In a quiet corner of the capital markets, a furious race has been taking place for the past two years. Teams of well-paid financial engineers have been striving to build the perfect tax-deductible tier-one capital security for European banks. Accusations of intellectual theft and skulduggery are quick to fly. And it's little wonder. A standardized, easy-to-use tier-one structure would be irresistible to bank treasurers looking to trim their cost of capital. The firm that makes a name for arranging these deals would be in line for a string of juicy mandates.
Most of the creations brought to market so far have been unwieldy. Tax-deductible tier-one capital has to look like equity as far as bank regulators are concerned but be sufficiently debt-like for interest payments to be tax-deductible. That usually requires a special-purpose vehicle incorporated in a tax haven. (For German banks, which have an exemption from the Basel rules, things are rather simpler, but that's another story.) In a typical tier-one deal the SPV issues preference shares and lends the proceeds to the parent bank.
The resulting creation flies, but only just. And that is why only a handful of European banks have issued hybrid tier-one securities since 1998, when new Basel guidelines opened the way for their use in all BIS countries.