Context:Regulatory changes are on-going and Pillar 2 Requirement that for European Banks must be met only with equity (i.e. CET1), will going forward be met with CET1, AT1 cocos and Tier 2. While this creates a on-off capital relief for European banks of ca. 90bps, this doesn’t change the trend of more capital and further de-levering, which is very supportive for subordinated debt holders.
Impact for the fund:No impact as this would be more an equity story
If related to Pillar 2 Requirement (P2R): Yes, this creates a capital relief Andrea Enria of the ECB Banking Supervision or SSM has been very clear on that:
“When considering the impact of Basel III, we should also consider recent legislative changes that will lead to more lenient requirements. For instance, the Capital Requirements Directive V contains new rules on the quality of capital for Pillar 2 requirements, which will impose a change in the policy the ECB has pursued until now – that of focusing only on Common Equity Tier 1, or CET1 for short. When this change was being negotiated, ECB Banking Supervision and the European Parliament voiced their concern about this change, warning that high quality capital was essential. According to our calculations, the change will generate an average reduction in CET1 requirements of 90 basis points, as banks will be able to rely on lower quality additional Tier 1 and Tier 2 capital, which is now available at favourable conditions.”
What is the SSM saying: Pillar 2 Requirement (P2R) that until now had to bet met only with equity or CET1 can, with the upcoming redefinition of P2R under Capital Requirement Directive 5 (CRD5), be met with a split of equity and sub-debt i.e. 56% CET1, 19% AT1 and 25% T2. This will create a capital easing of ca. 90bps or ca. EUR 30-40bn.
Timing should be around JAN22, earliest.
Looking at the bigger picture: this is not really an easing. Namely, implementation of revised-Basel III (so-called Basel IV) should start to kick in in 2022 too, which will lead to a gradual increase in risk-weighted-assets, offsetting this one off and up-front boost in excess capital. Another element to take into account is that banks will not be able to double count their CET1 between P2R and P2G (Pillar 2 Guidance).
If so, what is the potential implication for AT1/ T2 performance, and in turn, their fund performance
This is more an equity story (on margin positive) and is neutral for bond holders. We expect the performance of the fund to be strong, independent of impact of the revision of P2R, as indicated by our base case of +9% for the year. Additional info can be found in the Jan Spotlight that will be attached to the monthly comment