Regulatory changes may impact bank bonds

A tightening of the regulatory environment around banks is likely to have a negative impact on bank bonds, according to United Kingdom-based investment house Standard Life Investments.

The company believes that while the new regulatory approach being adopted in Europe, the US and elsewhere will ensure a safer banking system, it will have implications that investors will need to take into account, including higher bank funding costs and lower profitability within the sector.

Standard Life Investments investment director, fixed interest, Andrew Fraser said the implications of future discussions around bank regulation would be important not only for bank profitability but for the holders of bank debt.

“The most important issue for bond investors is that if banks fail, future losses will henceforth be spread across the capital structure,” he said. “As regulation develops, we think that it is likely to mean that spreads on bank bonds will trade at wider levels relative to history.”

Fraser said that, additionally, volatility in spreads would be persistent, implying investors would require a high-risk premium for holding the asset class.

He suggested that if bond investors were not comfortable with the new terms and conditions flowing from the changed regulatory environment, funding from institutional investors might be more difficult.