Resolution paper prompts UK HoldCo debt debate
LONDON, Dec 11 (IFR) - A joint Bank of England and FDIC paper on the resolution of global systemically important financial institutions could potentially trigger a major structural shift in how UK banks fund, market participants said this week.
The report published on Monday focuses on "top-down" resolution of large banks, which involves "a single resolution authority applying its powers to the top of a financial group" and raised the prospect of UK banks issuing more senior debt out of their holding companies rather than their operating companies.
As things stand, regulators' efforts to resolve a large UK bank could be hampered because, unlike their US counterparts, UK banks have traditionally raised the vast majority of their debt at the operating company rather than the holding company level.
While the consultation paper stops short of prescribing a shift in funding strategy for UK banks, it does note that either this will have to occur or UK supervisors may have to bail-in bonds of the top operating companies within the group.
The regulators acknowledged this latter route could complicate resolution and would need "careful planning", adding that UK authorities would make up their minds on what to do in due course.
"Given these comments, you could potentially see more issuance coming out of UK bank holding companies," said David Hague, head of UK and Ireland FIG DCM at RBS.
"The US dollar market is the natural choice for this kind of issuance because the investor base is much more familiar with holding company issuers."
There have already been rumblings about a shift to bank holding company funding models due to the Independent Banking Commission's recommendations - more commonly known as the Vickers report - to ringfence retail from investment banking.
"There's been a renewed focus on HoldCo debt since the Vickers proposals were published, although it's still premature for UK banks as they aren't set to kick in until 2019," said Alex MacMahon, head of EMEA FIG DCM at Citigroup.
"The cost of issuing HoldCo has traditionally held banks back. In the US the concept of HoldCo vs OpCo is well established, while the European market isn't used to it."
HoldCo debt has traditionally traded at a premium to OpCo debt as a result, although bankers noted the spread had narrowed over the last year from around 75bp to 25bp.
The HoldCo structure is very much a US-centric philosophy: 84% of commercial banks operate under such a model, said MacMahon.
A treasurer at a major UK bank characterised a potential move towards a HoldCo structure for European banks as a major structural change. Some market observers believe this is already happening.
"We think that regulators in Europe are beginning to adopt this view [that a HoldCo structure would facilitate the resolution of banks] and although holding companies are not common in European banking outside the UK, they will become so over the next few years," said CreditSights analysts at their Euro Banks 2013 Outlook on December 5, citing initiatives such as the Vickers Report, the Liikanen Committee and bail-in debt as catalysts.
The CreditSights analysts even singled out an RBS USD2bn three-year deal issue out of its holding company back in September as typical of the structural shift that will become "a more prominent feature of the European banking landscape."
RBS also issued a USD2.5bn Lower Tier 2 bond out of its holding company. Officials at the bank noted issuing out of the HoldCo gave it greater flexibility and capital efficiency given CRD4 rules on regulatory haircuts.
Both issues show the dollar market is the go-to jurisdiction for issuing HoldCo debt due to investors' familiarity with this type of issuer, giving banks all the accompanying benefits in terms of size, pricing and secondary market liquidity.
"It's clear from the RBS issue that there is appetite for HoldCo debt, and our best estimate is that the pick up over OpCo debt is currently pretty minimal," said Roger Doig, fixed income analyst at Schroders.
"Once banks look at regulatory requirements and the need to be able to move capital between group entities, they may decide it's a useful funding route."
Indeed, the increased flexibility that funding at the HoldCo level affords - in terms of being able to shift cash between different operating entities with greater ease - may also prove a draw to the HoldCo model for European institutions.
"Bank funding was very prevalent pre-crisis but more recently, most US banks have been issuing at the HoldCo level just given increased flexibility for use of proceeds and huge deposit balances at the bank level that are the primary funding source there," said Citi's MacMahon. (Reporting By Christopher Whittall, Editing by Helene Durand and Julian Baker)