Danish mortgage bank Nykredit Realkredit's decision to issue senior subordinated Tier 3 notes that will sit between equity and subordinated debt and senior unsecured debt in the liquidation hierarchy will have a widespread impact across Europe, says Brian Caplen.

In 2016, the 400th anniversary of William Shakespeare’s death, performances of his most popular play about Hamlet, the prince of Denmark, will be given across the globe. Since a wide range of interpretations are possible with any Shakespeare play, each of the many productions is likely to have its own unique character.

The same is true of Tier 3 securities, which are currently being trailblazed by Denmark’s own prince of finance, Nykredit Realkredit. The mortgage bank announced in late May that its plan to issue senior subordinated Tier 3 notes that will sit between equity and subordinated debt and senior unsecured debt in the liquidation hierarchy. 

The expectation is that banks across Europe will follow suit in issuing Tier 3 securities as they gear up to conform with the EU’s minimum requirement for own funds and eligible liabilities (MREL). In pursuit of making banks resolvable without recourse to taxpayers, supervisors will be setting out MREL requirements for individual banks by the end of the year. 

But just as a Shakespearian tragedy is beset with intrigues and counter plots, expect that each of the 28 EU members and many individual banks will have their own take on Tier 3 and the liquidation hierarchy. 

The devil, of course, is in the detail. In a report called ‘As the Tier 3 ball starts to roll, European banks continue to plot their bail-in buffers’, Standard & Poor's notes that Article 44 of the Bank Recovery and Resolution Directive (BRRD) “excludes certain classes of instruments from bail-in such as: secured or otherwise collateralised debt, covered (i.e. insured) deposits, client money, and interbank and payment systems exposures under one week”.

“It also gives national authorities the right to exclude other types of liabilities during the bail-in process in ‘exceptional circumstances’ – for example, to ‘avoid giving rise to widespread contagion’,” the report continues.

In other words, the playwright seems to be granting huge licence to directors of the play to do their own thing. While the BRRD lays down that national authorities must keep resolutions harmonised with local insolvency treatment, this opens the gate for new country-by-country liquidation hierarchies to be put in place. 

S&P talks about “a proliferation of approaches across the EU” that “creates a confusing patchwork for investors and adds complexity to the task of resolving cross-border banks”. 

Already Germany has moved senior unsecured bonds below other senior unsecured claims from 2017 and Italy has raised corporate depositors above other senior unsecured from 2019. Other permutations with surely follow. To paraphrase the bard: “Something is rotten in the state of EU Tier 3.” 

Brian Caplen is the editor of The Banker.

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