FT BeyondBrics: ICBC sets the benchmark for Asian Basel III bonds

FT BeyondBrics, October 4 2013

Read this article in the FT here

China’s biggest bank has launched a landmark deal that will help other Asian banks understand what they will have to pay for regulatory capital under Basel III, the new banking standard.

Industrial and Commercial Bank of China (Asia), the international funding arm of ICBC, the largest bank in the world by both assets and market capitalization, raised $500m this week in a bond issue. The deal is significant as the first tier two dollar bond from Asia to be compliant with the Basel III standards, developed by the Basel Committee on Banking Supervision in 2010 to try to avert a repeat of the global financial crisis.

Whereas tier one capital is considered core capital by regulators, tier two is supplementary capital and, when raised as a bond, is subordinated and ranks lower than tier one. Both forms are vital parts of a bank’s capital base; a great deal of both tier one and tier two issuance is expected from Asia in the year ahead.

The deal was issued in a 10-year non-call five format, which means that it has a stated maturity of 10 years but has a one-off call option in October 2018 under which ICBC may redeem it, if it has written consent from the Hong Kong Monetary Authority. Despite treading something of an unfamiliar path, those close to the deal say it raised $2.3bn of orders from 150 accounts, with Asian investors particularly strongly represented, accounting for just under three quarters of demand.

But the big question about the bond was not really whether people would want to buy it – ICBC is a popular credit and was responsible for the first ever Basel III compliant bond from Asia in any currency, with a Rmb1.5bn ($245m) issue in October 2011 – but what it would price at. Unusually, the lead managers (ICBC itself alongside a glut of 11 international banks) did not give price guidance when the deal opened on October 2.

At the heart of the pricing challenge is a Basel III clause called non-viability. For any bank capital bond, there comes a point at which it can be forced into a writedown to zero, or a conversion into equity, if the regulator considers that the bank will either need a write-off or an injection of public funds to stay afloat. This is called the point of non-viability, and the market is still trying to work out what to price it at.

This is challenging at the best of times. In ICBC’s case two separate regulators would be involved in making the call on whether the bank was in need of public support: the HKMA and the Chinese Banking Regulatory Commission. Also, a conversion into equity would be impossible in this case since the issuer, ICBC Asia, is not listed, and is instead privately owned by its parent, ICBC on the mainland.

“That was the meat of it,” said a banker close to the deal. “Investors had to be comfortable not just with the Basel III non-viability clause, but the fact that two different regulators would be involved in deciding whether it would be invoked.” He noted that Fitch was expected to rate the bonds BBB+, two notches below the issuer itself, to reflect this uncertainty.

The deal eventually priced with a 4.5 per cent coupon and a spread of 315 basis points over US Treasuries. Bankers said that, judging by ICBC’s outstanding bonds, the non-viability triggers for Basel compliance had cost it about 50 basis points, or a half of one per cent per year. That figure will now be a benchmark for all other Asian banks looking to raise similar capital.