PRA pins down changes to capital issuance rules

IN-DEPTH ANALYSIS

On 10 March 2020 the Prudential Regulation Authority (PRA) published PS5/20 Regulatory capital instruments: update to Pre-Issuance Notification (PIN) requirements (the Policy Statement). The amendments take effect from 1 April 2020.

Background

Firms subject to the Capital Requirements Regulation (CRR) must notify the PRA before issuing capital instruments that they wish to include in their capital resources or own funds. This notification is generally achieved by completing and sending a pre-issuance notification (PIN) form.

Usually, a PIN is required to be sent at least 30 days before the intended issuance of the instrument (unless there are exceptional circumstances which must in any case be explained to the PRA).

The PIN regime is intended to enhance and maintain the quality of firms' capital resources, by providing the PRA with an opportunity to comment on the terms and conditions of proposed capital instruments prior to issuance or amendment.

In September 2019, the PRA opened a consultation into proposed changes to the PIN regime (on which we commented here). These proposals were made to account for CRR II, which made changes to the CRR in light of international prudential standards, and to make improvements that the PRA identified through its experience in assessing capital instruments.

The changes were intended to make the PIN regime more risk-sensitive and proportionate, and to allow firms greater flexibility in issuing and amending capital instruments.

What is changing?

Changes have been made to the following documents:

the PRA Rulebook: CRR Firms: Definition of Capital
PRA Supervisory Statement 7/13 Definition of capital (CRR firms) (the Supervisory Statement)
the PRA's PIN form for CRR firms
the PRA's common equity tier 1 (CET1) template for CRR firms (the CET1 template).

We summarise the main changes under the following three themes:

Improving quality and governance of CET1 issuance

Independent legal opinion required for all new CET1 issuances

All applications made under Article 26(3) of the CRR will need to be supported by an independent legal opinion on the CET1 eligibility of the new instrument. The Policy Statement clarifies that a legal opinion is not required where the firm proposes a subsequent issuance on substantially the same terms as a previously notified CET1 issuance.

Complex capital structures

The PRA has amended the Supervisory Statement to set out its preference for "plain vanilla" CET1 share structures with only one class of share. Firms are to refrain from including features in CET1, additional Tier 1 (AT1) and Tier 2 capital instruments which may be ineffective or less effective in absorbing losses.

The PRA considers that complexity will also arise where CET1 shareholders have different rights and entitlements including preferential realisation provisions or other features that guarantee a distribution to CET1 shareholders.

Expectations on senior management accountability, and share structure complexity

The PRA has amended the Supervisory Statement to make it clear that it expects the relevant Senior Management Function (SMF) to take responsibility for the quality of the capital structure overall. The relevant SMF will be the individual with:

responsibility for managing the allocation and maintenance of the firm's capital, funding, and liquidity, or
responsibility for managing the firm's financial resources (for small firms).

In particular, the relevant SMF will be accountable for the quality of notifications to the PRA. The signing and submitting of the PIN form may be delegated, however. The PRA initially proposed that the SMF would be responsible for the signing and submission of all PIN forms.

Where the CET1 instrument includes complex features (which should be rare, see above), the PRA expects the relevant SMF to inform the firm's board in advance, evidencing why the instrument cannot be issued without the proposed features and that, notwithstanding the proposed complexity, they consider the instrument compliant with the objective of CRR.

This proposal should then be subject to the board's review and discussion, and if approved by the board, the inclusion of such complex instruments in the share structure should be discussed at least annually as part of the Internal Capital Adequacy Assessment Process (ICAAP).

Notification requirements for subsequent issuances of CET1 and AT1

Alignment of requirements for subsequent issuances of CET1 and AT1

Under the existing PRA rules, a firm is allowed to classify an instrument as CET1 where:

it is issued on "identical" terms to a CET1 instrument which has been approved in the previous 12 months, and
the PRA is notified no later than the day of issuance.

The CRR II amendments mean that, under Article 26(3), a subsequent issuance may be classified as CET1 where:

it is issued on "substantially the same terms" as an instrument previously approved, and
notified to the PRA "sufficiently in advance" of its classification as CET1.

The PRA proposed to amend its rules to remove the overlap. In the Policy Statement, it noted that this would cause there to be a more restrictive regime in place for subsequent issuances of AT1 instruments than for CET1, which would be disproportionate and unduly complex.

The PRA has therefore aligned the notification requirements for subsequent issuances of CET1 and AT1 instruments.

Interpretation of CRR II terms

In the amended Supervisory Statement, the PRA has clarified the definition of two terms relevant to subsequent issuances of CET1 and AT1 instruments: "substantially the same" and "sufficiently in advance".

Term	Subsequent issuance or amendment of CET1	Subsequent issuances of AT1 and Tier 2 instruments	Amendments to previously issued AT1 and Tier 2 instruments
Term	Subsequent issuance or amendment of CET1	Subsequent issuances of AT1 and Tier 2 instruments	Amendments to previously issued AT1 and Tier 2 instruments
"Sufficiently in advance"	No later than the intended date of the subsequent issuance if substantially the same. At least 1 month in advance if not substantially the same.	AT1: no later than the intended date of the subsequent issuance. At least 1 month in advance if not substantially the same.	AT1: on the day of amendment if substantially the same. At least 1 month in advance if not substantially the same.
		Tier 2: on or immediately after the date of issuance.	Tier 2: on or immediately after the date of amendment.
"Substantially the same as"	Includes instruments issued on identical terms as an instrument which the PRA has already approved. Excludes instruments issued on terms where: there is any change to provisions governing voting rights, subordination, or distributions, or any feature which might be considered a barrier to recapitalisation, or there is material change to other provisions governing the instrument, or the transaction involves new side agreements or material amendments to an existing side agreement which were not considered in the PRA's previous assessment.	Includes instruments issued on identical terms as an instrument which the PRA has already approved. Excludes instruments issued on terms where: there is any change to provisions governing subordination, conversion or write-down mechanism, call option, frequency or amount of distributions, or any feature that might be considered a barrier to recapitalisation or an incentive to redeem, or there is material change to any other provision governing the instrument.

Post-notification regime for Tier 2 instruments

There will no longer be a requirement for firms to notify the PRA in advance of issuing Tier 2 instruments. The PRA will retain the post-notification requirement, and will review a sample of Tier 2 instruments. Firms giving notice of an issue of Tier 2 instruments must provide the PRA, on or immediately after the date of issuance, with:

a completed PIN form
a copy of the terms and conditions of the instrument together with any side agreement
a properly reasoned, independent legal opinion from an appropriately qualified individual confirming that the capital instrument qualifies as Tier 2 capital (unless issued on substantially the same terms as a previously issued instrument notified to the PRA).