ABI RESPONSE TO THE EUROPEAN COMMISSION DISCUSSION PAPER ON THE DEBT WRITE DOWN TOOL BAIL IN INTRODUCTION The Association of British Insurers (ABI) welcomes the opportunity to comment on the Discussion Paper. The ABI represents the UK s insurance, investment and long-term savings industry, the largest in Europe and the third largest in the world. It has over 300 members, accounting for some 90% of premiums in the UK domestic market. As institutional investors ABI members have some 1.7 trillion of assets under management of which approximately 50% fall within fixed income asset classes. They also manage considerable sums on behalf of the third party clients. 1. GENERAL COMMENTS ABI members, as institutional investors, have interests in all parts of banks capital and funding structures. These differing interests are likely, from time to time, to be in conflict. Bail in increases the capacity for conflict by blurring the distinction between debt and equity. Institutional investors are driven by the mandates from their clients, in the case of ABI members both internal insurance funds as well as external third party clients. The Discussion Paper, by its nature, gives insufficient details and clarity as to eventual outcomes for institutional investors for ABI to be able to express a single view. Opinion among ABI portfolio managers is divided as to the value of bail in as a resolution tool. However, they accept that regulators have decided that it will be part of their toolkit. In such circumstance ABI is concerned that bail in should be introduced in a way that limits any negative and unintended consequences. Key to this is that certain principles should be adhered to in the design and implementation of bail in and regulator discretion precisely defined so that the market can efficiently price bail in instruments when they are issued and traded. The guiding principles are; Clarity so as to give the markets full transparency; Certainty so as to give the markets predictability; and Respect for the hierarchy of capital ABI recognizes that there will be tension between adherence to these principles and the flexibility that regulators will desire to deal with specific situations. We also recognize the tension between adherence to these Page 1
principles and practical implementation given the complex structure of markets and banking activities. We note for example the response of the City of London Law Society to the Discussion Paper and the comments by the UK Financial Markets Law Committee (issue 167 Bail-in, March 2012), in respect of UK developments, that legal certainty is best achieved by implementation of narrow policy objectives by tightly defined statutory or regulatory powers. 2. SPECIFIC COMMENTS In respect of the Discussion Paper we would make the following points from the institutional investor viewpoint. Question 1 All resolution tools should be available at the point of entry into resolution. Those ABI bond portfolio managers who favour bail in see it being enforced at the point of non-viability so as to minimize the danger of transfer of value to other stakeholders. We note that the text of the Discussion Paper gives rise to the impression that regulators would also wish to have the flexibility to apply bail in as a recovery tool. The Commission s paper does not touch on the triggers to activate bailin. We believe that these should be rooted in capital adequacy and solvency, and that the framework should be closely aligned with the Basel III rules. Question 2 Notwithstanding our concern that bail in is applied at the point of non viability, the debt write-down tool works in principle in both an open bank and a closed bank scenario. The choice between the two will depend on the circumstances in each individual case, though it may contribute to market stability if the legislation sets out principles for the regulator to follow in making this choice. In all cases, the institution will need a source of fresh liquidity. The debt write-down tool recapitalises the institutions to a certain extent; it does not provide fresh liquidity. Question 3 In principle there should be no excluded liabilities. Narrowing the scope of liabilities increases the potential stress on bail in debt in issue and its characterisation as the equivalent of equity. However, for practical purposes, i.e. to ensure a smooth implementation of resolution and to maintain market confidence, we would agree that liabilities with original maturity shorter than the one month should be excluded. This should be coordinated with the implementation of Basel III LCR and NSFR so as to prevent large build-ups of very short-term (unsecured) debt. Page 2
Our current views (in the absence of detailed proposals) reflect concerns that multiple exclusions will lead to complex financial engineering particularly as a bank comes under stress. Question 4 In terms of the implementation of the write-down tool, we believe that the process should be kept as simple and transparent as possible. We therefore prefer Option 1, maintaining the hierarchy of capital, to the sequential approach in Option 2. Question 5 At present we have no views on the minimum requirement for eligible liabilities. However, we query the practicability of incorporating the market evaluation of a bank s securities into the regulator s assessment of the minimum requirement. Question 6 Some bond investors believe that there should be an absolute obligation to cancel the existing shares before bail in is implemented. Given the severe implications of bail in bond investors believe that, in circumstances where there is a haircut rather than conversion to equity, then such bailed-in debt should benefit from equity-like pay offs and, in certain circumstances, enfranchisement through voting rights. Equity investors are concerned about transfer of value particularly if bail in is used for recovery of an open bank and would expect to retain an interest. We have no fixed views as to the degree to which existing equity should be diluted in a recovery situation save that equity should be written down to nugatory value before bail in is subject to similar treatment. It is sensible to require that banks should maintain at all times sufficient authorized share capital to allow sufficient new shares or instruments of ownership to be created to enable conversion of liabilities. However, this provision appears to conflict with the apparent need to issue shares on a basis that is severely dilutive of existing shareholders. We emphasise that debt instruments that are issued that are potentially subject to bail in and equity conversion should be issued within the scope of appropriate authorities governing share capital issuance and disapplication of preemption rights. Question 7 Page 3
We have no views. Question 8 We agree that including a contractual recognition of the debt write-down tool would facilitate the enforcement of the debt write-down powers with respect to instruments issued under the laws of third countries. In order to mitigate the impact of the debt write-down tool, and to maintain investors confidence in the debt markets we believe that it is essential to maintain the sanctity of contract. There should be no retrospective changes to existing contractual arrangements. Question 9 The existence of the debt write-down tool will inevitably have an impact on EU banks access to debt funding. Ability to access the debt markets is a matter of market confidence, and there are other more significant factors than the bail in regime currently affecting the markets confidence in bank debt. The relationship between the resolution regime and banks access to the debt markets is inexact. Bail in existed de facto for a couple of years in the British market with no impact on banks funding plans. On the other hand, the debt markets closed to Danish banks very quickly after the Danish authorities bailed in Amaergabanken. This suggests that there is a difference in the markets eyes between the existence of the tool, and the authorities demonstrated willingness to use it. The closure of the bank senior unsecured debt markets since last summer probably has more to do with the risks of contagion from sovereign debt, but there is no doubt that the prospect of an EU level bail-in regime played its part. Logically sentiment in the market should not be affected, as resolution is better for creditors than insolvency. However, the signal to the markets that authorities themselves consider their banking institutions so frail as to require this tool is a very powerful one. There is also the real threat that nervous authorities will trigger this tool before the point of non-viability has been reached, effectively dispossessing bondholders and shareholders in order to ensure a smooth resolution. To ensure continued market confidence in bail in bank debt, the authorities need to meet the principles set out at the start of this paper. In particular, it should be entirely clear to the market when and how the authorities will intervene. Given the fragile state of the bank funding market, now dependent on LTRO, it would be wise to set the date of entry into force of the bail in tool some time in the future, well after the three years expiry date for the LTRO. There should be no impact on existing contracts. Page 4
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