"They're Missing Out On A Cash Cow" - Why The EU Is Finally Punishing Megabanks With Recovery Bond Freeze-Out

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by Tyler Durden
Wednesday, Jun 16, 2021 - 10:25 AM

Just as 10 of the world's biggest megabanks (primary dealers responsible for selling and making markets for European sovereign debt) were salivating at the opportunity to make easy revenue from hawking EU recovery bonds - inventory that carries a slight premium to German bunds with the same AAA rating - Brussels abruptly pulled the rug out from under them when they announced that 10 megabanks, including Barclays, JP Morgan, Citigroup and Bank of America, would be frozen out of the syndicated bond deals.

The reason? According to Bloomberg, the move was "punishment" for the bank's past transgressions during the market-manipulation scandals that exploded in Europe a decade ago starting with the Libor-manipulation scandal that cost former Barclays CEO Bob Diamond his job. Regulators in the UK, EU and the US eventually pursued charges of manipulation against the banks and even individual bankers, which cost the banks billions of dollars in fines.

For years, scandal after financial scandal in Europe harmed the reputation of the continent's regulators and enforcers, as scandals like the Danske Bank-led money laundering ring, the collapse of Greensill and other issues. Now, the Continent's regulators are finally showing the banks they regulate that there will be consequences for bad behavior.

As Bloomberg reported on Wednesday, the banks might still be able to get out from under the ban, as long as they meet regulators' demands. The ban will last at least until the bloc carries out an "assessment" to determine whether the banks have done enough to fix previous breaches of anti-trust rules.

Still, even if the 10 megabanks are let out of the dog house early enough to get a piece of the "cash cow" business, it's virtually certain that Brussels' decision to punish them for their past sins could dramatically rearrange the Continent's league tables as smaller banks win the larger fees and mandates. Yesterday's €20 billion issuance by the EU (the largest the bloc has raised in a single sitting) generated more than $20MM in fees for the banks involved. And there will be many more of those as the EU seeks to finance the European Commission's €800 billion ($970 billion) "NextGenerationEU" program.

Syndications like these are "cash cows,” according to Liam O’Donnell, head of nominal rates at Aberdeen Standard Investments, who spoke with BBG. It "certainly would have been a profitable environment recently with multiple syndications."

As a reminder, the banks that lost out include:

Source: Bloomberg

One EU bureaucrat said they couldn't give an expected timeline for how long the EU Commission's "review" of the recidivist might take, which would suggest that there's still a possibility these banks could be shut out entirely.

"These banks have to demonstrate and to prove that they have taken all the necessary remedial actions which have been demanded by the Commission when deciding about these cases," budget commissioner Johannes Hahn told reporters Tuesday. "We now expect the submission of the necessary information and then of course we have to analyze and assess it. I cannot predict how long it takes."

Another two syndications are expected before the end of July, which would suggest that the scale of the missed fees could snowball. While missing out won't kill the franchise, it will make it extremely difficult to show competitive growth, especially since the EU bonds sold so far this year are equivalent in value to 10% of the rest of the Continent's sovereign bond market, according to Bloomberg data.

It is in the EU's "interest to include all the key players and banks which have qualified themselves for the primary dealer network," Hahn, the commissioner, said. "But of course the legal aspects have to be respected."

Most of these banks are among the 39 or so "primary dealers" who have an obligation to bid for sovereign bonds during regular debt auctions. The EU is expected to start those in September. As for yesterday's auction, the lead managers included BNP Paribas DZ Bank, HSBC, IMI-Intesa Sanpaolo and Morgan Stanley, with Danske Bank and Banco Santander hired as co-leads.

Considering the important role these banks play in financing the Continent's governments, Europe can't simply tell them to kick rocks. But the pressure is one way to compensate for a European financial regulatory framework that has been criticized for being wildly ineffective at deterring bad behavior.

Barring banks from participating in a bond deal is rare, but not unheard of: Morgan Stanley temporarily lost its status as a primary dealer of French government bonds in August as a result of some minor transgressions. The ban only lasted three months, but for what it's worth, it may have proved effective at correcting MS's behavior. After all, the bank was left off the last of black-balled banks (it was also notably absent from the market manipulation scandals that inspired the ban).