Since the additional tier-1 ( AT1 ) deeply subordinated hybrid capital asset class was created back in 2013, banks globally have sold over half a trillion dollars-equivalent of this instrument to institutional investors in the international bond market. That excludes issuance in domestic markets ( like the Nordic currency markets ) or in retail markets like Australia. But is the asset class under threat?

After the wipeout of Credit Suisse ( CS ) AT1s at the time of its takeover by UBS in spring 2023, the market shut for about three months as issuers sat on their hands while the market rode out some severe near-existential volatility. But institutional investors eventually rediscovered their interest ( underpinned by the higher yields available ) and found reasonable accommodation with issuers.

The stark warnings that the act of subordinating CS hybrid capital to equity ( something the market hadn’t envisaged ) could kill the asset class evaporated. Yet there remains a lingering undercurrent.

Speaking to the instrument’s popularity, global AT1 issuance year-to-date has reached almost US$48 billion-equivalent in the international bond market, according to Bond Radar. That’s double the tally from the same period of last year. A total of 55 issuers from 26 countries have been active so far this year, the most recent being Nordic banking group Nordea, which captured enormous peak demand of US$11.5bn on its AT1 on September 19. That’s equivalent to an over-subscription ratio of 14.375 times.

Petra Mellor, head of bank debt at the bank, noted in a social media post that the coupon of 6.3% was the lowest achieved by a European bank in US dollars since January 2022. Mellor also noted that the reset spread, that is, the coupon to which the notes switch if they’re not called in 2032 – is the second tightest on a European dollar USD AT1. That is, the tightest since the 260.2 basis points over swaps on Nordea’s own US$1 billion 3.75% AT1 issued in August 2021.

The market reception to Nordea’s issue came soon after a frisson that swept through the market after the Australian Prudential Regulation Authority ( APRA ) said in a September 10 discussion paper that it might ditch AT1s for banks ( but not for insurance companies ) because it thinks common equity tier-1 ( CET1 ) and tier-2 capital are more reliable and effective forms of regulatory capital that will ensure that the capital strength of the Australian banking system operates more effectively in stress and that depositors would benefit as it will reinforce confidence in the safety of their deposits.

The shiver that went through the market was a surprise in itself since the regulator had already flagged it might do away with the instrument in a 2023 paper seeking feedback on the effectiveness of AT1 capital. Also, the Australian AT1 market is distinct from its international peers because up to 30% of locally listed AT1s are in retail hands. That makes it an outlier. Other markets have banned retail participation because AT1 securities are considered complex and high risk so distribution is exclusively institutional.

Follow-on impacts

But what did make market participants perhaps more anxious than a potential Australian ban is the impact it might have on other jurisdictions that might be minded to follow suit. In some respects, the narrative espoused by APRA is already pushing against a half-open door in some quarters. In light of the CS debacle, the Dutch finance ministry had said in a March 2024 report that it is exploring the possibility of modifying or doing away with AT1s.

The report questioned whether AT1 capital potentially contributes to market turmoil and investor uncertainty. “A reassessment of the complexity, transparency and regulatory qualifications of AT1 instruments may be needed,” the report said. That caused more of an intake of breath because it came from a core EU jurisdiction. And because European banks have accounted for 72.5% of global AT1 issuance, having issued US$373 billion-equivalent in the international market.

In a response to the Dutch finance ministry report, Jerry del Missier, founder and chairman of Copper Street Capital, the alternative investment firm focus on the financial sector, wrote a comment published in the FT that said such a move would be a serious mistake. “Rather than making heavy-handed interventions in the market, regulators should carefully consider the function of AT1s as time and time again, they have proved their own value. The AT1 market, while complex, has been a resounding success, and it would be wrong to eliminate it,” he wrote.

In similar vein in the wake of the APRA September 10 discussion paper, Romain Miginiac, fund manager and head of research at Geneva asset manager Atlanticomnium brushed off APRA’s potential move as “a very interesting non-event for the global AT1 market”.

He added that getting rid of AT1s is not necessarily a more desirable option outside of Australia: “Forcing European banks to raise approximately US$200 billion of CET1 capital or relaxing capital requirements both seem like undesirable options for stakeholders. Moreover, replacing AT1 with tier-2 reduces the quality of banks’ capital structures. While not perfect, AT1s offer more flexibility in a situation of crisis, for example, as banks in trouble may not be able to refinance tier-2s coming to maturity – causing capital depletion. Regulators giving up optionality by phasing out a stronger form of capital seems counter-intuitive,” he wrote.

“Will AT1 bashing continue in Europe? No doubt. Will AT1s disappear from European banks' capital structure? Unlikely,” Miginiac concluded.

I don’t think we’ve heard the end of this story. Let’s see.