Overview

On 4 May 2015 the European Banking Authority (the “EBA”) published an update to its original report (published in October 2014) on the monitoring of Additional Tier 1 (“AT1”) instruments issued by EU institutions. The update is partly based on the EBA's review of new AT1 issuances and includes clarifications and final conclusions, some of which are outlined in this note.

Only full regulatory calls are acceptable

The EBA confirms that only full regulatory calls are acceptable for the purposes of Article 78 of the CRR, regardless of whether regulatory changes trigger a full or partial derecognition from AT1 capital. Partial derecognition from AT1 capital owing to write-down or conversion will not be considered as an eligible trigger for a regulatory call. The EBA has also confirmed that it has no specific concern from a purely prudential perspective in allowing calls below par, i.e. when an AT1 instrument that has been written down is called without being written back up first.

Potential changes in the regulatory or tax assessment are not valid triggers

The EBA clarifies that a potential change in the regulatory or tax assessment cannot be considered as a valid trigger for regulatory or tax calls.

Furthermore, regulatory call provisions should not be read as if supervisory approval was a given. The fact that the issuer determines, at its own discretion, that the instruments are subject to “any other form of less advantageous treatment” cannot be a trigger for a regulatory call.

No provision should link a change in payment or write-up to other obligations

As payments on AT1 instruments are fully discretionary, no provision should link a change in payment to contractual, statutory or other obligations, or to payments on other AT1 instruments. Similarly, no provisions should link the write up of the instrument to contractual, statutory or other obligations, as write ups are fully discretionary.

Notice of redemption should not be given after a trigger event notice has been given

The EBA considers it appropriate to include in the terms and conditions of AT1s a condition that the institution should not give a notice of redemption after a trigger event notice has been given. Such provisions should also make it clear that if a trigger event notice is given after a notice of redemption has been given but before the relevant redemption date, the notice of redemption shall be automatically revoked and the relevant redemption shall not be made.

Tax gross up clauses

The EBA is of the view that (1) it should be clarified that the gross up clause is activated by a decision of the local authority of the issuer, not of the investor; (2) increased payments should only be possible if they do not exceed distributable items; and (3) gross up clauses should be allowed only in relation to dividend/coupon withholding tax.

Share conversion clauses in AT1 instruments are now considered acceptable

Some AT1 issuances have included share conversion clauses which give shareholders the chance to buy shares resulting from the conversion and thereby give cash to AT1 holders as compensation. The EBA has now agreed that share conversion clauses are acceptable, notwithstanding the reservations that it had previously expressed.

EBA recommends disallowing the use of contingent clauses

Although it recognises the potential benefits of contingent clauses in order to obtain debt accounting treatment for AT1 securities for hedge accounting purposes, the EBA is of the view that the prudential concerns raised by the inclusion of contingent clauses outweigh the benefits from a hedge accounting perspective. It therefore recommends disallowing the use of contingent clauses in EU issuances.

Triggers for instruments issued within a banking group

For the issuance of an institution controlled by a holding company to be eligible as consolidated Tier 1 capital of the holding company, the terms and conditions of the instruments issued by that institution should include a trigger event based on the consolidated solvency of the parent company. However, the issuance is still eligible at sub-consolidated and solo levels if it includes triggers at these level as well.

For issuance by subsidiaries, a trigger that is only based on the consolidated solvency of the parent holding company is insufficient and an additional trigger at the level of the issuing entity is mandatory, except in cases where Article 7 of Regulation (EU) No. 575/2013 is applicable.

Further clarification on group/solo triggers for eligibility criteria for instruments issued by subsidiaries in third countries (calculation of third country CET1)

On a more general level, instruments issued by subsidiaries in countries non-EU are required to comply with all requirements as specified under CRR and associated implementing regulations in order to be eligible at group level. As a result, an AT1 instrument issued in a third country might be Basel III compliant but might not necessarily be compliant in all aspects with the CRR (e.g. if the terms of such AT1 instrument included a “dividend stopper”) and consequently would not be recognised as AT1 for the purposes of the consolidated solvency position of an EU banking group. For the purposes of the definition of the trigger event, the CET1 capital shall be calculated in accordance with the provisions of the CRR.

Clarification on loss absorption in institutions that issued instruments with different triggers

Where an institution has issued instruments with different triggers (e.g. a “lower trigger” instrument with a 5.125% CET1 loss absorption trigger and a “higher trigger” instrument with a 7% CET1 loss absorption trigger), it is possible that those triggers are hit simultaneously (e.g. from above 7% to below 5.125%). In that specific case, losses corresponding to the amount required to go back to 5.125% should be absorbed by both the lower trigger and the higher trigger instruments on a pro rata basis. Losses above 5.125% will only be supported by the higher trigger instrument.