Geier, counsel at Allen & Overy in Frankfurt, tells Euromoney. “However, each member state might need to adjust its rule to the local market, as the discussion around the German Schuldschein shows.”
Protection
Indeed, implementation in Germany itself may still take time. Having now bailed in all senior debt, the rule only exempts instruments that benefit from deposit protection from subordination in insolvency. With the EU Deposit Guarantee Scheme Directive, which comes into effect on July 3, large companies will no longer be ineligible for deposit protection. There is, therefore, the potential that bank Schuldscheine held by large German corporates such as Siemens could be covered by deposit protection.
As such they would be treated as a claim with preferred treatment in insolvency, which would be even better than the pari passu treatment that it carries at present. Rather than being subordinated, the large corporate investor could leapfrog over senior bondholders in the insolvency waterfall. This seems far-fetched, and under BRRD only SMEs are eligible for depositor protection, but it does raise the possibility of banks and investors being able to work around the new rules.
There might be pressure in Germany for the rule to become law quickly, but its implementation elsewhere will probably take time. “The German banking sector is very unrepresentative of the rest of Europe, so even though it’s carefully watched everywhere the impact [of this rule] may be quite different in other regions,” says Schulte.
