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Barclays Capital Response to CEBS Draft Proposals on Tier 1 Hybrids

Core Content Summary

Barclays Capital has responded to the CEBS Draft Proposals for a common EU definition of Tier 1 hybrids (CP17). The response is divided into two main sections: High Level Concerns and Specific Objections. The letter outlines both support and reservations for the proposals, emphasizing the potential negative consequences for banks, investors, and the financial system.

Main Views and Key Points

Support for CEBS Proposals

• Permanence: Barclays supports the proposal that Tier 1 hybrids should be undated and callable only under strict conditions with prior supervisory approval.
• Flexibility of Payments: They agree with the principle that issuers must be able to waive payments in case of capital breaches or financial stress, and that distributions should only be paid from distributable items.
• Non-cumulative Nature: They agree that the instrument should be non-cumulative in cash or kind, with any unpaid coupon or distribution being forfeited.

Reservations and Concerns

1. Loss Absorption

• Write-down / Write-up Mechanism: Barclays strongly opposes the proposed write-down/write-up mechanism due to:
  • Tax Consequences: Loss of tax deductibility for directly issued Tier 1 hybrids in several jurisdictions.
  • Accounting Complexity: The mechanism is not achievable under IFRS and would create transparency and complexity issues.
  • Market Impact: Increased cost and reduced demand for Tier 1 hybrids.
  • Corporate Law Incompatibility: In the UK, non-step-up preference shares are classified as Core Tier 1 but cannot be written down, leading to a perverse ranking in stress situations.
  • Subordination of Hybrid Tier 1: The proposal effectively subordinates hybrid Tier 1 to equity, contradicting the stated aim of preserving relative subordination.
• Conversion into Equity: They also oppose the conversion into equity proposal, citing:
  • Tax Implications: Loss of tax deductibility for direct issuance.
  • Investor Behavior: Fixed income investors are unlikely to hold such instruments, as they cannot invest in equity.
  • Market Disruption: Conversion could lead to immediate selling of shares, depressing the issuer's share price.

2. Flexibility of Payments

• ACSM (Alternative Coupon Satisfaction Mechanism):
  • Barclays disagrees with the restriction of ACSM to tax reasons and to 15% of Tier 1 capital.
  • They believe ACSM should be allowed across the EU, even in non-tax contexts.
  • They also argue that ACSM should not be limited to 15% and should be permitted to settle in kind or hybrid securities, not just ordinary shares.
  • Direct subscription by hybrid holders is not acceptable due to marketability concerns.

3. Limits on Hybrid Inclusion

• Overall Limit: Barclays disagrees with the 70% limit for ordinary shares and disclosed reserves/retained earnings, preferring the current FSA position of 50%.
• Incentive to Redeem and ACSM: They argue that instruments with an incentive to redeem and ACSM should not be limited to 15% of Tier 1 capital, as ACSM is not an incentive to redeem.

Additional Concerns

• Timing of Proposals: Barclays questions the CEBS timetable, as the Basel Committee is expected to review Tier 1 hybrid definitions in the near future, potentially requiring modifications.
• Market Conditions: They believe the current financial climate is not suitable for introducing new regulations.
• Legal and Accounting Frameworks: The proposed mechanisms may not be compatible with existing legal and accounting standards, leading to complexity and uncertainty.
• Impact on Investor Confidence: The proposals could lead to a decrease in investor appetite and increase the cost of capital for banks.

Conclusion

Barclays Capital concludes that the CEBS proposals, as currently drafted, would result in significant costs with no clear benefit. They urge the CEBS to consider the practical implications and the need for flexibility, particularly in stress situations, and to align with existing regulatory frameworks and market realities. They also recommend that the CEBS integrate its timeline with the Basel Committee’s review process to avoid market confusion.