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The ECB could have a shock in store for European bank AT1s

The European Central Bank has radical suggestions for ending AT1 conversion triggers and allowing only profitable banks to pay coupons. This could make these instruments riskier than equity.

Preview of the illumination at ECB headquarters for the Euro's 20th anniversary in Frankfurt
The ECB headquarters in Frankfurt. Photo: Reuters

The European Commission is due to complete a review of macroprudential provisions in the Capital Requirements Regulation (CRR) and the Capital Requirements Directive (CRD) by June. If appropriate, it will submit a legislative proposal to the European Parliament and the European Council by December.

At the end of March, the European Central Bank (ECB) provided its 43-page response to the Commission’s call for advice on this review. The central bank discusses ways to increase so-called releasable capital buffers – capital conservation buffers, countercyclical capital buffers and a systemic risk buffer – to address large and disruptive systemic shocks that might hit all or most of the banking union at once.

Think a pandemic or a European war.

Rather buried within are some pithy observations on the additional tier 1 (AT1) market, which consists of buffers that are not releasable in the same way but rather are triggered by extreme losses at individual banks.

If the regulator raised the trigger any higher, the sector would require a very punitive coupon for banks or become uninvestable
Dillon Lancaster, TwentyFour Asset Management
dillon_lancaster_TwentyFour Asset Management.jpg

The first point is that the typical trigger level on AT1s for write-down or conversion into equity at 5.125%

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