China opens door to $450bn bank funding buffer

Bloomberg

A new type of bank bond is coming to China, albeit slowly. Chinese regulators in March released preliminary guidelines encouraging mainland banks to consider selling securities that can take in large losses in the event of a crisis. Bond watchers have taken that as a sign that total-loss absorbing capacity (TLAC) issuance may make its debut in China, following global lenders, which have issued more than $1 trillion worth of instruments in this format in the aftermath of the 2008 financial crisis.
The first TLAC sale from China isn’t imminent, with Hong Kong-based investment bank AMTD Group expecting it may come in the next two or three years at the earliest. But an estimate from Moody’s Investors Service gives an idea of the potential volume. The risk assessor expects China’s four biggest banks need an extra 2.85 trillion yuan ($453 billion) to meet a stricter loss-absorption buffer by 2025, which is more than double the size of dollar bond issuance from Chinese borrowers last year, a record.
“These offerings from the big four banks that have good credit support may take a big chunk of the allocations from investors onshore,” said Lv Pin, a senior associate at Citic Securities. “TLAC debt-instrument issuance will result in supply pressure in the coming years, especially for lower-rated corporate bonds.”
Lenders from emerging nations received an additional six years to 2025 to meet rules drawn up by global regulators to avoid taxpayer bailouts of large banks. Chinese banks are behind the rest of the world in terms of TLAC implementation and will need to play catch-up going forward, according to Tim Fang, co-head of debt capital markets at AMTD. “Potential TLAC issuance volume could be huge. The banks would need to access both onshore and offshore markets on a consistent basis to meet the additional TLAC requirements,” he said.
Global-systemically important banks, or G-SIBs, in emerging markets, must have liabilities and instruments available to “bail in” the equivalent to at least 16 percent of risk-weighted assets by 2025, rising to 18 percent in 2028, according to the Financial Stability Board (FSB), created by the Group of 20 nations. Developed-nation peers must already meet the first stage of those rules.
Industrial and Commercial Bank of China Ltd., Bank of China Ltd., China Construction Bank Corp. and Agricultural Bank of China Ltd. are considered G-SIBs by the FSB. The four banks didn’t reply to Bloomberg queries requesting comment on their TLAC bond issuance plans.
The new guidelines from Chinese regulators show China is aware of the funding gap its banks face with overseas counterparts and is preparing to meet the FSB’s requirements, Moody’s Nicholas Zhu said.
Nomura International Plc shares a similar view on the good intentions of the regulatory push, said Emil Petrov, the bank’s London-based head of capital solutions for EMEA. It remains to be seen though if the motivation is a genuine desire to make Chinese banks less dependent on state support for recapitalisation or “merely a tick-the-box exercise to demonstrate compliance with internationally agreed standards without the intention to actually use the bail-in tool,” he said.

CAPITAL INSTRUMENTS
Chinese regulators are also moving to give the nation’s banks greater flexibility to structure their capital instruments, in terms of writedown options and equity conversion loss features. The regulator said in March it wants to increase the types of capital instruments banks can issue to include perpetual notes and convertible Tier 2 bonds.
While perpetual notes are a common type of Additional Tier 1 instrument used in Europe and in some Asian countries, Chinese banks currently can only sell preference shares to replenish AT1 capital, according to AMTD’s Fang.
“It is unclear how the alternative capital instruments would differ from existing T2 or AT1 instruments in terms of loss-severity and non-performance risk,” according to a note from Fitch Ratings last month.