NVCC bonds get their due
Now included in the fixed-income index
Some financial history was made this week when the first issue of non- viability contingent capital — a security that automatically converts to equity under certain circumstances — was included in bond market indexes. Being included in an index, specifically the Universe index, is noteworthy because fixedincome managers are ranked against the benchmark.
Marina Mets, managing director of fixed income at FTSE Russell, said including such bonds in the index “supports the objective of the benchmark which is to provide an accurate representation of the domestic Canadian investment grade fixed income universe.”
In making that decision Mets said FTSE Russell, the entity that provides bond and equity indexes around the world, “carefully considered feedback from the market and feel this is the direction for that objective.”
The breakthrough issue, a $ 1.5- billion capital raise in the form of subordinated medium- term debt by TD Bank, wasn’t the first NVCC offering by a Canadian financial institution. But having that offering — on which TD will pay 3.224 per cent — included in the relevant indexes caps a journey that started a few years back. The word is that demand for the issue was very strong, with about 80 investors and “late fills in the low digits.”
Getting to this stage was quite the journey as along the way surveys taken among fixed- income investors concluded that the securities should not be included. Investors felt the securities were not absolute debt and the indexes measure the performance of fixed-income investments.
But NVCC debt was going to be part of a bank’s regu- latory capital because the regulators wanted to ensure banks would be better able to withstand financial stress if a second global financial crisis occurred. Having more equity capital, or capital that would readily convert to equity, was the key way to achieve that objective.
Despite those admirable goals, investors balked at the prospect of having them included. In February 2015, when the first survey results were released, about 55 per cent of respondents agreed with the decision taken by FTSE TMX not to include them in the index. ( FTSE TMX emerged in 2013 when the TMX merged its bond index business with FTSE. In 2015, FTSE and Russell combined.)
The survey helped confirm FTSE TMX’s decision, which was controversial because, in general, issuers wanted them included because if they were in the index, investors would have to buy them. ( In this way, demand would be stronger than otherwise.)
Late l ast year, participants were surveyed again, against the backdrop of further information being made available to the market, of the broader evolution of this asset class, and further consultations about bail-in issuance. ( Ottawa recently released its bail-in regulations for comments.)
On the basis of all those factors, it was decided, “to include NVCC debt in the broad base Universe index from July 1,” noted Mets. That decision was conveyed to participants last month. “Non- viability contingent capital bonds, issued and settling on or after 1 July 2017, are eligible for inclusion on a go- forward basis,” said the note, part of a 16-page report titled Ground Rules.
Mets said a decision on whether to include legacy NVCC bonds hasn’t yet been made. ( In all about $ 15 billion of such securities have been issued: those securities are included in the NVCC index that’s managed by FTSE TMX.)
But Mets said when the final rules for bail- in bonds are released and when issuers raise capital in that format, the expectation is that “based on our preliminary assessment and given what we know now, we expect they will also qualify for inclusion.”