On 8 December
2011 the European Banking Authority (the “EBA”)
published the term sheet listing the minimum requirements for
contingent capital instruments to qualify for the purposes of the core
tier 1 ratio by 30 June 2012.
The purpose of Recommendation EBA/REC/2011/1 is to create exceptional
and temporary capital buffers to address current market concerns over
sovereign risk and other residual credit risk related to the current
difficult market environment.
In accordance with such recommendation, the relevant banks must
ensure they build up capital of the highest quality to reach a level
equivalent to 9% of their risk weighted assets, plus an additional
requirement for the valuation (reflecting market prices as of September
2011) of their sovereign debt.
In addition to the instruments included in the definition of core
tier 1 used in the 2011 EU-wide stress test, are eligible for the
purposes of this ratio: (a) issued convertible bonds that are converted
into core capital before 30 October 2012; and (b) newly issued
contingent convertibles that comply with the EBA’s term sheet.
Below is a summary of the main characteristics that the capital
instruments must comply with in accordance with the EBA’s term sheet.
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1.IntroducTION
The purpose of Recommendation EBA/REC/2011/1 (the
“EBA Recommendation”), which was
published on 8 December 2011, is to create exceptional and temporary
capital buffers to address current market concerns over sovereign risk
and other residual credit risk related to the current difficult market
environment.
In accordance with the EBA Recommendation, the relevant banks[2]
must ensure they build up capital of the highest quality to reach a
level equivalent to 9% of its risk weighted assets, plus an additional
requirement for the valuation (reflecting market prices as of September
2011) of their sovereign debt.
These guidelines must be complied with as from 30 June 2012 and will
remain in force until such time as the EBA Recommendation has been
amended, repealed or cancelled.
Credit institutions which are identified as having a capital
shortfall in accordance with the EBA’s methodology are required to
submit their capital plans to reach such requirements by 20 January
2012. To achieve this banks may: (i) issue new capital instruments (including
contingent capital), (ii) by reducing dividends and their employees’
variable remuneration, (iii) conducting transactions with its own
liabilities (such as swap transactions and repurchases), (iv) sell
assets, or (v) modify the calculation method of their risk weighted
assets; although the EBA imposes additional restrictions in the last two
cases.
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2.ELIGIBLE INSTRUMENTS
The definition of core tier 1 is the same used in
the 2011 EU-wide stress test and comprises only the highest quality
capital instruments: (a) common equity, and (b) hybrid instruments
subscribed by governments.
As an exception, since capital buffers are intended to absorb
potential (contingent) losses: (a) issued convertible bonds that are
converted into core capital before 30 October 2012; and (b) newly issued
contingent convertibles that comply with the EBA’s term sheet, may also
be taken into account for the purposes of the ratio.
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3. CHARACTERISTICS OF CONTINGENT
CAPITAL
Below is a summary of the main
characteristics that the capital instruments must comply with in
accordance with the EBA’s term sheet:
- Nature: Contingent
capital instruments are perpetual securities, without a maturity date (unless
they are redeemed early or converted).
- Eligibility: Contingent
capital is eligible for tier 1 in the solvency coefficient (pursuant to
the Circular of the Bank of Spain 3/2008 of 22 May) and for the EBA’s core
tier 1 ratio. It would not however be eligible as principal capital (capital
principal) unless (i) it has a fixed conversion ratio and (ii) it is
necessarily converted into capital before 31 December 2014.
- Ranking: Subordinated
to the claims of ordinary and subordinated creditors, and pari passu with
others qualifying as tier 1 capital. Contingent capital will rank senior
to ordinary capital.
- Early redemption: The
issuer may, on its own initiative, elect to redeem all but not some of the
securities from the fifth anniversary subject to the prior approval of the
Bank of Spain. Such approval will be subject financial and solvency
criteria similar to those recently implemented in Spanish law by Circular
4/2011 of 30 November of the Bank of Spain.
In addition, regulatory calls[3]
can be introduced for the event that securities do not qualify as
additional tier 1 in January 2013, after the entry into force of a
Regulation on prudential requirements for credit institutions and
investment firms to be adopted by the European Union. Alternatively, the
bank may amend the terms and conditions of the issue, with the approval of
the supervisory authority, so that the instrument can continue qualifying.
- Payment: Payment of
remuneration is discretional and has the same limitations as those
established under Spanish law.
- Remuneration payment date:
The coupon payment dates will be determined on a case by case basis.
However, unless otherwise agreed by the Bank of Spain, they must be
aligned with the dividend payment dates.
- Conversion ratio: It
will be determined on a case by case basis, although the EBA requires
either that: (i) a conversion range be predetermined, or (ii) in addition
to the conversion ratio, a maximum conversion amount be permitted. However,
the Bank of Spain must decide if these minimum requirements have to be
complied with by Spanish banks.
- Mandatory conversion events:
The contingent securities will become newly issued ordinary shares when a
“contingency event” or a “viability event” arise. In addition, the EBA
allows national supervisory authorities necessary conversion on a
predetermined date (this would enable securities issued in Spain as
necessarily convertibles bonds (obligaciones necesariamente
convertibles) to qualify if the remaining requirements are fulfilled).
“Contingency event” is defined as an event
in which the core tier 1 falls below 7% (or, if the common equity tier 1
ratio falls below 5.125%). A “viability event” occurs when the competent
authority determines that the bank would become non-viable (i) without the
conversion of the securities, or (ii) without a public sector injection of
capital or equivalent government support.
- Conversion at investor’s
initiative: The EBA gives discretionary powers to the Bank of
Spain as regards the possibility of including this type of clauses.
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[1] The information contained
in this newsletter is general information and does not constitute legal
advice. This newsletter was drafted on 12 December 2011 and Uría
Menéndez does not assume any undertakings concerning the update or
review of its contents.
[2] The relevant banks are the
71 banks listed on page 15 of Recommendation EBA/REC/2011/1. The
relevant Spanish banks are the following: Banco Santander, S.A., Banco
Bilbao Vizcaya Argentaria, S.A. (BBVA), Banco Financiero y de Ahorros,
S.A. (BFA Bankia), Caja de Ahorros y Pensiones de Barcelona and Banco
Popular Español, S.A.
[3] This is the possibility of
redeeming the issue early in the event it does not qualify as additional
tier 1 after the entry into force of the mentioned Community Regulation.
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