August 4, 2014 / 12:21 PM / in 3 years

An opportunity missed

LONDON, Aug 4 (IFR) - By leaving Banco Espirito Santo’s senior debt intact, the Portuguese authorities have missed out on a golden opportunity to finally make a stand for Europe and show that senior debt is not sacrosanct.

After the Portuguese lender unveiled a bigger-than-expected EUR3.6bn loss last week, speculation was rife as to what plan the central bank would come up with and who would get swept up in a resolution.

But while senior prices dropped, they never collapsed, and it turns out that senior debtholders were right to hold their nerve.

The central bank’s decision to split BES into a good and a bad bank and place the senior debt in the newly created Novo Banco flies in the face of everything the global and European authorities have been trying to achieve since the collapse of Lehman Brothers in 2008.

The case for leaving senior in the bad bank is easy to make. First, the rules that will enshrine bail-in of senior debt in the European framework are a less than two years away from being implemented, and in some cases just a few months away. The UK and Germany are accelerating the timeline for implementation to January 2015 instead of January 2016.

Regardless of this, European authorities have shown time and time again that, when needed, they can pass emergency legislation allowing them to haircut debtholders.

You only have to look back at the Netherlands and Cyprus for the most recent examples when authorities were able make something happen when they want to. And take a look at Austria and the fact that the legislator is a few steps away from retroactively removing government guarantees on subordinated debt.

Second, bail-in has increasingly become less of a taboo. Again, there are enough examples that show investors now accept that this is the new world in which they live. Previous cases of banks being shut out of the market because an event of bail-in has occurred are no more: again, see what has happened in the Netherlands and the fact that Dutch banks have been able to raise sub debt post-SNS.

Third, while it was understandable during the height of the sovereign crisis that authorities would be reluctant to haircut bondholders for fear of contagion, it has been quite clear that the market views BES’s situation as idiosyncratic. The market is solid enough that it can withstand these shocks and ECB president Mario Draghi is still happy to do “whatever it takes”.

The Portuguese authorities used pretty much every single tool available under the EU bank resolution and recovery directive: sale of business, a bridge bank and asset separation.

It seems incredible that they would stop short of the bail-in tool. Keeping senior in the bad bank would have provided much needed capital while the institution was being wound down and shown that the EU authorities mean business when they say they want to end too big to fail.

Instead, senior debtholders across the continent will be rubbing their hands, secure in their belief that no one, for now, is willing to be the first mover. (Reporting by Helene Durand; Editing by Philip Wright, Luzette Strauss)

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