More disclosure needed on encumbrance
Euromoney, is part of the Delinian Group, Delinian Limited, 4 Bouverie Street, London, EC4Y 8AX, Registered in England & Wales, Company number 00954730
Copyright © Delinian Limited and its affiliated companies 2024
Accessibility | Terms of Use | Privacy Policy | Modern Slavery Statement
Sponsored Content

More disclosure needed on encumbrance

The ‘bail-in’ provisions of the European Union’s resolution regime continue to create concerns among creditors about where they stand in the pecking order for payments if everything goes wrong. Meanwhile regulators and owners of bank debt are still evaluating the demand for credit under the new rules.

Tim Skeet, Managing Director for RBS Financial Institutions Group

The European Banking Authority (EBA) met earlier this year to discuss new reporting standards for asset encumbrance. This was in response to a directive from the European Systemic Risk Board (ESRB) to formulate a reporting template to help measure asset encumbrance.


The degree of encumbrance is not just a theoretical concern. In the event of another crisis, creditors will want to know to what extent they are at risk of being ‘bailed-in’ (in other words, having their debt written down in value or written-off completely). Secured creditors will be exempt from these provisions and given preferential treatment if a bank does fail. The example of the Cyprus rescue package has added fresh fuel to the debate.


European banks have increasingly used secured funding to raise wholesale liquidity, partly in response to investor appetite. Regulators are aware of the situation but, as the EBA made clear, measuring the extent of the collateral pledged remains incomplete. Overall, however, levels of encumbrance remain modest, although some investors are now calling for the extent of encumbrance in the banking system to be clarified.

The shift from senior unsecured funding to lower-cost secured funding has seen several sources of encumbrance being tapped. These sources include the covered bond sector and less visible forms of collateral-hungry funding options, such as repos, some aspects of securitisation, assets pledged against derivatives exposures, and assets pledged to central banks (including the Long-term refinancing operation, LTRO).

'Unsecured creditors face the prospect of being subordinated to lengthening lines of secured creditors.' As unsecured creditors face the real prospect of a future bail-in, they also face the prospect of being increasingly subordinated to lengthening lines of secured creditors, including the central banks. As a result, you might expect them to charge higher spreads and reduce their appetite for these risks. To complicate the situation further, an even greater potential source of subordination could result from proposed ‘depositor preference’ rules which would put bank depositors ahead of other creditors.


Should investors be concerned and should regulators take action?

An International Capital Market Association (ICMA) working group held a number of meetings with various investors, issuers and regulators last year to debate the topic. Broadly, the conclusions were that encumbrance levels should be neither a source of particular concern nor the subject of further regulatory action. However, the group noted that there were uncertainties surrounding the attitude of different banking authorities and concerns over the possible impact of arbitrarily determined encumbrance limitations.

The EBA has now had a preliminary stab at a common definition for encumbrance, and enhanced regulatory reporting, but there is no easy way for investors to calculate it from available public data. Still, several of the strongest banks in Europe, particularly the Nordic ones, have comparatively high levels of encumbrance, although these same banks enjoy strong access to the senior unsecured funding markets. Moreover, Nordic bank encumbrance levels reflect the traditional use of covered bonds, often through their domestic markets. This reinforces the point that encumbrance levels are dictated by business models and local custom. Any regulatory response needs to take account of these regional differences, different types of encumbrance, and the funding flexibility of individual banks.

However encumbrance is defined and measured, there remains the need for investors to assess the risk of investing on a senior unsecured basis. Investors will take comfort from the greater capital and liquidity cushions and closer regulatory scrutiny currently enforced, but they are likely to look for better disclosure levels. There is a strong incentive now for the strongest banks to publish useful measurements, such as the ratio of high-quality unencumbered assets to unsecured liabilities. Further discussions between the issuers, investors and regulators will help to clarify the best course of action and this will form part of the ongoing work of the ICMA.


For more RBS Insight content, click here


Disclaimer

The views expressed are those of the author and do not necessarily reflect the views of RBS or ICMA.


This communication has been prepared by The Royal Bank of Scotland N.V., The Royal Bank of Scotland plc or an affiliated entity (‘RBS’). This material should be regarded as a marketing communication and has not been prepared in accordance with the legal and regulatory requirements to promote the independence of research and may have been produced in conjunction with the RBS trading desks that trade as principal in the instruments mentioned herein. This commentary is therefore not independent from the proprietary interests of RBS, which may conflict with your interests. Opinions expressed may differ from the opinions expressed by other divisions of RBS including our investment research department. This material includes references to securities and related derivatives that the firm’s trading desk may make a market in, and in which it is likely as principal to have a long or short position at any time, including possibly a position that was accumulated on the basis of this analysis material prior to its dissem nation. Trading desks may also have or take positions inconsistent with this material. This material may have been made available to other clients of RBS before it has been made available to you and regulatory restrictions on RBS dealing in any financial instruments mentioned at any time before is distributed to you do not apply. This document has been prepared for information purposes only. This document has been prepared on the basis of publicly available information believed to be reliable but no representation, warranty or assurance of any kind, express or implied, is made as to the accuracy or completeness of the information contained herein and RBS and each of their respective affiliates disclaim all liability for any use you or any other party may make of the contents of this document. This document is current as of the indicated date and the contents of this document are subject to change without notice. RBS does not accept any obligation to any recipient to update or correct any such information. Views expressed herein are not intended to be and should not be viewed as advice or as a recommendation. RBS makes no representation and gives no advice in respect of any tax, legal or accounting matters in any applicable jurisdiction. You should make your own independent evaluation of the relevance and adequacy of the information contained in this document and make such other investigations as you deem necessary, including obtaining independent financial advice, before participating in any transaction in respect of the securities referred to in this document. This document is not intended for distribution to, or use by any person or entity in any jurisdiction or country where such distribution or use would be contrary to local law or regulation. The information contained herein is proprietary to RBS and is being provided to selected recipients and may not be given (in whole or in part) or otherwise distributed to any other third party without the prior written consent of RBS. RBS and its respective affiliates, connected companies, employees or clients may have an interest in financial instruments of the type described in this document and/or in related financial instruments. Such interest may include dealing in, trading, holding or acting as market-makers in such instruments and may include providing banking, credit and other financial services to any company or issuer of securities or financial instruments referred to herein. This marketing communication is intended for distribution only to major institutional investors as defined in Rule 15a-6(a)(2) of the U.S. Securities Act 1934 (excluding documents produced by our affiliates within the U.S.). Any U.S. recipient wanting further information or to effect any transaction related to this trade idea must contact RBS Securities Inc., 600 Washington Boulevard, Stamford, CT, USA. Telephone: +1 203 897 2700. In Singapore, this marketing communication is intended for distribution only to institutional investors (as defined in Section 4A(1) of the Securities and Futures Act (Cap. 289) of Singapore). In Hong Kong, this marketing communication is intended for distribution only to Professional Investors (as defined in Schedule 1 of the Securities and Futures Ordinance of Hong Kong).


Issuers mentioned in any material may be investment banking clients of RBS Securities Inc. and RBS Securities Inc. may have provided in the past, and may provide in the future, financing, advice, and securitization and underwriting services to these clients in connection with which it has received or will receive compensation. Accordingly, information included in or excluded from this material is not independent from the proprietary interests of RBS Securities, Inc., which may conflict with your interests.


For further information relating to materials provided by RBS, please view our RBSMarketplace Terms and Conditions: RBSM Terms and Conditions


The Royal Bank of Scotland plc. Registered in Scotland No. 90312. Registered Office: 36 St Andrew Square, Edinburgh EH2 2YB. The Royal Bank of Scotland plc is authorised by the Prudential Regulation Authority and regulated by the Financial Conduct Authority and the Prudential Regulation Authority. The Royal Bank of Scotland N.V., established in Amsterdam, The Netherlands. Registered with the Chamber of Commerce in The Netherlands, No. 33002587. Authorised by De Nederlandsche Bank N.V. and regulated by the Authority for the Financial Markets in The Netherlands.


The Royal Bank of Scotland plc is in certain jurisdictions an authorised agent of The Royal Bank of Scotland N.V. and The Royal Bank of Scotland N.V. is in certain jurisdictions an authorised agent of The Royal Bank of Scotland plc.


Copyright © 2013 The Royal Bank of Scotland plc. All rights reserved. This communication is for the use of intended recipients only and the contents may not be reproduced, redistributed, or copied in whole or in part for any purpose without The Royal Bank of Scotland plc’s prior express consent.


Copyright © 2013 RBS Securities Inc. All rights reserved. RBS Securities Inc. member FINRA (http://www.finra.org) / SIPC (http://www.sipc.org), is a subsidiary of The Royal Bank of Scotland plc. RBS is the marketing name for the securities business of RBS Securities Inc.

Gift this article