European Commission defanged by hybrid debt

September 2, 2009

Fans of the weird and wonderful world of hybrid debt will have enjoyed the European Commission’s U-turn with Belgian bank KBC.

The EC wants banks that have benefitted from state aid to “burden share’’ with private sector investors by deferring optional coupons on their subordinated bonds. That sounds simple enough — after all the essence of subordinated debt is that it can defer interest without counting as a default. Burden sharing, whether imposed by the EC or not, is what hybrid debt is all about.

However, after saying that KBC should defer coupons on certain securities the EC has now backtracked because the Belgian bank and third party lawyers were able to pick through the docs and argue that the coupons weren’t optional after all. 

It looks like the EC is going to need to do some hardcore analysis of its own to work out exactly which coupons can be legally deferred. Perhaps it will conclude there are easier ways to `burden share’.

CreditSights analysts point out that KBC isn’t the first bank to be able to get round the EC’s demands, following Commerzbank and Bayerische Landesbank.

The EC will continue to try to restrict discretionary coupon payments, but it is “likely to find that many of the hybrids have mandatory payments,’’ CreditSights analysts wrote in a report.

This should all be good news for hybrid capital investors, who have been fretting over the risk of coupon deferral ever since the EC got tough earlier this year.

Still, the fact these instruments have proven are so insanely complicated suggests there must be a better way for banks to raise regulatory capital.

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