In recent years, European Union banks have increasingly turned to Additional Tier 1 (AT1) bonds to bolster their capital reserves in the aftermath of the global financial crisis. These high-risk debt instruments, also known as contingent convertibles or CoCos, are designed to convert into equity or be written off if a bank’s capital falls below a certain threshold. However, concerns have been raised by the European Banking Authority (EBA) regarding the valuation of these AT1 bonds and the potential inflation of their value by banks.
The EBA’s investigation into the issuance of AT1 bonds has revealed discrepancies between the “carrying” value of these bonds on banks’ balance sheets and their “nominal” value. This inconsistency could lead to a lack of clarity in regulatory reporting and increase the complexity of these financial instruments. As a result, the EBA has proposed new templates to standardize information and ensure a more accurate reflection of the true worth of AT1 bonds.
Implications for the Industry
The heightened scrutiny of AT1 bonds by regulators signals a growing focus on the level of capital banks hold in times of distress. Chris Woolard of EY predicts that the industry can anticipate further investigations in the near future, as investors and regulators seek greater standardization across the banking sector. Moody’s Simon Ainsworth emphasizes the importance of a standardized and conservative approach to valuing AT1 bonds, highlighting the benefits of enhanced transparency and reduced legal risk for investors.
The fallout from events such as Credit Suisse’s write-down of AT1 debt to zero has prompted regulators worldwide to reassess the use of these instruments in capital buffers. The Basel Committee of banking regulators has indicated a need to evaluate the complexity, transparency, and understanding of AT1 bonds in light of recent turmoil in the banking sector. While the European Central Bank has refrained from commenting, the push for a more uniform and stringent valuation of AT1 bonds is gaining momentum.
As EU banks navigate the evolving regulatory landscape surrounding AT1 bonds, the need for greater accuracy and consistency in their valuation is paramount. By adhering to standardized guidelines and promoting transparency, banks can enhance investor confidence and fortify their capital buffers against future crises. The EBA’s recommendations serve as a wake-up call for banks to reassess their approach to AT1 bonds and adopt a more conservative valuation methodology moving forward.