NVCC sub-debt excluded

The vote to determine the issue is similar to a Canadian municipal election: there’s a low turnout (around 30%); the vote is normally close with no candidate romping to victory and things are never permanent.

That was the situation in the recent poll conducted by FTSE TMX — the body that constructs fixed income indices — on the matter of how to treat issues of non-viable contingent capital debt.

The matter is noteworthy because fixed income managers are measured against an index benchmark. It’s noteworthy as well because three banks have issued NVCC-compliant sub-debt. Last July, Royal Bank was first out of the gate with a $1 billion five-year offering that paid 3.04%. Since then RBC has returned with another $1 billion issue while BMO and CIBC both raised $1 billion.

But NVCC sub-debt isn’t normal debt because there is a potential equity component that becomes an actual component if a so-called triggering event occurs. In essence, if OSFI deems the financial institution is in such a bad financial condition, then under the triggering event, the sub-debt converts to common equity according to a pre-determined formula. Because FTSE TMX manages fixed income indices, it commissioned a poll asking whether a potential equity security could be included in an index of strictly debt securities.

This week the results of that poll was released. Of the 267 surveyed, 74 (or 28%) responded, meaning 193 firms, or 72%, abstained. While the responders were small in number it’s understood they included the bulk of the country’s fixed income assets.

The key result: FTSE TMX decreed NVCC bonds are ineligible for the FTSE TMX Canada Bond Indices. That decision was supported by about 55% of the respondents. Alternatively, about 45% wanted the securities to be included.

“The index Ground Rules have been updated to clarify this point,” said the FTSE TMX report, adding the decision was made in consultation with “the FTSE Americas Bond Index Advisory Committee and review of Global Benchmark treatment of similar debt, as well as consideration by the internal Governance Board.” In this way, the poll served as input to the final decision.

The decision pleased at least one participant. “We were supportive of it. This security looks a little bit like equity than old style sub-debt and shouldn’t go in the index,” added the participant.

“It was surprising how close the poll was. The majority still said no, but it was a smaller majority than the last vote.”

FTSE said that the poll was conducted “as an informal reach out,” about four years ago.

The FTSE report noted the new rule is similar to the current rule. “NVCC bonds have been ineligible for inclusion in the FTSE TMX Canada Universe Index because they can convert to common equity,” it said.

But the report noted that while market participants have spoken this time, the situation is still fluid with the potential for a different decision next time.

For instance, the report noted that “both sides would support waiting until this market has an opportunity to mature (gain mass) allowing investors to better assess risk associated with these issues.” Accordingly, if the NVCC sub-debt market gets big enough the securities may find a way into the index.