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Germany wins ECB collateral respite but debate far from over
October 6, 2016 / 12:11 PM / in a year

Germany wins ECB collateral respite but debate far from over

* Statutorily subordinated senior bonds can be pledged as collateral

* Non-preferred senior still left out in the cold

By Alice Gledhill

LONDON, Oct 6 (IFR) - German banks scored a major coup this week after the European Central Bank confirmed that their senior unsecured debt would remain eligible as collateral even after changes to insolvency rankings kick in from January 2017.

The ECB’s statement on Wednesday cleared up a key question hanging over the sector since Germany first proposed subordinating senior unsecured bonds to other senior liabilities to help its banks tackle new loss absorbing requirements.

European countries have been grappling with how best to implement bail-in rules in local laws, resulting in a wide range of solutions and vastly different looks for the new style of senior debt.

The news that the ECB will take a lenient approach is a particular boon for the German Landesbanks.

“This is a highly politicised decision,” said one banker.

“Collateral is important for the Landesbanks and they will be able to keep buying each other’s senior.”

Savings and Landesbanks are said to have lobbied for the asset class to remain ECB repo eligible, a key reason for bank treasuries to buy these securities.

The development aligns German senior with structurally subordinated senior debt, such as the senior bonds that UK banks issue out of their holding companies.

“This is a positive,” said a second banker. “By having a wider investor base, you can get more price leverage and maybe achieve tighter pricing.”

KICK IN THE TEETH

The outlook is not so rosy for other jurisdictions, however. The ECB at the same time reaffirmed February’s statement that statutorily subordinated unsecured bank bonds that are also contractually subordinated will not be eligible.

That includes non-preferred senior, of which the French banks are set to be major issuers, potentially leaving them at a disadvantage compared to their European peers.

“In our view, aside issuer specific credit risk or available subordinated buffer considerations, this will be a pricing negative for senior unsecured bonds eligible for bail-in to be issued in the latter format going forward,” said Maureen Schuller, head of financials research at ING.

NOT A CLOSED BOOK

But the ECB made clear in Wednesday’s statement that further changes are likely next year as the direction of insolvency regimes across Europe become clearer - one of the hottest and most toxic topics in the financials debt market.

“This is not a stable situation, in our view. Ultimately it will need to be regularised,” said Richard Thomas, a research analyst at Bank of America Merrill Lynch.

European countries have started taking steps to subordinate senior unsecured debt so that it can be used to beef up loss absorbing buffers, with the aim of shifting the cost of failing banks from taxpayers to creditors.

However, the European Commission fears that the diverging solutions adopted by Germany, France and Italy threaten to create competitive distortions and complicate the bail-in tool.

As part of its statement, the ECB reaffirmed its support in reaching agreement on a common EU approach to the creditor hierarchy in bank insolvency and resolution, and notes that work is ongoing in this respect.

“The ECB will review this decision during the course of 2017, and the collateral eligibility framework eventually applicable to unsecured bank bonds will also reflect progress made within that period towards a common EU approach,” it added.

Reporting by Alice Gledhill, editing by Helene Durand, Julian Baker

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