With the flurry of bank resolution developments and news just before Xmas I thought I would open 2016 with this brief round up and comparison from the point of bondholders.

Monte dei Paschi (MPS)

The final eleventh hour bungled attempt at a market solution, involving a subordinated debt for equity exchange offer and new money equity, predictably failed in the days before Xmas. Any offer where success is dependent acceptance by a large number of retail investors needs to be open for at least 3 weeks with a comprehensive communication and education strategy in place. So attempting it in just 5 days before Xmas was a non-starter and a waste of time and money. If the PRA had any seasonal spirit they would have shared the lessons learned in the UK during the successful Co-op Bank restructuring with the Italian regulator (CONSOB).

With all other options for MPS to meet the ECB’s end of year deadline to raise €5 billion of Common Equity Tier 1 capital exhausted this left some sort of resolution under the EC’s Bank Recovery and Resolution Directive (BRRD). The options being –

  1. A full blown bail-in of all subordinated debt (and possibly also senior bonds under rules brought in at the start of 2016); or
  2. ‘Bail-in light’ using the ‘exceptional measure’ of a precautionary recapitalisation by the State. The following strict criteria must be satisfied for a bank to be eligible for this option under the BRRD; the bank must be solvent, the bank must have to address a capital shortfall under the adverse scenario of a stress test (as opposed to a real world shortfall), and the process must be deemed necessary ‘to remedy a serious disturbance in the economy of a member state and preserve financial stability.’

There is also the prickly political issue of the huge number (reported at over 40,000) of Italian retail investors who hold MPS subordinated debt. No doubt from a time when bans and regulators were only too happy to have retail investors stump up the capital banks needed and before holders of subordinated bonds could be bailed in on the whim of stress test or real world capital threshold goalpost moving by regulators.

This led to reports of plans to protect retail investors by exchanging their subordinated bonds for new senior bonds via the back door. The plan appears to be that the government will compensate retail investors holding about 2 billion euros of MPS’s subordinated bonds, who will convert their notes into shares. The retail investors will then be able to swap those shares for senior bonds, with the state buying back the shares from the bank.

All these rumours about the Italians fiddling with the rules clearly upset some German politicians and central bankers who started grumbling in public and insisting on a hardline full scale bail-in. That saying about people who live in glass houses and stones comes to mind in view of the current state of accident prone Deutsche Bank and its precarious capital position. The ECB then further muddied the waters between Xmas and New Year by deciding that MPS’s €5 billion capital shortfall had suddenly become a €8.8 billion shortfall. This lead to further public recriminations between Italy and the ECB.

It now seems that the Italians are winning the argument and MPS is heading for a ‘precautionary recapitalisation by the State’ (rather than a full blown bail-in) with compensation for or protection of retail investors. This will mean over €6 billion of the €8.8 billion of capital required will be borne by Italian taxpayers with senior bondholders and retail holders of MPS subordinated debt being spared.

Banco Espirito Santo

Banco Espirito Santo (BES), then Portugal’s second largest listed bank, was put into resolution by the Bank of Portugal (the Central Bank) back in August 2014. The resolution measures applied involved splitting the bank into a good bank (Novo Bank) with the toxic assets remaining in the existing bank and the bail-in of subordinated bondholders.

Then on 29 December 2015 the Central Bank controversially ordered the transfer of 5 tranches (about €2 billion) of senior bonds from the good bank to the bad bank, which is being liquidated. The Central Bank said it chose the 5 tranches because they were under Portuguese, rather than English, law and because they were not intended to be sold to retail investors. The transfer was contentious on at least 2 fronts. Firstly only 5 out of 52 tranches of senior bonds were transferred to the bad bank which gives rise to questions over breach of rights to pari passu treatment. Secondly it appeared that the Central Bank was invoking its right under BRRD based on the exceptional circumstances at the time of the original resolution in August 2014 rather than based on circumstances in December 2014 when the retransfer took place. No doubt this will all be resolved in the courts in due course.

Then on 19 December 2016 it announced that the Portuguese government had caved in to protests and legal action from around 4,000 retail investors in BES linked bonds. Under the compensation plan offered by the Portuguese government retail investors who invested up to €500,000 will receive up to 75% of their investments and those who put more will get up to 50%. One of the conditions of the offer is that investors give a litigation waiver. No doubt due to litigation risks having complicated ongoing efforts to sell Novo Banco.


PrivatBank is Ukraine’s largest lender, has 37 per cent of retail deposits and one-fifth of banking assets so is of great systemic importance to the country. The bank, which was owned by powerful oligarchs, was deemed insolvent by the National Bank of Ukraine (NBU) on 19 December and officially nationalised on 21 December with the NBU announcing that the temporary administrator of the bank had ruled to bail-in the bank’s senior Eurobonds with further detail to be announced ‘in due course.’

At his first press conference on December 22, PrivatBank’s new CEO confirmed that all the bank’s Eurobonds were converted into equity as part of a bail-in with the words ‘For some reason, Eurobonds were included into the list of financial instruments that were converted into equity.’ Maybe something has been lost in translation but the ‘for some reason’ opening does not sound convincing. He then went on to add ‘Together with the National Bank, we will try to find common ground with the Eurobond holders. If not, then we will prove our case in court.’ Then on 26 December the NBU issued a statement to the holders of PrivatBank Eurobonds explaining that no more payments will be made on the securities.

As things look to stand the Eurobond holders will be the only party to get nothing from the nationalisation of the PrivatBank. Depositors are being fully protected and the previous owners of the bank have, to date, been able to keep the estimated $5.6 billion in related party loans they reportedly made to themselves.

Until recently Ukraine did not even have a bail-in law, and yet (with encouragement from the IMF) they have just passed something that allows them to expropriate creditor rights ex-post. It is incredible that policy makers seem to believe that there is no such thing as property rights when it comes to bank paper but would scream blue murder if you suggested the same with any other type of borrower.

So holders of the senior Eurobonds look to have been particularly harshly treated with nobody eager to accept responsibility. It could well be that, as reported, the former owners of PrivatBank are also holders of a large proportion of the Eurobonds and so the treatment is intended to separate them out from third party investors with who the bank and NBU may be willing to talk to strike a deal. Failing that this one looks set to end up in court and that could get very messy. The issuer of the Eurobonds is a UK special purpose vehicle and the terms are under English law and the jurisdiction of the English courts. I am sure the NBU will be wary of the can of worms over what they knew about the state of the bank and did not disclose as well as the problems riding roughshod over foreign institutional investors could cause next time they or one of their banks needs to issue paper.

The battle lines appear to be being drawn. Concorde Capital has reported that holders of more than 20% of the Eurobonds formed a committee for the common protection of their rights and interests. With the committee consisting of five funds, including British, American and Swiss, holding different issues of securities for a total of more than $120 million and other funds seeking to join the committee. I also understand that US law firm Dechert LLP is involved.


So pulling this all together it is notable that it is the country (Ukraine) which did not even have a bail-in law until recently which has aggressively bailed in senior bonds whereas EC countries with established powers to bail-in senior bonds under the BRRD are either baulking or bungling at the prospect. Also that the spectre of all the retail investors to whom banks and their regulators were happy to provide the capital they needed until recently still hangs over attempts to bail-in bondholders.

In my view it is a major weakness of BRRD that the EC failed to consider the issue of existing capital securities already issued in developing the new rules. There are always going to be problems when a central bank or regulator seeks to bail-in retail investors who bought before such a thing was possible. Especially when, as many suggest, one of the biggest sources of uncertainty is the regulators and the regulations themselves. The regulators are often complicit in the problems which give rise to bail-in and have often let them go undisclosed to the market and afforded banks forbearance when management can or will not address them. This together with the constantly moving regulatory goalposts, such as stress test severity, thresholds and real world minimum ratios, which can trigger a bail-in without anything changing in the state of a bank are making the whole area of investing in bank capital securities an unnecessary minefield.