The Bank's Restructuring Proposal
The Co-operative Bank PLC's (the "Bank") announcement last week of a proposed Exchange Offer (the "Exchange") of its subordinated bonds was presented almost as a fait accomplis. The fact is, of course, that the announcement can be no more than a proposal requiring consent of the requisite percentage of the bondholders themselves in accordance with the terms and conditions of the affected instruments. As there are different instruments contemplated to be affected by the Exchange, it will be interesting to see whether or not the Exchange will be presented as a "package deal" requiring the relevant majority consent of each instrument before the Exchange is considered accepted, thereby upping the stakes for all parties. The announcement clearly indicates that each instrument will have its own tailor-made Exchange of a mix of fixed-income instruments in the Co-operative Group Ltd. and/or the Bank and shares in the Bank. There has further been no suggestion that the Exchange is going to be "coercive." Following the High Court’s decision last year in Assenagon v. IBRC, any coercion would be highly controversial, signalling the Bank’s preparedness to litigate all the way to the UK Supreme Court.
Bondholders Should Organise and Proactively Engage with the Bank and the Government
Many questions arise out of the announcement. What practical options do bondholders actually have to avoid the Exchange’s threat of a significant haircut and partial exchange of their debt for equity in the Bank? The answer lies in organisation and engagement with their counter-party. It is clear in the terms and manner of the announcement that it is no more than an invitation from the Bank (and the Government) for the bondholders to negotiate a consensual deal. Bondholders should use the time between now and the announcement of the precise terms to engage in talks with the Bank to influence a fair arrangement amongst all stakeholders and other parties for contribution to the Bank’s reported £1.5bn Common Equity Tier 1 capital shortfall (the “Tier 1 gap”). One obvious question that arises out of the announcement is whether the proposal could be said to be just and equitable in view of the fact that the existing shareholders of the Bank appear not to be contributing their fair share of the burden. Bondholders should further also be engaging in discussions with the Government to point out concerns as to the proper application to the Bank of the Governmental Authorities’ (the “Authorities”) powers under the Banking Act 2009 (the “2009 Act”), as further discussed below.
Alternatives to an Exchange
In preparing for the negotiations, bondholders should bear in mind the alternatives to the Exchange. Knowing the options available to the Bank and to the Authorities — and the downsides to those parties of invoking those options, as well as the limitations and scope of those options — are vital tools in the negotiations. The precise terms of the Exchange have not yet been announced, leaving bondholders to fear the worst. The stated date of October 2013 also gives plenty of time for the Bank and the Authorities to drum up press scare-mongering, so that bondholders will believe the worst. Being prepared is the best way to offset any fears.
One alternative to the Exchange that the Bank will be keen to remind bondholders of is that, absent the Exchange, the Bank may be seen as being in a degree of “financial difficulty” justifying the intervention of the Authorities under the “Special Resolution Powers” of the 2009 Act. It is significant for bondholders that intervention may occur even before the onset of insolvency. In such a case, bondholders may nevertheless be looking to a recovery analysis on their investment, relying on an “independent valuer” appointed by the Authorities in assessing the value of their claim. Bondholders should be crunching the numbers on the likelihood of that scenario arising and they should be arming themselves now with grounds for judicial review. The Special Resolution Powers that bondholders will be fearing are those that (at least indirectly) adversely affect the value of the bonds. Whilst the controversial “bail in” powers may not be expressly permitted under the 2009 Act, the Authorities can certainly nationalise the bonds (for “adequate compensation”) and also effect a transfer of the Bank’s valuable assets, leaving the bondholders with a claim in a toxic or worthless vehicle — the classic ‘good bank’/‘bad bank’ scenario.
Ammunition in the Bondholders’ Armoury
There are, of course, strict criteria that the Authorities must satisfy before exercising their powers, and it is these criteria and the manner of exercise of the power that bondholders will carefully scrutinise in any judicial review process. The criteria that the Authorities must assess include:
- Concluding that there are no other viable ways of plugging the Tier 1 gap;
- Arriving at the decision that the action is ‘necessary’;
- Ensuring the accuracy of the Tier 1 gap calculation; and
- Ensuring the fairness and accuracy of any valuation exercise. (In any valuation argument, the Bank has the upper hand since bondholders will largely be at the mercy of information provided to it by the Bank.)
The Future of the Legislative Landscape
Bondholders should be aware of the wider EU Framework for Recovery and Resolution of Credit Institutions and Investment Firms Directive which is due to become an EU Directive at least by year-end. Whilst the UK Government will not need to rely on the powers under the Directive in order to legislate for a bondholder bail in in the Bank, the UK Government will no doubt be mindful of the marked shift in attitude across the EU and this is evidenced in the Financial Services (Banking Reform) Bill, which is due to be enacted shortly (though will be unlikely to apply retrospectively). Having said that, there is no guarantee that the UK Government will not pass legislation bespoke for the Bank’s situation that includes a bail in. One thing is for certain — no longer will taxpayers be seen as the first port of call in bearing the burden of propping up a troubled bank. From now on, the shareholders, subordinated creditors and even senior creditors and depositors will be expected to bear that burden first, as seen very starkly in the recent bail in of depositors in the Cyprus banks.