Regulation, funding and liquidity in focus
For the first time, in 2017 Canadian bank treasurers sat on a panel at the KangaNews DCM Summit. They discussed their interpretations of the Canadian regulatory environment and how the changing landscape is affecting bank funding and liquidity.
REGULATORY ENVIRONMENT
Arden What are the latest Canadian developments around total loss-absorbing capacity and bail-in?
The expectation is that all our eligible senior debt issued after the effective date of these new rules will be subject to bail-in. This means that – unlike the preferred versus nonpreferred structure seen in jurisdictions like France – all our eligible senior-unsecured debt will be subject to bail-in.
To be eligible, debt needs to be issued in tradeable form, so it needs to have a CUSIP or ISIN. It needs to have a term to maturity of more than 400 days and excludes any secured or structured debt. Deposit funding is not eligible.
The minimum requirement is to be determined but we expect it to be similar to levels stipulated in the Financial Stability Board’s termsheet and that we will be granted a period of time to become compliant with the minimum requirement. Given the normal issuance cadence of the Canadian banks, our expectation is that we will all be compliant well within the timeframe so we don’t expect any banks to have to issue debt just to meet the minimum levels.
None of the Canadian banks are currently classified as global systemically important banks (G-SIBs). This may present a timing issue as I believe some Canadian banks will become G-SIBs over the next couple of years. This means we have less of a concern about the cross-holding restrictions for G-SIBs, although we expect that Canadian domestic systemically important banks will be subject to cross-holding restrictions with a carve-out for market-making.
The Canadian proposal will not allow for writedowns, unlike in Europe. In my view, there are flaws in how writedown mechanisms have been designed. The concern is that they will cause losses for individual, small investors.
The Canadian banks worked with the Canadian government in 2013 and 2014 to design the local framework. We laid out a couple of principles, including that there should not be impediments to triggering and that terms should be favourable to debt investors.
In triggering, it is equity investors that get hurt because significant volume of shares will be issued which will dilute their interests. But debt investors will be converted to equity, as these are conversion-only bonds, and the conversion terms must be superior to the next instruments in the capital structure to preserve the hierarchy of claims.
This means the next instrument in the structure would be Canadian-bank-issued subordinated debt. This, if it were to convert, would be written back to par, multiplied by one-and-a-half times and divided by the share price. Senior debt would be written back to par, multiplied by a to-be-decided multiplier, most likely two, and divided by the share price. There would be the opportunity to sell the shares and effectively recoup cash, potentially with a significant gain.
Arden There have been some announcements in Canada recently with respect to the net stable funding ratio (NSFR). Can the treasurers share their insights into the latest news in this arena?
Having said this, most banks, including the Canadians, are believed to already meet the 100 per cent NSFR requirement. The rules are not yet final, though, so while we think we may be compliant today we may discover ourselves to be less compliant if the rules change adversely.
NSFR shouldn’t increase the total level of wholesale funding but it certainly puts a floor on the amount of debt longer than a year that we must issue. NSFR will prevent banks from shortening the term-funding structure too materially, because funding issued at less than one-year maturity will not count as stable. Thus the NSFR creates permanence around the term structure of our funding programmes.
Again, I don’t expect to see a material difference for most Canadian and Australian banks. But what we don’t yet know is whether banks will change their pricing for clients because the NSFR materially affects the funding for certain products. For some products within corporate and wholesale banking we think there is no material need for longer-dated funding. But the regulators don’t share this view. Whether or not the cost is passed on to our clients remains to be seen.
FUNDING AND LIQUIDITY
Arden TD Bank has seen a dramatic change in the size and complexity of its borrowing programme over the last five years. What is the extent of these changes and what challenges have they brought?
It has been a lot of work, but I don’t think it has been a particularly big challenge. We are being well received in many different markets, and we all value the benefits of diversification.
Arden How do you assess raising liquidity in senior-unsecured format versus other issuance options?
We mainly concentrate on the difference between senior-unsecured and covered. We want to ensure we are issuing covered when we are getting a sufficient benefit relative to senior-unsecured.
Even so, there is a certain level below which we will not go, based on a differential between secured and unsecured.
Arden Asset-backed securities (ABS) issuance has a well-earned reputation for being onerous to structure, organise and issue. From an ABS issuer’s perspective, is it worth the effort?
The Canadian market has never really recovered from the financial crisis, so ABS there remains more of a challenge. The market is somewhat unreliable and limited and there is more of a question around whether the ABS market is worth the effort in Canada.
One pleasing development in Canada is evidence of increasing numbers of mortgage-backed securities (MBS) investors. A few years ago, one could count these on one hand. But this is changing. One of the country’s largest-ever residential mortgage-backed securities (RMBS) deals was issued just a couple of months ago and 38 accounts were involved, including investors that had not previously bought RMBS in a Canadian context. MBS are obviously more complex and tricky to value – there is duration uncertainty for RMBS that have prepayment features built in. But it seems investors are doing more work on the asset class in Canada and I hope this spreads rapidly.
EYES ON AUSTRALIA
Arden Australian banks have been reasonably regular issuers in global private-placement markets. How do Canadian banks view private placements as part of their funding mix and would they contemplate broadening these, for instance by adding new currencies?
However, certain investors have requested very large secured-funding transactions – in the region of C$1 billion (US$743.9 million) – at pricing that was adverse relative to public markets in private-placement format. Because we are not large and frequent issuers in this product, in my view I am depriving the investor base of a scarce commodity. This means that unless the economics are particularly compelling we tend to stay away from these types of transactions.
The exception is in Europe. Our London desk receives reverse enquiries on a weekly basis for 50-100 million in euros or sterling. From my perspective, these price more attractively than public markets usually because investors have bespoke requirements and are more willing to negotiate around the best place to invest. This market is certainly where most of our private-placement issuance occurs. In Canada, we might issue a small amount but it is usually limited.
Arden TD Bank recently issued its first capital instrument not denominated in Canadian dollars. What was the strategy around this and did the exercise achieve your objectives?
I would describe Canadian-market capacity as adequate in the sense that we have not had any issues in executing our transactions in the domestic arena. But we believe there is a benefit to having access to more than one market for this product.
We monitored the US market and waited until we could issue in callable format but not pay a sizeable spread relative to where we can issue in Canada. When we saw favourable market conditions we commenced a nondeal roadshow and structured the transaction based on investor feedback to achieve our objectives but also to be as attractive as possible.
In the end we issued US$1.5 billion from an order book of US$9 billion at a pricing level that was very close to where we would issue in Canada. The notes have traded through Canadian levels ever since. Going forward, we will look to balance our capital issuance between Canada and the US.
Mirror image
Similarities between Australia and Canada extend to housing. Vancouver and Toronto bear a striking resemblance to Sydney and Melbourne when it comes to price growth. There are also similar concerns about property investment, household debt and housing affordibility.
HOOPER Like Australia, Canada is somewhat concerned about housing affordability and consumer indebtedness. The government has taken a number of actions to address this issue over the past few years, with the most recent round of changes in October last year.
The two markets that are primarily discussed are the Greater Vancouver and Greater Toronto areas. Both have supply constraints – Vancouver being an island and Toronto having a green belt on the north side and a lake to the south.
Canada hasn’t historically had much informative data around foreign homebuyers but anecdotally there is some concern about foreign buyers parking money in Canada by acquiring properties in Vancouver. In 2016, the government of British Columbia imposed a tax of 15 per cent for foreign purchasers of homes in specific parts of the Greater Vancouver area. The same government has also imposed a vacancy tax.
Audience question In Australia we hear a lot about the supposed similarities between the Australian and Canadian debt markets. Is this something the panellists are asked about by investors, and if so how do they respond when the subject arises?
A noteworthy difference, though, is that Australia has become more politicised. Two years ago, the Royal Commission on Financial Services introduced ‘unquestionably strong’ to Australia, forcing the banks to hold higher levels of capital to meet the ‘unquestionably strong’ requirement. In Canada, we have fortunately been spared the politicisation of regulation – although with some noise in newspapers recently we think it could be coming.
Audience question Is the Australian dollar market a more appealing and consistent issuance option for Canadian banks than it was a few years ago?
However, as of July last year our Sydney-based operation received approval by the Australian Prudential Regulation Authority and we are now an ADI in Australia. We will be entering the market as a senior-unsecured debt issuer.
The Australian market is attractive. It is a disciplined and well-developed part of the world in which to issue. It has been a gap in our portfolio, so to speak, for some time but it is a gap that we intend to close in the next year.
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