european additional tier 1 coco bonds market

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    European Additional Tier 1 "CoCo" Bonds 2014-2015

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    Issuance by Allied Irish Banks of EUR500m of Additional Tier 1 Securities was a notable development for this type of capital security in the European market.

    2015 has been the second busiest ever for this market (after a record year in 2014). Additional Tier 1 securities can count as regulatory equity capital and hence permit banks to meet capital targets.

    Whereas the general trend has been for more AT1 instruments to achieve higher ratings in the investment grade category, the AIB bond was notable for its 4x over-subscription despite a B- rating.

    The regulatory framework is becoming clearer at the national level in most jurisdictions as well as at EU level. Banks capacity and willingness to issue AT1 securities seems clear so further heavy issuance can be expected over the next few years.

    Banks in the UK, Switzerland, Spain, Italy, France, the Nordics and most recently the Netherlands have all issued significant levels of AT1 securities. Two law firms, Linklaters and Allen & Overy have dominated this market, with approximately 50% of all instructions during 2014 and 2015.

    Additional Tier 1 CoCo Bonds A Fast-Developing Asset Class

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    Following the financial crisis, regulators sought to create capital buffers for any future crisis with a view to limiting the potential for any state or EU institutional support.

    Higher capital requirements implied significant capital raising, asset sales and/or de-risking by banks. One of the solutions has been the development of Additional Tier 1 securities, sometimes referred to as coco bonds.

    Since Lloyds Bank exchange offer in 2009, almost every European banking institution has raised capital via AT1 instruments.

    As the market develops, greater investor acceptance and understanding of the risks has gone alongside regulatory clarification.

    As higher rated institutions have issued CoCo bonds, the average rating for the bonds has also increased, with 50% of bonds now investment grade, according to Fitch Ratings.

    Additional Tier 1 CoCo Bonds Systemically Important for European Banks

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    Additional Tier 1 Securities

    Trigger Loss Absorption Mechanism

    Write-Down Conversion Discretionary Mechanical

    Book-Value Market-Value

    Mechanical Trigger Levels are driven by regulatory requirements.

    Market-Value Triggers have not been used to date. Discretionary Triggers such as a

    regulators call of point of non-viability present challenges for investors.

    Loss Absorption Mechanism is driven by investor choice some fixed income investors are not able to invest in even contingent equity hence preferring the write-down model which appears to entail greater loss severity.

    Additional Tier 1 CoCo Bonds Defining Triggers and Loss Absorption Features

  • In a paper written in June 2014*, Scope Ratings explored some of the major credit issues investors in AT1 need to be aware of relative to securities more senior in the capital structure: The structure of contingent convertible securities, of which AT1 capital instruments are the major component, is shaped by their primary purpose as a readily available source of bank capital in times of crisis.1 Specifically, they aim to provide a private-sector alternative for recapitalizing financial institutions, aside from the issuance of new equity which can at times be less appealing due to dilution effects. We note that the regulatory framework (CRD4-CRR) behind their structure aims primarily to minimize systemic risk and provide depositor protection, rather than to increase their market appeal. Based on the specific features of AT1 capital instruments, we see four key risks for investors two related to coupon payments (distributions) and two related to principal writedown or conversion: Coupon cancellation risks: The issuer does not make distributions as it has full discretion not to do so. In general, we do not believe that financially viable issuers would exercise this discretion lightly as the reputational risk could be significant and future market access could be materially harmed. The issuer is restricted in making distributions as it has breached its combined buffer requirement. Principal loss absorption risks: The instruments are written down or converted as the relevant CET1 ratio has breached the trigger level. The instruments are written down or converted as relevant authorities have determined that the issuer has reached the PONV i.e. the point when the issuer meets the conditions for resolution or the authorities decide that the issuer ceases to be viable if the capital instruments are not written down or converted.


    *AT1 Capital Instruments Background and Key Risks for Investors, June 2014

    Additional Tier 1 CoCo Bonds Investors Caveat Emptor

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    Pauline Lambert Director, Financial Institutions, Scope Ratings DealFolio: How has the market for AT1s been developing recently? Pauline Lambert: 2014 and 2015 were very busy years in the Additional Tier 1 issuance market. European issuance (according to figures from Bloomberg) was around EUR85bn in 2014 and EUR45bn to November 2015. The 2015 issuance had a strong Dutch flavour as institutions there received the regulatory clarification to move forward with issuance. DealFolio: Is the trend likely to continue? Pauline Lambert: With Pillar 2 requirements, it is likely that institutions would have the capacity and willingness to issue further AT1 securities. DealFolio: Are we seeing standardisation in deal structures? Pauline Lambert: The trigger levels in each jurisdiction may be driven by the local regulator. This has driven specific deal structures. For example, the UK regulator has questioned whether the minimum 5.125% trigger would be effective which has led to UK banks issuing with a 7% trigger. Investor appetite has influenced the choice between the conversion-to-equity model and the write-down model, with some investors unable to invest in the conversion model due to restrictions in their mandate. DealFolio: What is your view on documentary trends in terms of certainty for investors? Pauline Lambert: In terms of the language regarding triggers, the language is pretty clear, particularly as the triggers are activated mechanically. The uncertainty arises to the extent there could be a conversion before hitting the trigger or a cancellation of coupon payments as a result of regulatory discretion. The terms and conditions as well as risk factors included in the prospectuses of the securities highlight these risks for investors.. For example, in transactions issued by UK banks, the consent to UK bail-in powers is explicitly specified. As regulations have evolved and been adopted, the language and documentation has become clearer.

    Additional Tier 1 CoCo Bonds A Credit Analysts View on Market Developments


    Conversion Loss Absorption Write-Down Loss Absorption Banco Popular Linklaters (I), Allen & Overy (M) ABN AMRO Allen & Overy, Clifford Chance

    Banco Santander Slaughter and May (I), Linklaters (M) BNP Paribas Allen & Overy, Cleary Gottlieb

    Barclays Bank Clifford Chance (I), Linklaters (M) Credit Agricole Cleary Gottlieb (I), Davis Polk (M)

    BBVA Allen & Overy (I), Linklaters (M) Danske Bank Allen & Overy (M), Gorrissen Federspiel (M)

    Coventry Building Society Allen & Overy (I), Linklaters (M) Deutsche Bank Cleary Gottlieb (I), Davis Polk (M), Freshfields (M)

    HSBC Bank Clifford Chance (I), Allen & Overy (M) DNB Clifford Chance (I), Allen & Overy (M)

    ING Linklaters (I), Davis Polk (M) KBC Bank Allen & Overy (M), Linklaters (I)

    Lloyds Bank Linklaters (I) Intesa Sanpaolo White & Case (I)

    Nationwide Building Society Allen & Overy (I), Linklaters (M) Nordea Bank Clifford Chance (I), Linklaters (M)

    RBS Linklaters (I), Shearman & Sterling (M) Nykredit Allen & Overy M), Gorrissen Federspiel (M)

    Standard Chartered Slaughter and May (I) Rabobank Linklaters (M)

    Swedbank Gernandt (I), Wistrand (M), Allen & Overy (M), Clifford Chance (I)

    Santander UK Allen & Overy (M), Slaughter and May (I)

    Societe Generale Davis Polk (M)

    UniCredit Allen & Overy (I), Clifford Chance (M)

    Varengold Bank Allen & Overy (I)


    Additional Tier 1 CoCo Bonds Issuers and Legal Advisers

    I = Issuer Counsel, M = Managers/Underwriters Counsel

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    Additional Tier 1 CoCo Bonds Overall Advisers 2014-2015

    Allen & Overy 27%

    Linklaters 24% Clifford Chance


    Davis Polk 11%

    Cleary GoClieb 8%

    W&C 4%

    Slaughter and May


    Gorrissen 4%

    Gernandt 2%

    Freshfields Bruckhaus Deringer


    Allen & Overy and Linklaters have dominated the AT1 market in the last two years, with over 50% of instructions in the European market. AT1 instruments are usually issued out of established MTN programmes and essentially follow senior unsecured bond documentation. The key documentary differences are the subordination, definition of triggers and loss absorption mechanisms and ensuring adequate disclosure to investors regarding potential losses arising from regulatory action as well as mechanical trigger breach.

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    Linklaters 35%

    Allen & Overy 23%

    Clifford Chance 15%

    Slaughter and May