If Euromoney had sat down with a group of bank treasurers just after the markets crashed in 2008 and asked them to name their number one concern, it would have been new banking regulation.
Seven years later, when the magazine did just that over the summer, their number one concern was… new banking regulation.
It seems incredible that the regulatory environment is still so opaque. Spend any amount of time talking to bank treasurers and their exasperation that the dialogue has not changed becomes all too clear.
“One year ago we were at the beginning of the finalization of [Capital Requirements Regulation and Directive] CRD IV and we thought regulatory uncertainty was behind us, but it wasn’t,” says Stephane Landon, head of group ALM and treasury at Société Générale. “We have to deal with it.”
Patience is wearing thin. “Regulatory changes complicate the job, both for us and for investors,” says Carlo Pellerani, group treasurer at UBS. “Not having absolute clarity affects the situation, but because there is so much liquidity in the market this hasn’t been as damaging as it could have been. It is our hope that there will be regulatory clarity before this liquidity dries up.”
The market volatility of 2015 makes such hopes increasingly remote. The extent to which this volatility barely makes it onto the radar of many treasury teams’ principal concerns is, however, quite striking.
“I am more concerned about – and spend much more time on – regulation than I am about market volatility,” says one US commercial bank treasurer. “In the time that I have been in this role there has been a massive shift in focus to regulation. It has been all regulation, all of the time.”
It is of little surprise that the strain is starting to show. “People are doing their jobs and then on top of that they are dealing with regulation,” he says. “There is therefore a big focus on keeping people motivated and keeping them energised. People can get discouraged and run out of gas.”
Having spent the years since 2008 focusing on building up their capital buffers, banks are now faced with the dual headache of leverage rules and looming Total Loss-Absorbing Capacity (TLAC) requirements, never mind further potential Basel IV changes in treatment to risk-weighted assets.
In the US, the results of the Federal Reserve’s recent Comprehensive Capital Analysis and Review (CCAR) released in March this year show that the average common equity capital ratio of the 31 bank holding companies reviewed has risen from 5.5% in 2009 to 12.5% at the end of last year. That is an increase of more than $641 billion, which brings aggregate common equity capital at the banks to $1.1 trillion.
But the job of raising capital is far from complete.
In November this year the final TLAC rules are due to be announced at the G20 meeting, with the aim of ensuring that there is sufficient firepower available to resolve every globally significant banking entity from 2019 onwards. Loss absorption will be in the form of internal TLAC, which is subscribed by entities within the group, and external TLAC, which is sold to investors. Treasurers need to be involved in both efficiently allocating the former and opportunistically tapping appetite for the latter. The problem is that the rules governing both are far from set in stone.
“The challenge is that as soon as you have climbed one regulatory hill then the next one is already looming,” says Rogier Everwijn, head of capital and secured products, treasury at Rabobank Group.
This presents bank treasury teams with a perennial dilemma: try to get ahead of the regulators and anticipate change, or err on the side of safety and take a wait-and-see approach, which could see you lagging your peers when regulations are eventually finalized.
Both seem fraught with pitfalls. The best-laid plans of any bank treasury team may be sent back to the drawing board with each new utterance from the regulator.
“In 2012 we formulated our capital structure in anticipation of bail-in regulations,” says Everwijn. “We thought that bail-in could be a threat to our funding and banking model. We wanted to operate at high capital ratios and minimal 20% to protect bondholders.”
The Dutch bank has been at the forefront of innovation in bank capital and first sold contingent capital bonds, or CoCos, in 2010. However, the threat of new rules meant that the 2012 plans had to be revisited.
“Over the last year we have reformed the capital programme in reaction to TLAC and are now looking for mid-20% capital levels. We have doubled our capital base since 2009,” says Everwijn. According to Dealogic, Rabobank was one of the 10 most prolific global FIG issuers in the first half of this year, having issued $16.3 billion by July 21. It is far from one of the 10 biggest global banks.
UBS found itself caught in the crosshairs of regulatory inconsistency when it issued SFr9.5 billion ($9.7 billion) of tier-2 CoCos as part of its capital plan. These instruments are compliant with the Swiss systemically relevant bank leverage ratio but are not compliant for the BIS Basel III leverage ratio. The bank’s average Swiss SRB leverage ratio for the second half of 2015 was 5.4% (phase-in) and 4.7% (fully applied). But its BIS Basel III leverage ratio at June 30 this year was 4.3% (phase-in) and 3.6% (fully applied).
The Swiss National Bank has been demanding a tougher leverage ratio for Swiss global systematically important banks since 2013. In June this year it exhorted UBS and Credit Suisse to improve their leverage ratios – indicating a 5% target. The SNB is understood to be considering aligning the SRB leverage ratio with the Basel III leverage ratio, which will leave UBS with a far greater distance to cover to make that target.
The Swiss banks are not alone in facing unforeseen capital and liquidity demands: in early August the ECB ruled that certain tier-2 instruments issued by Dutch bank ABN Amro should be excluded from its total capital calculation. The move follows a Dutch court ruling stemming from the nationalization of lender SNS Reaal in 2013.
The ECB decided that the Dutch ruling enhanced the ranking of claims by tier-2 creditors, so these instruments are no longer compliant with CRD. It reduces ABN Amro’s total capital ratio of 20.2% (fully loaded 19.5%) in the first quarter of this year to 18.8% (fully loaded 16.2%).
Trying to second-guess developments can clearly be an expensive business: it is no surprise that ABN Amro announced its debut additional tier-1 issuance in September via Citi, Goldman Sachs, HSBC, Morgan Stanley and UBS.
In an environment where the regulators frequently seem to be unsure which way to go themselves, bank issuers are often put in an impossible position. They have to issue something, and the decision about what is best for the bank’s own capital structure becomes overtaken by what the regulators’ next move might be.
“There is always regulatory uncertainty around capital instruments,” says Everwijn. “There is obvious risk and you have to be very diligent in the way that you formulate your capital plan.”
There is only so much that any group treasury can do. “We try to always be on the safe side and make sure we make assumptions only with what we think is stabilized,” says Landon at SG. “We don’t try to anticipate what the regulators are thinking.”
For UBS and all Swiss banks, the proactive approach of Finma has forced them out of the gates ahead of many competitors.
“The Swiss regulator has wanted to lead the charge in bank regulation, which has contributed to our organization being ahead of the game in terms of restructuring and being compliant with the new rules,” says Pellerani. But he adds that: “When you are an early adopter you just want a clear and stable set of rules as we have seen with our tier-2 issuance.”
The Swiss bank started issuing AT1 in February this year. “The first thing we did was to organically accumulate common equity tier 1. We want to be the best-capitalized bank in our peer group – we are on 14.4% fully applied CET1,” Pellerani reveals. “Now we are trying to look ahead to address coming regulations early and decisively. We issued AT1 in February and July, and this will become a permanent feature in our regular funding plans. We will do more in the near future.”
For many banks, it is enough of a struggle just to keep on top of the regulatory proposals, let alone try to get ahead of them. It must feel like stumbling around a dark room searching for the light switch. But for the treasurers that Euromoney spoke to, that search has most definitely moved from a search for capital to a search for liquidity.
“Liquidity risk was on the back burner before and capital was a big deal until about three years ago,” says the head of group treasury at one US commercial bank. “Liquidity is now the focus from all regulators and within the bank.”
The finalization of the liquidity coverage ratio (LCR) requirements for G-Sibs in September last year means that meeting liquidity requirements is most treasurers’ number-one concern. Under the rules, banks must hold enough high-quality liquid assets to cover potential net outflows over 30 days, and they must be fully complied with by 2017.
“We bring in all parts of the firm that have the ability to influence our liquidity,” says David Wong, group treasurer at Credit Suisse. “There has been a dramatic increase in the time spent on this in the last 12 months. We need to know which transactions drive liquidity benefit and which take it away.” This is particularly important given the potential increase in leverage-ratio targets for the Swiss banks.
Until the rules are finalized, however, it remains a complicated judgement to make. “The toughest thing to deal with is the uncertainty around the required liquidity metrics, both globally and locally,” says Gina Orlins, head of long-term funding at Credit Suisse. “There are still rule interpretations that have to happen, rules that are not finalized and requirements that are several years out. And amidst this uncertainty, we still need to develop a sound funding plan.”
The cost of getting the liquidity guessing-game wrong could be material. “The financial impact of being inefficient in managing liquidity is severe,” warns one US treasurer. “We need to make sure that we are passing that cost to the businesses that require that liquidity. We need to make sure that they factor that into their decision-making – the liquidity requirements of the business. We have doubled our staffing on liquidity management in just the last year.”
Such concerns are the result of the now laser-like regulatory focus on bank resolution. The new resolution requirements are enshrined in Europe’s Bank Recovery and Resolution Directive (BRRD) and the Dodd-Frank Act in the US. Both embody the principle that no creditor should be worse off in resolution than they would be in insolvency. Bail-inable debt must account for at least 30% of the TLAC total and must be subordinated to excluded liabilities such as deposits.
“Our regulators are very focused on preparedness around resolution,” explains Celeste Mellet Brown, treasurer at Morgan Stanley. “From a treasury perspective, they are focused on broad capabilities and planning and liquidity stress testing. The regulators are very organized, and there has been a constant dialogue with them on our resolution plan.”
For large global banks structured with multiple points of entry in resolution the risk of trapped capital is a constant concern, and one that the treasury function is increasingly being drawn into.
“Each location has an incentive to stockpile locally,” points out the treasurer at one such institution headquartered in the US. “This is not in the interests of everyone. You can only mitigate trapped capital and trapped liquidity to a certain extent. The emphasis around structure – whether the entity is subsidy or a branch – puts the onus on us, and we are very much involved in making these decisions.”
Each global bank has a ‘regulatory college’ that liaises with the key regulators that oversee the different parts of the business to determine how much capital is needed and where. “We continuously make the point at college that we need to coordinate,” the treasurer continues. “We need enough for local markets but we need to be efficient. We are in the early innings of the TLAC game, but you can see the fear: there is the risk that it could be a high capital requirement. Discussions are ongoing at college – they are getting it.”
Mindful of the fate of all that potentially leverage ratio-ineligible tier-2 issuance, any treasurer’s funding plan needs to take into account whether or not there are other costly instruments out there that could be redundant for TLAC and leverage ratio purposes.
A likely point of contention for US banks is the treatment of structured notes. Most large banks have big structured notes businesses, which form an important part of their institutional and retail activities: it is estimated to be a $6 trillion business globally. Structured notes can be principal-protected or not, but the initial TLAC proposals banned such instruments from counting towards capital due to the difficulty in accurately decoupling them from their derivative exposure.
In June this year there were rumours that the Financial Stability Board might be weakening its objections and was exploring the option of allowing structured notes to the extent that the repayment of the principal at maturity would be unconditional and not contingent on any derivative-linked feature. However, a leaked FSB paper dated August 24 indicated that there was strong agreement at the FSB that structured notes should remain excluded liabilities for TLAC purposes.
“The US regulators are far more open to structured notes than the FSB, and this is a large open spot,” says one US bank treasurer. “Structured notes could be ruled ineligible, and there is nothing I can do to mitigate this. If they are, the entire debt stack would be ineligible. But I am not going to go out and issue preemptively because of this.” It is, therefore, a waiting game until November.
For Orlins at Credit Suisse, an adverse decision would not be too problematic, however. “There may be some capacity for TLAC to include principal-protected structured notes, but even if it doesn’t we still see structured notes as a useful tool to manage the diversification of our funding,” she says.
G-Sibs are positioning themselves for the new guidelines and the task of meeting the 30% bail-inable debt target. Banks with holding companies, of which there are many in the US and the UK, can achieve structural subordination by issuing bail-inable debt at the holding-company level. Others will issue contractually subordinated, or tier-3, debt for which some regulators are already laying the groundwork. In Spain a draft law was introduced in May to enable banks to issue senior subordinated tier-3 notes that will rank ahead of pre-existing tier-2 notes in resolution. In Germany and Italy subordination will be achieved by statute: in March the German government released a draft proposal that all existing German bank senior debt would be subordinated to other senior liabilities in insolvency.
This was a gift to German bank treasurers, who would immediately find themselves TLAC-compliant. The draft proposal is viewed as highly political as it could be seen to be legislating in favour of one bank: Deutsche Bank. It would enable it to circumvent the massive liability management exercise that could see banks buying back non-TLAC compliant senior debt and re-issuing compliant – and more expensive – tier-3 senior subordinated debt in its place.
Italy has also put forward a similar legislative proposal that would elevate depositors above senior bondholders in resolution. The impact of these moves has been clear to see in the performance of senior bank debt in both markets.
After the German proposal was announced on March 10 Deutsche Bank’s 1.25% senior bonds due September 2021 moved swiftly from close to their highs of 103.4 on February 26 to trade at 101.5 little more than a week later. By mid-July they were trading at below 98. And when Commerzbank attempted to raise €750 million in September it had to scale the deal back to €500 million. Italy’s Banco Popolare similarly scaled back a €500 million three-year deal the same month.
There is no doubt that senior debt is more expensive to issue. “A lot of investors have taken where holdco banks trade as the proxy,” observes one European bank-funding specialist. “These banks are repricing to Barclays and Credit Suisse.” Both of those banks have issued holdco debt that has widened a lot as concern over bail-in implementation grows.
Keeping investors happy as they traverse the regulatory minefield is a top priority for treasury functions: every team that Euromoney spoke to for this article emphasised how much more time they spend talking to investors than they did before the crisis. Confusing and inconsistent proposals mean that holders can find themselves bumped down the creditor hierarchy and their bonds suddenly subject to savage repricing. Structural change at the institutions themselves also needs to be carefully transmitted to buyers of bank bonds – a process in which treasury plays a vital role.
“We have benefitted from our focus on debt investors and they have reacted positively to the Morgan Stanley story,” claims Brown. “There has been a fundamental change in the way debt investors perceive Morgan Stanley as a credit.”
Not everyone is so fortunate. Treasurers at banks with large liquidity needs are under pressure to deftly negotiate the current market volatility to satisfy their TLAC requirements. The most prolific issuer so far has been JPMorgan, with $25.7 billion from 46 deals by July 21. Credit Suisse raised $24.1 billion in the same period, and Goldman Sachs raised $23.1 billion from 101 deals.
But even among the largest issuers there is little room for complacency. “Markets can change on any given day and the windows are not big,” observes the group treasurer at one large US commercial bank issuer. “We have a 10-Q blackout, which reduces this further. But this is now business as usual and you have to be ready.”
Being ready now involves the ability to launch a transaction almost instantaneously. By implication this means boilerplate documentation: the luxury of crafting each deal to the environment in which it will be launched seems to be something that banks are prepared to sacrifice in exchange for certainty of execution.
“Our willingness and conviction is pretty strong that if we don’t want to lose investors, standardization is a key element,” says SG’s Landon. “We try to be very flexible and opportunistic in finding the right funding windows. The market has been shaky, so we try to have documentation ready to go so that if we find windows, we are ready to go. If you are organized, this is something you can deal with.”
The extent to which many bank treasurers took advantage of market conditions at the beginning of this year to front-load their programmes is a clear indication of how they now have to grab funding when the opportunity arises.
Deutsche Bank, whose rating was cut to triple-B by Standard & Poor’s in June, is more exposed than many to market turmoil, operating as it now does on the cusp of non-investment grade. The bank had issued $11.25 billion by late July, according to Dealogic, and plans to raise up to $35 billion in total for the year.
“Volatility in the capital markets is obviously a concern, but generally a manageable one,” Jonathan Blake, global head of debt issuance at Deutsche Bank tells Euromoney. “Our funding plan is €30 billion to €35 billion, but only a relatively small proportion of that comes from public benchmark issuance. Private placements and retail-targeted funding account for between €20 billion and €25 billion of that total.”
Credit Suisse is another FIG borrower that moved quickly to fill its coffers at the beginning of this year. “The first two quarters of this year were very different – the second quarter really brought home the Greek situation, so there has been a delay in issuance since the end of May,” explains Sandeep Agarwal, co-head of the global markets solutions group at Credit Suisse. “We front-loaded our funding programme in good size, and more than 50% of it has been funded,” he told Euromoney in August.
The lumpy nature of FIG issuance means that many treasury teams now look further afield to maximize the options available to them should conditions in core currencies be adverse.
“The market has been more volatile recently and we do look to a more diversified set of currencies to issue,” says Orlins. “Of our $35 billion funding plan for the year roughly $6 billion will come from smaller currencies. Pre-crisis we were maybe issuing between $1 billion to $2 billion in non-US currencies, so there has been a meaningful change. We recently closed a $1 billion samurai trade just one week after the Greek referendum.”
However, non-core currency trades are a lot more time-consuming and there is likely a limit to how far diversification will go at some borrowers. “There are longer lead times, depending which market you are looking at,” says the treasurer at a US bank. “We are looking at doing something in Japan but there is only about one week per quarter that you can issue in that market,” he grumbles.
Others see this as just the cost of doing business in the new, unpredictable funding environment. “We have a significant programme of subordinated debt, so it is important to reach the largest investor base for this,” says Landon. “This is important in terms of security on our side even if it comes at a slight price. If you are more present in several markets, you can reach a deeper source of investors.”
The ability to move quickly and fund in a range of currencies should arm bank treasurers against most of the unpredictability that the market can throw at them. But the less they have to issue, the happier they will be. UBS has issued $18.89 billion so far this year, a far cry from the volumes of funding it used to source in the FIG markets.
“The strategic repositioning of UBS has had a big influence on issuance,” Pellerani explains. “We have moved from a very balance-sheet-intensive business model to a leaner, much more focused bank, and this has had a big impact on the quantum of funding required. When we restructured we found ourselves with surplus funding, so we have not been large issuers in the past couple of years in order to rebase ourselves.”
Another bank that has seen its funding requirement shrink is Rabobank, which has benefitted from investor concerns over other lower-rated European lenders. “Liquidity has been less of an issue for us as we are seen as a safe haven,” says Robbert Muller, global head of funding, treasury. “Our programme is now far smaller than it was between 2009 and 2011, and there is less execution risk. We are targeting €20 billion of long-term funding this year.”
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There has been a dramatic increase in the time spent on liquidity in the last 12 months. We need to know which transactions drive liquidity benefit and which take it away David Wong, |
For others it makes sense to move early on those rules that you know are set in stone. “The perspective of banks in Switzerland has been early implementation,” agrees Wong at Credit Suisse. “Credit Suisse has its holding company in place, and for us to implement TLAC, the path would be relatively clear. We have taken a market-leading approach and have already funded over $10 billion of holding company debt that will be TLAC-eligible.”
The regulatory challenge that all banks face has forced their treasury teams to adopt a much larger and proactive role in the running of the bank.
“The job of treasurer has changed completely since the crisis,” says Pellerani. “The treasurer used to be in the background making sure that there were sufficient and appropriately priced financial resources for the bank, but it was a second-order effect. Now the job is strategic and you have to be very smart about financial-resource management as this can be a competitive differentiator for the bank.”
Treasury is now not only a far more important function in the bank than it was pre-crisis; it is also far more interconnected with the rest of the organization. Not only is it integrally involved in advising on the liquidity implications of many of the bank’s own activities, the treasury team is also responsible for managing far larger liquidity buffers within its own mandate.
“We haven’t increased our headcount on managing the liquidity pool, but there are a lot more connections in managing assets brought in as a result of business as usual,” says one US-based treasury executive. “We make sure that the secured funding teams are always looking at the assets that they have, and that rather than funding them short term they fund them longer term to satisfy our liquidity metrics.”
But in many other institutions this has necessitated growing the treasury team. “Liquidity is a driver of the increase in treasury headcount,” confirms Wong. “There has been an increase in the number of individuals focused on liquidity planning and forecasting.”
The demands of TLAC and its European equivalent, MREL (minimum requirement of own funds and eligible liabilities) have often necessitated the establishment of entirely new teams within treasury – at no small cost. “Treasury headcount is growing, and we have a whole team dedicated to resolution,” says Brown at Morgan Stanley. “We are investing heavily in technology, and will leverage this investment as a foundation for application elsewhere.”
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“The biggest worry for us at the moment is the discussion around Basel IV and risk-weighted assets,” says Rabobank’s Everwijn. “This is another climb up the hill, and we can’t predict what the outcome will be. It is not a fair assessment of the underlying risk on the balance sheet and could have very serious consequences for capital.”Even as banks staff up, not only to best equip themselves to deal with new regulation but also to lobby the regulators before its finalization, the establishment of stable capital and liquidity requirements looks further away than ever.
As long as the markets remain liquid and receptive to bank paper, the implications of the never-ending regulatory demands for capital and liquidity will be relatively manageable for treasury teams at most of the big banks.
But even with TLAC due to be finalized in November, there is no end in sight for regulatory flux.
“We want clarity of regulation and we don’t always have it,” says Pellerani. “We are still in the middle of reviews to leverage rules and at the beginning of the introduction of TLAC requirements. Until we know which way these things go, it will continue to be challenging for issuers and investors.”
