{"id":8041,"date":"2009-09-28T17:36:39","date_gmt":"2009-09-28T21:36:39","guid":{"rendered":"http:\/\/www.prefblog.com\/?p=8041"},"modified":"2009-09-28T17:36:39","modified_gmt":"2009-09-28T21:36:39","slug":"hm-treasury-responds-to-turner-report","status":"publish","type":"post","link":"https:\/\/prefblog.com\/?p=8041","title":{"rendered":"HM Treasury Responds to Turner Report"},"content":{"rendered":"<p>The <a href=\"http:\/\/www.prefblog.com\/?p=5954\">Turner Report on Financial Regulation<\/a> was reported on PrefBlog in March. The government has now taken some time off from its regularly scheduled banker-bashing to address the issues raised.<\/p>\n<p>The response <a href=\"http:\/\/www.hm-treasury.gov.uk\/reforming_financial_markets.htm\">was released on July 8<\/a> with the admission:<\/p>\n<blockquote><p>There were many causes of the financial crisis:<\/p>\n<ul>\n<li>first and foremost, failures of market discipline, in particular of corporate governance, risk management, and remuneration policies. Some banks, boards and investors did not fully understand the complexities of their own businesses;\n<li>second, regulators and central banks did not sufficiently take account of the excessive risks being taken on by some firms, and did not adequately understand the extent of system-wide risk; and\n<li>third, the failure of global regulatory standards to respond to the major changes in the financial markets, which have increased complexity and system-wide risk, or to the tendency for system-wide risks to build up during economic upswings.<\/ul>\n<\/blockquote>\n<p>&#8230; which is a lot more balanced than what they spout for the benefit of the man in the street.<\/p>\n<p>The British firm Barrow, Lyde &#038; Gilbert has prepared a <a href=\"http:\/\/www.mondaq.com\/article.asp?articleid=83634\">precis of the government response<\/a>; there are, however, two proposals in <a href=\"http:\/\/www.hm-treasury.gov.uk\/d\/reforming_financial_markets080709.pdf\">the full-length report<\/a> worthy of highlighting for preferred share investors:<\/p>\n<blockquote><p><b>Box 6.C: New international ideas for improving access to funding markets<\/b><\/p>\n<p>Two ideas to improve banks access to capital during downturns or crises are being aired in academic and policy circles. Both have merits although how they could be applied in practice is yet to be determined.<\/p>\n<p>Capital insurance:Banks essentially face an insurance problem: when faced with a shortage of capital, rather than having to raise new capital at a high market cost it would be more efficient if banks were delivered capital at a pre-agreed (lower) price though a pre-funded insurance policy. Paying the insurance premium in an expansion would be one method of providing some cost to the expansion of credit in an upturn. However, in a systemic crisis the insurance policy would need to pay out to several banks together. In order to ensure that these obligations could always be met, the insurance would probably need to be run by the state sector.<\/p>\n<p>Debt-equity conversion: When banks are forced to raise new equity capital the initial benefits are shared with the existing debt holders as they have a senior claim over equity in the event of liquidation. One solution would be to make some of the debt (perhaps the subordinated debt tranche  only) convertible into equity in the event of a systemic crisis and on the authority of the financial regulator. This would immediately inject capital into the bank and reduce the need to raise any new equity capital. The holders of the debt would also have more incentive to impose market discipline on the banks.<\/p><\/blockquote>\n<p>The reference supplied for the second option is \u201cBuilding an incentive-compatible safety net\u201d, C. Calomiris, in Journal of Banking and Finance, 1999; this article is <a href=\"http:\/\/www.sciencedirect.com\/science\/article\/B6VCY-3XC1VG5-4\/2\/05a7de23068cf0bc3d15657a3566fbb7\">available for purchase from Science Direct<\/a> and is <a href=\"http:\/\/www.aei.org\/article\/15089\">freely available in HTML form<\/a> from the American Enterprise Institute for Public Policy Research. Assuming that the AEI transcript is reliable, though, I see very little support for the idea in the Calomiris paper (Calomiris&#8217; ideas are <a href=\"http:\/\/www.prefblog.com\/?p=5474\">frequently discussed on PrefBlog<\/a>, but I certainly don&#8217;t remember seeing this one).<\/p>\n<p>Regardless of origin, I consider this a fine idea at bottom, although I am opposed to the idea that the triggering mechanism be a ruling by regulatory authorities. I suggest that greater certainty for investors, regulators and issuers could be achieved with little controversy if conversion were to be triggered instead by the trading price of the bank&#8217;s common.<\/p>\n<p>In such a world, regulators approving a preferred share for inclusion in Tier 1 Capital would require a forced conversion at some percentage of the current common price if the volume-weighted trading price for a calendar month (quarter?) was below that conversion price. Thus, assuming the chosen percentage was 50%, if RY were to issue preferreds at $25 par value at a time when its common was trading at $50, there would be forced conversion of prefs into common on a 1:1 basis if the common traded below $25 for the required period.<\/p>\n<p>This could bring about interesting arbitrage plays with options &#8211; so much the better!<\/p>\n<p>One effect would be that as the common traded lower &#8211; presumably in response to Bad Things happening at the company &#8211; the preferred share would start behaving more and more like an equity itself &#8211; which is precisely what we want.<\/p>\n<p>We shall see, but I hope this idea gains some traction in the halls of power.<\/p>\n<p><b>Update:<\/b> Dr. Calomiris has very kindly responded to my query:<\/p>\n<blockquote><p>Yes, the citation of my work is relevant to the proposal, although it takes a little explaining to see the connection. I have been advocating the use of some form of uninsured debt requirement as part of capital requirements for a long time. The conversion of hybrid idea is a new version of that, which has the advantages of my proposal and also some additional advantages that Mark Flannery and others have pointed to. I like the idea of requiring a minimal amount of &#8220;contingent capital&#8221; which would take the form of sub debt that converts into equity in adverse circumstances.<\/p>\n<p>You may quote me.<\/p><\/blockquote>\n","protected":false},"excerpt":{"rendered":"<p>The Turner Report on Financial Regulation was reported on PrefBlog in March. The government has now taken some time off from its regularly scheduled banker-bashing to address the issues raised. The response was released on &hellip;<\/p>\n","protected":false},"author":1,"featured_media":0,"comment_status":"open","ping_status":"open","sticky":false,"template":"","format":"standard","meta":{"footnotes":""},"categories":[32,12],"tags":[],"class_list":["post-8041","post","type-post","status-publish","format-standard","hentry","category-contingent-capital","category-interesting-external-papers"],"_links":{"self":[{"href":"https:\/\/prefblog.com\/index.php?rest_route=\/wp\/v2\/posts\/8041","targetHints":{"allow":["GET"]}}],"collection":[{"href":"https:\/\/prefblog.com\/index.php?rest_route=\/wp\/v2\/posts"}],"about":[{"href":"https:\/\/prefblog.com\/index.php?rest_route=\/wp\/v2\/types\/post"}],"author":[{"embeddable":true,"href":"https:\/\/prefblog.com\/index.php?rest_route=\/wp\/v2\/users\/1"}],"replies":[{"embeddable":true,"href":"https:\/\/prefblog.com\/index.php?rest_route=%2Fwp%2Fv2%2Fcomments&post=8041"}],"version-history":[{"count":0,"href":"https:\/\/prefblog.com\/index.php?rest_route=\/wp\/v2\/posts\/8041\/revisions"}],"wp:attachment":[{"href":"https:\/\/prefblog.com\/index.php?rest_route=%2Fwp%2Fv2%2Fmedia&parent=8041"}],"wp:term":[{"taxonomy":"category","embeddable":true,"href":"https:\/\/prefblog.com\/index.php?rest_route=%2Fwp%2Fv2%2Fcategories&post=8041"},{"taxonomy":"post_tag","embeddable":true,"href":"https:\/\/prefblog.com\/index.php?rest_route=%2Fwp%2Fv2%2Ftags&post=8041"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}