December 1, 2011 / 5:46 PM / 6 years ago

EU eyes losses for bank bondholders-document

4 Min Read

* New law could take effect from 2015 - EU draft

* Rules would allow losses for bondholders at struggling banks

* Banks fear such law would scare off debt investors

By John O'Donnell

BRUSSELS, Dec 1 (Reuters) - Owners of unsecured bonds issued by troubled banks could be forced to take losses from 2015, according to a draft European Commission proposal that would break the unwritten rule that debt is fully repaid unless the borrower goes bust.

The draft law outlines a framework to save a bank from collapse, giving supervisors extensive powers to temporarily take control and get the bank back on its feet, for example by ordering asset sales or restructuring its debt.

The proposal from the EU's executive is designed to prevent a repeat of the chaotic bank rescues in the 2008 financial crisis that cost governments billions and saddled them with bad loans that they have little immediate prospect of off-loading.

But the rules are controversial, chiefly because they raise the possibility of losses for investors in bank bonds. Secured bondholders are not subject to the rules.

The draft was due to be published in September but was kept under wraps for fear it would further rattle markets and compound the difficulties of EU banks already struggling to borrow.

An agreement that private owners of Greek sovereign debt must accept losses has been blamed for a drastic deterioration in the debt crisis and some fear a similar impact from provisions to have bank bondholders take losses.

Such concerns could result in a watering down of the proposal before it becomes law, which the undated document, written by officials at the EU's executive and seen by Reuters, said will take effect from 2015.

Lobbying by banks, worried the new rules could deter investors from buying their debt, has so far not succeeded in changing the thrust of the new law.

An EU official, speaking on condition of anonymity, said that while there may be changes to the proposal, it was still expected to underline the principle that bank bondholders, alongside shareholders, could be forced to accept losses.

"The principle that creditors will be bailed in remains," said the official.

Under Mattress

In the draft document, officials write: "The proposal extends the powers of supervisors to intervene at an early stage in cases where the financial situation or solvency of an institution is deteriorating.

"The debt writedown tool will give resolution authorities the power to write down the claims of unsecured creditors of a failing institution and to convert debt claims to equity.

"The tool can be used to recapitalise a failing institution, allowing authorities to restructure it."

The rules to save struggling banks also require emergency plans to be put in place.

While some bank bondholders suffered losses through the financial crisis, such as those that owned hybrid bonds exchanged at a discount into cash, they were spared the fate of shareholders, many of whom lost most of their investments.

Developments are being closely watched by banks, which oppose the idea because they fear it could make it harder for them to borrow.

"If you are an investor in banks through buying their debt, and it is possible that you can make a loss on that debt, then you are going to demand a higher price," said one banker.

"If you are prepared to take the risk, you will demand a premium. If you are risk averse, you will just stick your money under the mattress."

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