Assurances by the regulators in Singapore and Hong Kong that they would abide by the usual hierarchy of claims in possible bank liquidations should help address concerns after the wipeout of CHF15.8 billion of Credit Suisse Group AG's additional Tier 1 capital instruments rattled bond investors.
The Hong Kong Monetary Authority and Monetary Authority of Singapore said in separate statements March 22 that equity holders in banks would absorb any losses before the holders of additional Tier 1 and Tier 2 capital instruments if any lenders in their jurisdictions face liquidation.
"This should reassure investors in [additional Tier 1 capital instruments] issued by Singaporean and Hong Kong banks, allowing [additional Tier 1 capital instruments] to remain a viable instrument type in these jurisdictions," Michael Makdad, senior equity analyst at Morningstar told S&P Global Market Intelligence via email.
The Swiss government, central bank and financial regulator wrote off all CHF15.8 billion of Credit Suisse's additional Tier 1 capital instruments — debt which is converted to equity, or bailed in, if a bank gets into trouble — as downside protection for UBS Group AG, which agreed to acquire its smaller peer in an emergency CHF3 billion deal. The move rattled investors in such bonds and required regulators in the UK and eurozone to reiterate that additional Tier 1 bonds rank ahead of common equity in lenders' capital structure.
Surprise decision
The Swiss decision, though allowed under the terms under which Credit Suisse's additional Tier 1 bonds were sold, was seen as unusual by the bond markets.
"The decision clearly does not respect a bank's hierarchy of claims and, at least from an investor perspective, calls into question the viability of [additional Tier 1 capital instruments] as an asset class," Nomura said in a March 20 note.
Nomura said it expects most Asian authorities to adopt a more bondholder-friendly approach if a similar situation arises in Asia.
Additional Tier 1 capital instruments as an asset class will likely have to price in a higher risk premium compared to before, Nomura said in the note, adding that the Credit Suisse fallout provides investors with a good opportunity to pick up additional Tier 1 capital instruments from good quality Asian banks on the cheap after the dust settles.
Clarifications
The Monetary Authority of Singapore provided reassurance that creditors who receive less in a resolution compared to what they would have received had the financial institution been liquidated can claim the difference from a resolution fund. The compensation framework will also apply even if the regulator does not follow the creditor hierarchy for any reason, it said.
Hong Kong reiterated that holders of capital instruments, including core equity capital, additional Tier 1 capital and Tier 2 capital, issued by a financial institution should expect to be treated in resolution in accordance with the priority they would enjoy on the winding up of the institution.
The clarifications by the regulators in two of the biggest financial centers in Asia were to soothe turmoil in the bond market, Takahide Kiuchi, executive economist at Tokyo-based Nomura Research Institute, the economic research and consulting unit of Nomura Holdings, told Market Intelligence.
"They also tried to prevent banks from stopping an issue of [additional Tier 1] bonds," Kiuchi said, adding that the risk of bank failures in the region remains low as central banks in China and Japan, the two biggest Asian economies, have no intention to raise rates soon.
