EU bank write-down plan said to exclude forcing losses on pre-2013 debt

There are a number of issues that must be addressed to transition from the current model of governments' guarantee all investments in banks from solvency risk to a model where investors are responsible for bank solvency risk.

A Bloomberg article looked at a proposal by the European Union for how this might be accomplished.

Regular readers know that so long as financial regulators continue to perform and publish the results of stress tests, governments have a moral obligation to bailout investors for any solvency related losses.

The most recent example of this was Dexia Bank passing the European stress tests earlier this year and now having to be nationalized by the French and Belgium governments.

This blog has long said that the only way to make investors take on the responsibility for bank solvency risk is by requiring the banks to provide ultra transparency.  By disclosing each bank's current asset, liability and off-balance sheet exposure details, market participants can assess the risk of each bank.

With the ability to assess the risk of an investment in a bank comes the responsibility for accepting all gains and losses on that investment.

This blog has said that the way to manage the transition is for governments to continue to guarantee all investors from solvency risk until a bank has been providing market participants with ultra transparency for 6 months.

After this time, market participants will have been able to assess the risk of the bank and should be held responsible for all gains or losses.  This will apply to all new securities issued by the bank after the 6 month mark.

The European Union may exempt bank debt issued before 2013 from proposals forcing investors to take losses at failing lenders, said a person familiar with the plan.... Michel Barnier, the EU’s financial services chief, has promised to propose draft rules to end the need for taxpayer bailouts of failing banks. ... 

“From a funding point of view it brings two words to mind -- cliff effect,” Bob Penn, financial regulation partner at Allen & Overy LLP, said in a telephone interview in London today. 

“There’ll be swathes of bank-funding issuance and then it will fall off a cliff” when the so-called bail-in rules are implemented. 

Under draft proposals obtained by Bloomberg News, holders of long-term unsecured senior debt in a collapsing bank would be first in line to take losses once a lender’s capital and other subordinated debt is exhausted. Long-term bonds would be those with a maturity of more than one year....

Short-term debt, with a less than one-year maturity, and derivatives should only be written down by regulators as a last resort if losses from longer-term debt aren’t “sufficient to restore the capital of the institution and enable it to operate as a going concern,” according to the draft. 

“Exempting short-term debt and derivatives may be justifiable, but this would increase the use of systemically risky derivatives and excessive levels of short-term debt that contributed to the ongoing crisis,” said Sony Kapoor, managing director of policy advisory firm Re-Define. 

Taxing them “may help alleviate some of these distortions.” 

Regulators would also have the power to forcibly convert a bank’s bonds into ordinary shares, according to the draft. 

Authorities could intervene to impose losses if a bank was “likely, in the near future,” to breach its minimum required capital levels, or be unable to meet its obligations to creditors, according to the EU document. 

There is a “growing acceptance on the part of regulators” that the wind-down plans “have to be implemented in a way which does not overly conflict with the ability of financial institutions to refinance themselves in the near-term,” Richard Reid, research director for the International Centre for Financial Regulation, said in an e-mail.... 

Efforts amid the debt crisis to force investors to share in bailout costs have roiled markets and sparked disputes among policy makers. 

Last week, German Finance Minister Wolfgang Schaeuble suggested European governments may ease provisions in a planned permanent rescue fund requiring bondholders to share losses in sovereign bailouts. 

Other parts of the commission plans include giving regulators the power to force healthy banks to sell off parts of their business so that they could be wound up in a crisis. This process is known as bank “resolution.” 

“We need to put resolution regimes in place for every type of institution,” Paul Tucker, deputy governor of the Bank of England, told reporters at a Financial Policy Committee press conference in London today.... 

EU leaders last month agreed to offer their banks temporary guarantees on their debt issuance as part of a package of measures to restore confidence in lenders. 

Finance ministers agreed yesterday to coordinate the national guarantee programs, while rejecting proposals to pool them.