With the introduction of the revised EU Capital Requirements Directive (known as 'CRD IV'), European banks and investment firms will be subject to a new set of capital requirement rules. The European Commission's proposals, published on July 20 2011, outline the changes that will be made to the existing capital requirements regime in order to implement Basel III in Europe. The commission's proposal document signifies a drastic change in Europe's legislative environment as regards regulatory capital requirements.

Until CRD IV is adopted and transposed into the laws of the EU member states, the banking industry must apply the existing capital requirement rules as regards risk management, governance and bank funding. This gives rise to uncertainties, particularly as far as bank funding and the practical application of existing rules and regulations in that area are concerned. In order to address the existing uncertainties and various other matters arising in connection with the transition towards the implementation of Basel III and CRD IV, the Dutch Central Bank (DCB) has published further guidance on the policies in this area.

First, in October 2010 the DCB published a set of policies explaining its position on banks issuing new regulatory capital instruments that meet the requirements established by CRD II (Directive 2009/111/EC), but which may be in conflict with the revised requirements as laid down by CRD IV. The policies specifically address hybrid capital instruments; whereas CRD II contained relaxed provisions for regulatory capital instruments qualifying for the Tier 1 part of a bank's own funds, Article 49 of CRD IV will reverse this liberalisation by imposing stricter rules in order for hybrid capital instruments to qualify as part of the additional Tier 1 capital.

Second, while the DCB has endorsed the Committee of European Banking Supervisors Guidelines of December 10 2009, it has supplemented those guidelines by issuing further responses in question and answer format on a number of topics, including:

  • The period for which prospective data must be supplied on the development of, among other things, solvency in order to reach agreement on acceptability of the exercise of a call option or redemption of an instrument is three years.
  • The DCB does not accept that instruments with a definite period of 30 years or less qualify for inclusion in Tier 1 and has already taken up a position that aligns with the CRD IV rules which specify that qualifying instruments must be for an indefinite (perpetual) period in order to qualify for inclusion as additional Tier 1 capital.
  • The DCB only accepts loans from a special purpose vehicle to a bank with an initial maturity date of at least 30 years from the date of issue in order for structured instruments to be eligible for inclusion in a bank's own funds.
  • The DCB has issued an extensive explanation on the 'loss absorbency features' of hybrid capital instruments to detail further the requirements of Article 63a(4) of the CRD.

Among other provisions, the question of 'loss absorbency features' of hybrid capital instruments has resulted in a consultative draft (published at the end of July 2011) of amendments to the Dutch Decree on Prudential Rules. The draft decree seeks to clarify further the applicable Dutch regulations for hybrid capital instruments in light of the migration towards CRD IV and Basel III, and is the Netherlands' long-awaited CRD II implementation measure.

The purpose of the draft decree is to implement the provisions of CRD II. The rules applicable to the issue of hybrid capital instruments are contained in a government decree, as opposed to being set out in supervisory regulations. The draft decree introduces certain changes to the interpretation of the provisions of CRD II, as compared to the previous set of policies on that topic which were issued by the DCB in October 2010. The most important point in the draft decree is the recognition of definite instruments with maturities of minimum of 30 years as qualifying as Tier 1 instruments. With the adoption of the amendments to the draft decree (expected to happen in late Autumn 2011), the Dutch regulator will finally have introduced certainty in this area. Until implementation of the draft decree, Dutch law has not given and does not give the DCB significant powers to take action against issuing entities in times of distress. Among other actions that will be available on adoption of the draft decree is the ability to impose a write-off of principal on the bearers of hybrid capital instruments and to suspend dividend or interest payments by issuing entities. The relevant new provisions will not change the interpretations of the DCB as set out in its October 2010 policy document as regards the write-off of principal. Temporary write-down features will not be permitted in order for hybrid capital instruments to qualify as additional Tier 1 capital. Dutch law does not yet set out the authority of the DCB to apply discretion as regards the conversion mechanism.

In practice, many Dutch banks are working towards revisions of their capital base and there is activity towards redemption of outstanding instruments and replacement of the same for new (CRD II/CRD IV) qualifying instruments. In a recent policy statement of October 11 2011, the DCB gave the market an advance warning that it considers most recapitalisation decisions to be subject to a 'declaration of no objection' requirement based on the application of the provisions on structural supervision of banks if they result in a decrease of the bank's own funds. This means that before banks take irrevocable decisions on redeeming outstanding instruments, they must generally obtain a declaration of no objection from the DCB. This requirement is applicable to all instruments qualifying as regulatory capital, whether it be Tier 1, Tier 2, Tier 3 or hybrid instruments qualifying as Tier 1. By the introduction of this policy, the DCB has reiterated that it considers the mechanisms introduced with the adoption of CRD II for the recognition of hybrid capital instruments applicable to all of bank's regulatory capital.

In a policy published in parallel with the policy on hybrid capital instruments in October 2010, the DCB expressed its intention to grandfather hybrid instruments that are compliant with CRD II but are not compliant with CRD IV rules. The DCB issued the policy suggesting that the market should seriously consider structuring hybrid instruments in such a manner that they meet the CRD IV requirements in order to avoid "constraints as to grandfathering". Recent feedback from the market suggests that the DCB has extended this policy to encompass all types of regulatory capital instrument. Dutch banks are subject to one of the most severe supervisory regimes as regards bank capitalisation in Europe in view of the very strict interpretations and polices adopted by the DCB.

This is notwithstanding that formal legislation is lagging behind developments at a European level. The DCB's approach over a number of years has made it possible for the Dutch authorities to confirm that Dutch banks already comply with the stricter Basel III requirements. It is therefore expected that there will be no need for further recapitalisation efforts (other than those already scheduled) in order to comply with the accord reached by the European Council on October 26 2011 to introduce new requirements for capital buffers for addressing markets concerns over sovereign exposures.

For further information on this topic please contact Bart PM Joosen at FMLA Financial Markets Lawyers by telephone (+31 20 348 52 00), fax (+31 20 348 5201) or email ([email protected]).