Section 1 - Banking (prudential standard) determination No. 1 of 2014 - Prudential Standard APS 111 - Capital Adequacy: Measurement of Capital - Banking (prudential standard) determination No. 1 of 2014 - Prudential Standard APS 111 - Capital Adequacy: Measurement of Capital | Zoe
Banking (prudential standard) determination No. 1 of 2014 - Prudential Standard APS 111 - Capital Adequacy: Measurement of Capital
1Banking (prudential standard) determination No. 1 of 2014 - Prudential Standard APS 111 - Capital Adequacy: Measurement of Capital
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Banking (prudential standard) determination No. 1 of 2014
Prudential Standard APS 111 Capital Adequacy: Measurement of Capital
Banking Act 1959
I, Charles Littrell, delegate of APRA:
under subsection 11AF(3) of the Banking Act 1959 (the Act) REVOKE Banking (prudential standard) determination No. 4 of 2012, including Prudential Standard APS 111 Capital Adequacy: Measurement of Capital, made under that Determination; and
under subsection 11AF(1) of the Banking Act 1959 (the Act) DETERMINE Prudential Standard APS 111 Capital Adequacy: Measurement of Capital, in the form set out in the Schedule, which applies to ADIs and authorised NOHCs to the extent provided in paragraphs 2 to 5 of the prudential standard.
This instrument commences upon the date of registration of this instrument on the Federal Register of Legislative Instruments.
Dated: 8 April 2014
[Signed]
Charles Littrell
Executive General Manager
Policy, Statistics and International Division
Interpretation
In this Determination:
ADI has the meaning given in section 5 of the Act.
APRA means the Australian Prudential Regulation Authority.
authorised NOHC has the meaning given in section 5 of the Act.
Schedule
Prudential Standard APS 111 Capital Adequacy: Measurement of Capital comprises the 68 pages commencing on the following page.
Objectives and key requirements of this Prudential Standard<br>This Prudential Standard sets out the characteristics that an instrument must have to qualify as regulatory capital for an authorised deposit-taking institution (ADI) and the various regulatory adjustments to be made to determine total regulatory capital on both a Level 1 and Level 2 basis.<br>The ultimate responsibility for ensuring that an ADI’s regulatory capital meets the requirements of this Prudential Standard rests with its Board of directors.<br>The key requirements of this Prudential Standard are that an authorised deposit-taking institution must:<br>include in the appropriate category of regulatory capital (i.e. Common Equity Tier 1 Capital, Additional Tier 1 Capital or Tier 2 Capital) only those capital instruments that meet the detailed criteria for that category;ensure all regulatory capital instruments are capable of bearing loss on either a ‘going-concern’ basis (Tier 1 Capital) or a ‘gone-concern’ basis (Tier 2 Capital); andmake certain regulatory adjustments to capital, mainly from Common Equity Tier 1 Capital, to determine total regulatory capital.
This Prudential Standard is made under section 11AF of the Banking Act 1959 (the Banking Act).
Application
This Prudential Standard applies to all authorised deposit-taking institutions (ADIs), subject to paragraph 3.
This Prudential Standard does not apply to:
a foreign ADI, which must, however, be subject to comparable capital adequacy standards in its home country; or
a purchased payment facility provider (PPF provider).
A reference to an ADI in this Prudential Standard, unless otherwise indicated, is a reference to:
an ADI on a Level 1 basis; and
a group of which an ADI is a member on a Level 2 basis.
If an ADI to which this Prudential Standard applies is:
the holding company for a group of bodies corporate, the ADI must ensure that the requirements in this Prudential Standard are met on a Level 2 basis, where applicable; or
a subsidiary of an authorised non-operating holding company (authorised NOHC), the authorised NOHC must ensure that the requirements in this Prudential Standard are met on a Level 2 basis, where applicable.
Interpretation
Terms that are defined in Prudential Standard APS 001 Definitions appear in bold the first time they are used in this Prudential Standard.
Regulatory Capital
For the purposes of this Prudential Standard:
a component of capital is any form of capital defined in this Prudential Standard as eligible for inclusion in regulatory capital; and
a category of capital is a group of components of capital.
Regulatory Capital (Total Capital) consists of the following categories:
Tier 1 Capital (going-concern capital[1]), which comprises:
1. Common Equity Tier 1 Capital; and
2. Additional Tier 1 Capital; and
An ADI must ensure that any component of capital included in its Total Capital satisfies, in both form and substance, all requirements in this Prudential Standard for the particular category of capital in which it is included.
An ADI must not include a component of capital in a particular category of Regulatory Capital if that component, when considered in conjunction with other related transactions that affect its overall economic substance, could be reasonably considered not to satisfy the requirements of this Prudential Standard for that category of capital.
An ADI must ensure that the category of capital in which a component of capital is included, when measured at an individual group member level (Level 1 or equivalent), is not upgraded to a higher category of capital when measured in an ADI’s Regulatory Capital at Level 2. Any such component of capital must be reclassified to the appropriate lower category of capital when measured at Level 2.
An ADI must not include a capital instrument in a category of capital based on a future event, such as the future sale or issuance of a higher quality capital instrument, until such time as:
the future event occurs, and
the proceeds have been irrevocably received by the ADI.
APRA may, in writing, require an ADI to:
exclude from its Regulatory Capital any component of capital that in APRA’s opinion is not a genuine contribution to the financial strength of the ADI; or
reallocate to a lower category of capital any component of capital that in APRA’s opinion does not satisfy the requirements of this Prudential Standard for the category of capital to which it was originally allocated.
An ADI must provide APRA, as soon as practicable, with copies of documentation associated with the issue of Additional Tier 1 Capital and Tier 2 Capital instruments.
Where the terms of an instrument depart from established precedent, an ADI must consult with APRA on the eligibility of the capital instrument for inclusion in the ADI’s Regulatory Capital in advance of the issuance of the capital instrument, and provide APRA with all information it requires to assess the eligibility of the capital instrument.
An ADI must obtain APRA’s written consent before the terms or conditions of an instrument are amended in a way that may affect its eligibility as Regulatory Capital.
Application of fair values
An ADI may measure its financial instruments at fair value for capital adequacy purposes provided it complies with the requirements of Attachment A.
Common Equity Tier 1 Capital
Common Equity Tier 1 Capital comprises the highest quality components of capital that fully satisfy all of the following characteristics:
provide a permanent and unrestricted commitment of funds;
are freely available to absorb losses;
do not impose any unavoidable servicing charge against earnings; and
rank behind the claims of depositors and other creditors in the event of winding-up of the issuer.
Common Equity Tier 1 Capital consists of the sum of:
paid-up ordinary shares issued by an ADI that meet the criteria in Attachment B;
mutual equity interests issued by a mutually owned ADI that meet the criteria in Attachment K;
retained earnings;
undistributed current year earnings (refer to paragraphs 20 to 24);
accumulated other comprehensive income and other disclosed reserves (refer to paragraphs 25 and 26);
minority interests (calculated in accordance with Attachment C) arising from the issue of ordinary shares to third parties by a fully consolidated subsidiary[3] included in the Level 2 group where:
the shares giving rise to the minority interest would, if issued by the ADI, meet the criteria in Attachment B; and
the subsidiary issuing the shares is itself an ADI or an overseas deposit-taking institution that is subject to equivalent minimum prudential requirements and level of supervision as an ADI; and
regulatory adjustments applied in the calculation of Common Equity Tier 1 Capital in accordance with Attachment D.
Current year earnings must take into account:
negative goodwill;
the unwinding of any discount on credit loss provisions (refer to Attachment A of Prudential Standard APS 220 Credit Quality (APS 220));
expected tax expenses; and
dividends when declared in accordance with Australian Accounting Standards.
Declared dividends for the purpose of paragraph (d) may be reduced by the expected proceeds, as agreed in writing by APRA, of a Dividend Reinvestment Plan (DRP) to the extent that dividends are used to purchase new ordinary shares issued by the ADI. An ADI must review every six months the expected subscription for new ordinary shares under its DRP, having regard to experience over previous years and reasonable expectations of the level of subscription that might apply in future. If an ADI identifies any material change in the expected level of future subscription for new ordinary shares under its DRP, it must notify APRA and obtain APRA’s agreement to a new amount by which declared dividends may be reduced for regulatory capital purposes.
Current year earnings also include the full value of upfront fee income provided that:
the fee income has either been received in cash or has been debited to a customer’s account or otherwise forms part of the upfront fees owed by a customer;
outstanding amounts of fee income debited to customer accounts are claimable in full in the event of default by the customer, or capable of being sold to a third party as part of outstanding debts;
the provider of the income has no recourse for repayment in part or full of any prepaid income;
the customer cannot cancel any fees debited to the customer’s account for which they were otherwise obliged to pay upfront; and
there is no requirement for the provision of continuing additional services or products associated with the fee income concerned.
Fee income may include net positive amounts arising from the netting of deferred income and capitalised expenses associated with a product class provided the conditions in paragraph 22 are satisfied.
Current year earnings and retained earnings may include fair value adjustments provided these adjustments satisfy the requirements for the recognition of fair values set out in Attachment A and Attachment D.
Accumulated other comprehensive income and other disclosed reserves include, but are not limited to:
unrealised gains or losses recognised on the balance sheet;
reserves from equity-settled share-based payments (share or share options) granted to employees as part of their remuneration package provided that:
1. the share or share options granted relate only to the ordinary shares of the ADI;
2. the ordinary shares comprise only new ordinary shares to be issued by the ADI, or new ordinary shares already issued by the ADI for this specific purpose; and
3. there are no circumstances under which such remuneration can be converted into another form (e.g. cash).
Any other reserves associated with share-based payments must be excluded from Regulatory Capital;
foreign currency translation reserve;
cumulative unrealised gains or losses on hedges[4] offsetting gains or losses included in Common Equity Tier 1 Capital (such as movements in the currency value of foreign-currency-denominated hedging instruments that offset movements in foreign-currency-denominated items recognised in the foreign currency translation reserve). This includes fair value gains or losses on derivatives representing effective economic hedges of assets; and
any other gains and losses in accumulated other comprehensive income and other disclosed reserves that may be specified by APRA in writing.
Revaluation of property holdings may be included as part of other disclosed reserves only if:
the property is owned by the ADI or a member of the Level 2 group at Level 2;
the property comprises only land and buildings;
the property is readily available to be sold. A property need not be scheduled for sale, nor need a sale be intended. However, such a property must be capable of being readily sold within six months were a decision made to sell the property;
the reserves are shown as a component of equity in the audited published financial accounts of the ADI (and the group that it heads);
the revaluations are reliable, in accordance with Australian Accounting Standards, and subject to audit or review consistent with Australian Auditing and Assurance Standards. An investment property must be measured at fair value in accordance with Australian Accounting Standards; and
the amount of reserves incorporates the full effect of any fair value gains or losses and any gains or losses on hedges offsetting revaluations of the property (owner-occupied property and investment property) included in the reserves.
Additional Tier 1 Capital
Additional Tier 1 Capital comprises high quality components of capital that satisfy the following essential characteristics:
provide a permanent and unrestricted commitment of funds;
are freely available to absorb losses;
rank behind the claims of depositors and other more senior creditors in the event of winding up of the issuer; and
provide for fully discretionary capital distributions.
Additional Tier 1 Capital consists of:
instruments issued by an ADI that are not included in Common Equity Tier 1 Capital and which meet:
1. the criteria for inclusion in Additional Tier 1 Capital set out in Attachment E;
2. for instruments classified as liabilities under Australian Accounting Standards, the loss absorption requirements set out in Attachment F; and
3. the requirements for loss absorption at the point of non-viability set out in Attachment J;
instruments issued by a fully consolidated subsidiary[5] of the Level 2 group and held by third parties (calculated in accordance with Attachment C) where:
1. the instruments would, if issued by the ADI, meet the criteria in Attachment E;
2. instruments classified as liabilities under Australian Accounting Standards meet the loss absorption requirements set out in Attachment F; and
3. the instruments meet the requirements for loss absorption at the point of non-viability set out in Attachment J; and
regulatory adjustments applied in the calculation of Additional Tier 1 Capital in accordance with Attachment D.
Instruments may also be included in Additional Tier 1 Capital in accordance with Attachment L.
An Additional Tier 1 Capital instrument may be a stapled security structure provided the structure meets the criteria in Attachment G.
Tier 2 Capital
Tier 2 Capital includes other components of capital that, to varying degrees, fall short of the quality of Tier 1 Capital but nonetheless contribute to the overall strength of an ADI and its capacity to absorb losses.
Tier 2 Capital consists of:
instruments issued by the ADI at Level 1 that meet:
1. the criteria for inclusion in Tier 2 Capital set out in Attachment H; and
2. the requirements for loss absorption at the point of non-viability set out in Attachment J;
instruments issued by a fully consolidated subsidiary[6] of the Level 2 group and held by third parties (calculated in accordance with Attachment C) where:
1. the instruments would, if issued by the ADI, meet the criteria in Attachment H;
2. the instruments meet the requirements for loss absorption at the point of non-viability set out in Attachment J;
a General Reserve for Credit Losses (GRCL) (refer to APS 220), unless APRA determines otherwise in writing; and
regulatory adjustments applied in the calculation of Tier 2 Capital in accordance with Attachment D.
Instruments may also be included in Tier 2 Capital in accordance with Attachment L.
The GRCL may be included in Tier 2 Capital gross of tax effects up to the following limits:
for an ADI using the Standardised Approach to credit risk: a maximum of 1.25 per cent of total credit risk-weighted on-balance sheet and off-balance sheet assets calculated under Prudential Standard APS 112 Capital Adequacy: Standardised Approach to Credit Risk (APS 112);
for an ADI using the internal ratings-based (IRB) approach to credit risk: a maximum of 0.6 per cent of total credit risk-weighted assets for non-defaulted exposures, to the extent that total eligible provisions exceed total expected losses;
for an ADI using a partial IRB approach to credit risk: the sum of reserves proportionately based on the limits in (a) and (b); or
where it is not possible for the ADI to determine whether the GRCL relates to assets under the standardised or IRB approaches to credit risk: allocation on a basis that is reasonable and consistent.
If a GRCL has not already resulted in a charge to profit or loss (e.g. by way of establishment of a general reserve or provision in audited published financial accounts), a GRCL reported for capital purposes must be matched by a corresponding reduction in an ADI’s Common Equity Tier 1 Capital.
Additional Tier 1 or Tier 2 Capital issued overseas by ADIs or subsidiaries
Additional Tier 1 Capital instruments and Tier 2 Capital instruments may be issued by an ADI, or a consolidated subsidiary in the Level 2 group, either in its country of incorporation or through a branch in another country, provided the instrument:
constitutes an obligation of the ADI or of the consolidated subsidiary itself at all times;
is freely available to absorb losses on a going concern (Additional Tier 1 Capital only) and gone concern basis across all of the operations of the ADI, or the consolidated subsidiary that issued the instrument; and
meets all of the requirements of this Prudential Standard for inclusion in Additional Tier 1 or Tier 2 Capital.
Use of Special Purpose Vehicles to issue Additional Tier 1 and Tier 2 Capital instruments
Capital instruments issued through a Special Purpose Vehicle (SPV) must satisfy the requirements of Attachment I to be eligible Additional Tier 1 Capital or Tier 2 Capital.
Intra-group capital transactions
The matters APRA may consider in assessing whether a component of capital resulting from intra-group transactions does not represent a genuine contribution to financial strength include, but are not limited to, whether a component of capital:
is clearly supplied from debt raised by other group members;
results from intra-group transactions with no economic substance;
is contributed by a member of the group using funding sourced, directly or indirectly, from the ADI itself; or
is contributed by a group member and the funding of which contains cross-default clauses that would be triggered as a result of the ADI failing to meet any servicing obligations.
In assessing the overall strength of an ADI on a Level 2 basis, APRA will have regard to the ability of the ADI to readily extract capital from members of the Level 2 group should the need arise to recapitalise the ADI or other members of the group. APRA may require an ADI to adjust its Level 2 regulatory capital ratios to reflect any inability to readily extract capital and any limitations on the amount of capital that may be extracted.
In measuring Regulatory Capital at Level 2, an ADI must exclude any instrument issued by a member of the Level 2 group where the obligations under that instrument are guaranteed by another group member.
Holding of capital instruments in group members by other group members
Capital instruments[7] of an ADI, a member of a group headed by an ADI, or a NOHC at Level 2 that are held as direct investments by a vehicle[8] subject to consolidation within the ADI’s financial statements in accordance with Australian Accounting Standards may be included in Common Equity Tier 1 Capital, Additional Tier 1 Capital and Tier 2 Capital (on both a Level 1 and Level 2 basis, as appropriate) only if:
the ADI (or relevant vehicle) did not fund the acquisition of the capital instruments (i.e. acquisition of capital instruments is funded by third parties such as life insurance policyholders or other third-party investors);
the risk and rewards associated with the investments are borne primarily by third parties; and
the ADI can demonstrate to APRA, if required, that decisions to acquire or sell such capital instruments are made independently of the issuer of the capital instruments and in the interests of the third parties who primarily bear the risks and rewards of the investments in the instruments.
Direct investments in shares of an ADI by an SPV (e.g. a trust) established under a share-based employee remuneration scheme may be included in the ADI’s Common Equity Tier 1 Capital (on a Level 1 and Level 2 basis, as appropriate) only if:
the shares issued to the SPV represent ordinary shares of the ADI;
the amount included in Common Equity Tier 1 Capital is matched by an equivalent charge to profit and loss of the ADI for expensing the issue or funding the acquisition of ordinary shares by the vehicle; and
the ordinary shares issued cannot be converted to payment in another form (e.g. cash).
For the purposes of measuring Regulatory Capital at Level 2, the SPV holding such shares must be excluded from the consolidated group. As a consequence, any associated change in the fair value of the shares held by an SPV must be excluded from Regulatory Capital and risk-weighted assets at Level 2.
If the requirements in paragraphs 39 and 40 are not satisfied, the relevant capital instruments must be treated as holdings of own capital instruments and deducted from Common Equity Tier 1 Capital, Additional Tier 1 Capital and Tier 2 Capital, as appropriate.
Adjustments and exclusions
APRA may, by notice in writing, adjust or exclude a specific requirement in this Prudential Standard in relation to one or more specified ADIs or authorised NOHCs[9].
Attachment A
Use of fair values
An ADI may measure its financial instruments at fair value for capital adequacy (both banking book and trading book) and other stated prudential purposes provided:
the ADI complies with the requirements of Australian Accounting Standards relating to the use of fair values;
valuations are reliable, including use of reasonable estimates of values;
the use of fair values and associated valuations are covered by the ADI’s risk management systems, including related risk management policies, procedures and controls;
the ADI notifies APRA promptly whenever there is a material reclassification by the ADI of financial assets and liabilities from amortised cost to fair values or from fair values to amortised cost; and
the ADI meets all requirements set out below, as applicable, with respect to measurement of financial instruments at fair values.
For the purposes of paragraph (c), an ADI must:
have clear and robust governance structures for the production, assignment, verification and oversight of the valuation of financial instruments;
have adequate capacity, including during periods of stress, to establish and verify valuations. This capacity must be commensurate with the importance, risk and size of exposures being valued in the context of the business profile of the ADI;
for exposures that represent a material risk, have a capacity to produce valuations using alternative methods in the event that primary valuation inputs and valuation approaches become unreliable, unavailable or not relevant due to market discontinuities or illiquidity;
test and review on a regular basis the performance of its valuations, including under stress conditions, so that it understands the limitations of its valuations. This is of particular significance where an ADI makes use of models for valuation purposes; and
ensure adequate internal audit review of the implementation of policies and procedures for producing fair values and their application.
An ADI must advise APRA, if requested, of details of:
the ADI’s use of fair values of financial instruments and the ADI’s valuation policies and procedures;
the relationship between the ADI’s use of fair values and its risk management policies and procedures; and
the ADI’s assessment of the impact of the application of fair values on the value of financial instruments for capital adequacy purposes.
If APRA considers that an ADI’s policies and procedures for the application of fair values, or the fair values recognised by an ADI, are not reliable, or adversely affect the ADI’s safety and soundness, APRA may, in writing, require it to amend its policies and procedures, make adjustments to fair values of financial instruments included in Regulatory Capital, discontinue using fair value measures for regulatory reporting or hold higher levels of capital.
Systems and controls
An ADI’s systems and controls used for valuation purposes must:
include documented policies and procedures for the process of valuation. This must incorporate clearly defined responsibilities of the various areas involved in this process;
ensure clear and independent reporting lines for the areas responsible for the valuation process;
provide for the Board to receive reports from senior management on the valuation oversight and valuation performance issues that are notified to senior management for resolution, as well as all significant changes in valuation policies;
be integrated with other risk management systems within the ADI;
outline assets and liabilities and other positions to be recognised at fair value and the processes for approving use of fair values for new items, products and transactions. New product approval processes must include all internal stakeholders relevant to risk measurement, risk control and the assignment and verification of valuations of financial instruments involved;
enable the ADI to make choices regarding the alternative treatments for categorising financial instruments using fair value measures under accounting practice[10] in a fully informed and disciplined manner;
specify the relationship between the application of fair value measures and the ADI’s risk management framework;
detail the processes for ensuring that the use of fair values is applied consistently across the ADI for capital adequacy, reporting and risk management purposes, including across similar instruments (risks) and business lines (books). This must include the frequency at which fair values will be calculated and reported; and
explicitly assess valuation uncertainties and ensure that assessments of material valuation uncertainties are included in the information provided to the Board and senior management.
Valuation methodologies
An ADI’s policies and procedures governing the use of fair value measurement must:
outline the methods used for the selection and validation of valuation processes used in calculating and reporting fair values including, where appropriate, independent review, analysis of model stability and performance over a variety of conditions, use of back-testing and frequency of validation. The ADI must retain data and supporting documentation for these purposes;
include rigorous and independent validation and control processes in relation to the design and validation of methodologies used to produce valuations. These valuations must maximise the use of relevant and reliable inputs in a controlled and disciplined manner and incorporate all other important information so that fair value estimates are as reliable as possible;
maximise the use of relevant observable inputs, and minimise the use of unobservable inputs, when estimating fair values using a valuation technique; and
only mark-to-model where mark-to-market is not possible. The ADI must be able to demonstrate that any use of mark-to-model is prudent.
The relevance and reliability of valuations that an ADI makes are directly related to the quality and reliability of the inputs used in the valuation methodology applied. In determining whether a source of market prices or values used in the methodology applied is reliable, an ADI must consider, amongst other things:
accounting guidance provided in Australian Accounting Standards applicable to the determination of relevant market information and other factors likely to have a material effect on a financial instrument’s fair value;
the frequency and availability of the prices/quotes utilised;
whether those prices/quotes represent, or are supported by, actual regularly occurring transactions on an arm’s-length basis;
the breadth of the distribution of the price or value data and whether it is generally available to relevant participants in the market;
the timeliness of the information relative to the frequency of valuations required to be undertaken;
the number of independent sources that produce the prices/quotes; and
the similarity between a financial instrument sold in a transaction and the actual instrument held by the ADI.
Mark-to-market valuation methodologies
An ADI must mark-to-market at least daily utilising readily available close-out prices in orderly transactions.
An ADI must ensure that prices utilised for mark-to-market valuation purposes are:
sourced independently; and
use the more prudent side of the bid/offer close-out prices unless the ADI can demonstrate it is a significant market maker in a particular position type and can close out at mid-market closing prices.
Observable inputs must be considered but need not be determinative in valuation processes where an ADI has reasonable grounds to believe that:
observable inputs or transactions may not be relevant, such as in forced liquidation or distressed sale scenarios; and
inputs or transactions may not be observable such as where markets are inactive.
Mark-to-model valuation methodologies
Mark-to-model means any valuation that has to be benchmarked, extrapolated or otherwise calculated from a market input, other than valuations calculated from market inputs using market-convention pricing formulae (where such inputs are generally considered to be mark-to-market equivalents).
An ADI may only use mark-to-model if:
marking-to-market is not possible;
use of mark-to-model valuation can be demonstrated to be prudent; and
the valuation procedure applies an extra degree of conservatism.
In order for a mark-to-model valuation process to be reliable:
senior management of the ADI must be aware of the elements of fair valued positions that are subject to mark-to-model and understand the materiality of the uncertainty this creates in the reporting of risk/reward of the business undertaken;
market inputs in the model process must be sourced, to the extent possible, in line with market prices. The ADI must regularly review the appropriateness of market inputs used for the particular position being valued;
where available, generally accepted valuation methodologies for particular products must be used as far as possible;
where a model is developed by the ADI itself, it must be:
1. based on appropriate assumptions, which have been assessed and challenged by suitably qualified parties independent of the development process;
2. developed or approved independently of the area within the ADI that will be utilising the model for its business activities; and
3. tested independently, including validating the mathematics, the assumptions and the software implementation;
there must be formal change control procedures in place and a secure copy of the model must be held and periodically used to check valuations;
the ADI’s risk management function must be aware of the weaknesses in the model and how best to address such weaknesses in the valuation output;
the model must be subject to periodic review by the ADI to determine the accuracy of its performance, including:
1. assessment of the appropriateness of assumptions utilised; and
2. analysis of profit and loss versus risk factors;
comparison must be made between actual close-out values to model outputs; and
valuation adjustments must be made, as appropriate, including to cover the uncertainty of model valuations (refer to paragraphs 14 to 21 of this Attachment).
Valuation adjustments
If an ADI uses fair value measurement, it may need to adjust the values produced by its mark-to-market and mark-to-model valuation methodologies. If an ADI seeks to make such adjustments it must:
apply a rigorous and consistent process to determine valuation adjustments as appropriate;
consider whether any valuation adjustments are necessary where third-party valuations are used in mark-to-market or mark-to-model; and
take into account, at a minimum, the following matters:
1. close-out costs;
2. unearned credit spreads;
3. operational risks;
4. early termination;
5. investing and funding costs;
6. any future administrative costs; and
7. as appropriate, model risk.
Valuation adjustments that need to be made must, unless otherwise provided for in this Prudential Standard, impact on Common Equity Tier 1 Capital and may exceed those made under financial reporting standards.
Illiquid positions
An ADI must have procedures in place, if needed:
to adjust current fair value measurements to account for any illiquidity of positions;
to calculate the necessary adjustments where positions are judged to be illiquid; and
to review the appropriateness of those adjustments, or lack thereof, on a regular (at least monthly) basis.
This applies whether or not a position is marked-to-market using market prices, observable inputs or third-party valuations, or is marked-to-model.
Relevant factors an ADI must consider in determining valuation adjustments for illiquidity include, but are not limited to:
the average volatility of bid/offer spreads;
the availability of independent market quotes (number and identity of market makers);
the average volatility (under normal market conditions and in periods of market stress) of trading volumes and volumes of assets and liabilities that are exchanged;
market concentrations;
ageing of positions;
the amount of time it would take to hedge the position/risks within the position or to otherwise dispose of an asset or liability or other position;
the extent to which the valuation relies on mark-to-model; and
the impact of other model risks.
For complex products, including but not limited to securitisation exposures and nth-to-default credit derivatives, an ADI must explicitly assess the need for valuation adjustments to reflect model risk associated with using:
a possibly incorrect valuation methodology; and
unobservable (and possibly incorrect) calibrations in the valuation model.
An adjustment to the current valuation of less liquid positions must, unless otherwise provided for in this Prudential Standard, impact on Common Equity Tier 1 Capital and may exceed valuation adjustments made under financial reporting standards and those other adjustments required to be made (refer to paragraph 14 of this Attachment).
Independent price verification
An ADI must arrange independent price verification to be performed at regular intervals so that market prices or model inputs used in valuation processes are verified for accuracy. Such verification must be performed by parties independent of dealing, trading or asset or liability origination areas.
Independent price verification entails a higher standard of accuracy than market prices or model inputs used for daily marking-to-market purposes. For independent price verification where pricing sources are more subjective, an ADI must consider whether prudent measures such as valuation adjustments (see above) may be appropriate and make such adjustments as necessary.
Own creditworthiness
An ADI’s policies and procedures must set out how it determines the fair value gains and losses arising from changes in the ADI’s own creditworthiness and that of other group members at Level 2.
Attachment B
Criteria for classification as paid-up ordinary shares
To be classified as paid-up ordinary shares in Common Equity Tier 1 Capital, an instrument must satisfy the following criteria:
the instrument represents the most subordinated claim in liquidation of the issuer;
the instrument holder is entitled to a claim on the residual assets that is proportional to its share of issued capital, after all senior claims have been repaid in liquidation (i.e. there is an unlimited and variable claim, not a fixed or capped claim);
the principal amount of the instrument is perpetual (i.e. it has no maturity date) and is never repaid outside of liquidation (other than discretionary repurchases subject to APRA approval);
the issuer, and any other member of a group to which the issuer belongs, does nothing to create an expectation at issuance that the instrument will be bought back, redeemed or cancelled and the statutory or contractual terms of the instrument do not include any feature that might give rise to such an expectation;
distributions on the instrument are paid out of distributable items (retained earnings included) of the issuer, and the terms of the instrument do not provide for payment to investors other than in the form of a cash payment. The level of distributions must not be tied or linked to the amount paid up at issuance, or to the credit standing of the issuer, and must not be subject to a contractual cap, except to the extent that restrictions applied to the payment of distributions are in accordance with Prudential Standard APS 110 Capital Adequacy (APS 110);
there are no circumstances under which the distributions are obligatory. Non-payment of a distribution does not trigger any restrictions on the issuer or any other member of the group to which the issuer belongs. Any waived distributions are non-cumulative (i.e. they are not required to be made up by the issuer at a later date). Non-payment of distributions must not be an event of default of the issuer or of any other member of the group to which the issuer belongs;
distributions are paid only after all legal and contractual obligations have been met and payments on more senior capital instruments have been made. There are no preferential distributions, including in respect of other elements classified as Common Equity Tier 1 Capital;
the instruments take the first and proportionately greatest share of any losses as they occur[11]. Within Common Equity Tier 1 Capital, each instrument absorbs losses on a going concern basis proportionately, and pari passu, with all the other instruments included in Common Equity Tier 1 Capital[12];
only the paid-up amount of the instrument, irrevocably received by the issuer, is recognised as equity capital (i.e. it is not recognised as a liability) for determining balance sheet insolvency;
the paid-up amount of the instrument is classified as equity under relevant accounting standards[13];
the instrument is directly issued by the issuer, and, except where otherwise permitted in this Prudential Standard, the issuer, any other member of a group to which the issuer belongs, or any related entity[14], cannot have purchased or directly or indirectly[15] funded the purchase of the instrument;
the paid-up amount of the instrument, or any future payments related to the instrument, is neither secured nor covered by a guarantee of the issuer or a related entity[16], or subject to any other arrangement that legally or economically enhances the seniority of the claim. The instrument may not be subject to netting or offset claims on behalf of the holder or the issuer of the instrument;
the instrument is only issued with the approval of the owners of the issuer, either given directly by the owners or, if permitted by applicable law, given by the Board or by other persons duly authorised by the owners; and
the instrument is clearly and separately disclosed on the issuer’s financial statements and, in any consolidated financial statements. Disclosure must be in line with the frequency with which an ADI, or group of which it is a member, publishes its financial results.
Where an instrument is subject to the laws of a jurisdiction other than Australia or its territories, the ADI must also ensure that the instrument satisfies all relevant qualifying criteria for Common Equity Tier 1 Capital under the laws of that jurisdiction. APRA may require the ADI to provide an independent expert opinion, addressed to APRA by a firm or practitioner of APRA’s choice and at the expense of the ADI, confirming that the instrument meets all or any of the criteria applied to Common Equity Tier 1 Capital instruments in this Prudential Standard.
For the purposes of Attachment K, a reference in this Attachment (except in paragraphs 1(b) and (e)) to ‘ordinary shares’ is to be read as a reference to ‘mutual equity interests’.
Attachment C
Minority interest and other capital issued out of fully consolidated subsidiaries that is held by third parties
Common Equity Tier 1 Capital, Additional Tier 1 Capital and Tier 2 Capital issued to third parties by fully consolidated subsidiaries of a Level 2 group may be included in Total Capital at Level 2 to the extent set out in this Attachment and paragraphs (f), 27(b) and 27(b) of this Prudential Standard.
Where a fully consolidated subsidiary of a Level 2 group has its own subsidiaries, all calculations of eligible Regulatory Capital attributable to third parties must be undertaken in respect of that subsidiary and its subsidiaries as a consolidated group.
An ADI may elect not to recognise, at Level 2, capital issued by a fully consolidated subsidiary to third parties. However, the ADI must continue to include all exposures of those subsidiaries when calculating its total risk-weighted assets for Level 2 capital adequacy purposes.
The amount that may be included in Regulatory Capital at Level 2 is the:
total amount of the capital attributable to third parties, less
any surplus capital amount above the minimum regulatory requirements
as calculated in paragraphs 5, 6 and 7 below.
Common Equity Tier 1 Capital (minority interest)
Minority interest in Common Equity Tier 1 Capital of a Level 2 subsidiary that is eligible to be included in the ADI’s Common Equity Tier 1 Capital at Level 2 is calculated as:
the percentage of all Common Equity Tier 1 Capital of the subsidiary that is attributable to third parties; multiplied by
the amount of Common Equity Tier 1 Capital of the subsidiary that is used to satisfy the Common Equity Tier 1 PCR and capital conservation buffer requirements at Level 2 arising from exposures held by the subsidiary[17].
Tier 1 Capital
The amount of Tier 1 Capital instruments issued by a subsidiary to third parties that may be included in an ADI’s Tier 1 Capital at Level 2 is calculated as:
the percentage of all Tier 1 Capital of the subsidiary attributable to third parties; multiplied by
the amount of Tier 1 Capital of the subsidiary that is used to satisfy the ADI’s Tier 1 PCR and capital conservation buffer requirements at Level 2 arising from exposures held by the subsidiary[18].
Total Capital
The amount of Total Capital instruments issued by a subsidiary to third parties that may be included in an ADI’s Total Capital at Level 2 is calculated as:
the percentage of Total Capital of the subsidiary attributable to third parties; multiplied by
the amount of Total Capital of the subsidiary that is used to satisfy the ADI’s Total Capital PCR and capital conservation buffer requirements arising from exposures held by the subsidiary[19].
Attachment D
Regulatory adjustments
General rules for regulatory adjustments
In determining the size of deductions from an ADI’s Regulatory Capital, items must be valued on the same basis as an ADI’s balance sheet valuations.
For the purposes of regulatory adjustments to Additional Tier 1 Capital and Tier 2 Capital:
where the amount of Additional Tier 1 Capital is insufficient to cover the amount of deductions required to be made from this category of capital, the shortfall must be deducted from Common Equity Tier 1 Capital; and
where the amount of Tier 2 Capital is insufficient to cover the amount of deductions required to be made from this category of capital, the shortfall must be deducted from Additional Tier 1 Capital and, if Additional Tier 1 Capital is insufficient to cover the amount of the deductions required, the remaining amount must be deducted from Common Equity Tier 1 Capital.
All equity holdings and other capital support provided to financial institutions, and holdings of own capital instruments must be deducted following the corresponding deduction approach i.e. the deduction is to be applied to the same tier of capital for which the capital would qualify if issued by the ADI itself.
Where a capital instrument is required to be deducted and it is not possible to determine whether it should be deducted from Common Equity Tier 1 Capital, Additional Tier 1 Capital or Tier 2 Capital, the regulatory adjustment must be made from Common Equity Tier 1 Capital. An ADI must consult APRA if there is uncertainty about the category of capital against which a deduction must be made.
An ADI that finds it operationally difficult to look through and monitor the exact exposure to equity and other capital instruments that it holds in institutions, including through holdings of indexed securities, may apply to APRA to use a proxy approach for determining the amount of exposures to deduct. APRA may allow an ADI to apply an annual estimate of the amount to be deducted where the ADI can demonstrate that it can obtain details, at least annually, of the proportion of exposures to financial and commercial institutions (such as an indexed security) comprised of equity and other exposures of a capital nature. Where an ADI cannot meet this requirement, it must deduct the full value of its indirect exposures.
All amounts of assets corresponding to deductions from capital made at Level 1 and Level 2 must be excluded when calculating an ADI’s total risk-weighted assets at the respective level. Notwithstanding that the changes in value of some hedges may be deducted from capital, the credit risk of these hedges must continue to be included in total risk-weighted assets in accordance with Attachment H of APS 112.
For the purposes of deducting:
equity exposures;
holdings of Additional Tier 1 Capital and Tier 2 Capital instruments; and
securitisation exposures,
an ADI may net any specific provisions raised against the relevant exposures or holdings before making the necessary deductions from the relevant categories of capital.
Equity holdings and other capital support provided to financial institutions[20]
Unless otherwise indicated, an ADI must deduct from the corresponding category of capital direct, indirect[21] and synthetic equity exposures, guarantees and other forms of capital support, and holdings of Additional Tier 1 Capital and Tier 2 Capital instruments in ADIs and overseas deposit-taking institutions and their subsidiaries, insurance companies and other financial institutions. This includes:
equity exposures, guarantees and other forms of capital support held in the banking book;
net long positions[22] in equity held in the trading book (refer to Prudential Standard APS 116 Market Risk (APS 116)); and
underwriting positions in equity held for more than five working days.
An ADI is not required to deduct:
equity exposures in ADIs and equivalent overseas deposit-taking institutions[23] and their subsidiaries, insurance companies and other financial institutions held under a legal agreement on behalf of a third party, even if held in the name of the ADI (or other members of the Level 2 group), where the third party derives exclusively and irrevocably all the gains and losses of such exposures and investments;
underwriting positions in equities held for five working days or less. Such exposures must be risk-weighted at 300 per cent if listed and at 400 per cent if unlisted; and
at Level 1, equity exposures held in other ADIs or overseas deposit-taking institutions and their subsidiaries, and insurance companies that are subsidiaries of the ADI. Such exposures, after deduction of any intangibles component, must be risk-weighted at 300 per cent if listed and at 400 per cent if unlisted.
Equity holdings include:
equity exposures (as defined in paragraphs 49 to 52 of Prudential Standard APS 113 Capital Adequacy: Internal Ratings-based Approach to Credit Risk (APS 113)) and, in the case of an APRA-regulated institution or an overseas equivalent, holdings of debt instruments issued by the entity or other facilities that qualify as Regulatory Capital. Investments include indirect holdings such as holdings of units in a trust; and
equity exposures including any portion of current year earnings or retained earnings that represents any amount deriving from the ADI’s share of undistributed profit or loss in an associate under equity accounting that is reflected in the value of equity investments in associates.
For the purposes of this Prudential Standard, the amount of equity exposures (as defined in paragraphs 49 to 52 of APS 113) and any other capital support that must be deducted from capital is the book value of the equity exposure or other capital support, including any amount by which they have been revalued. Any intangible component (particularly goodwill) included in the valuation of equity exposures or other capital support must be deducted from Common Equity Tier 1 Capital. In the case of equity, or other capital support provided to a subsidiary, this would be calculated as the excess of the book value over the net tangible assets of the subsidiary.
Where any equity holdings and other capital support in non-consolidated subsidiaries, including minority interests, have been incorporated for accounting purposes into the ADI’s consolidated group accounts, the consolidation of these entities must, unless the value of such equity holdings and capital support is otherwise required to be deducted from Common Equity Tier 1 Capital under this Prudential Standard, be reversed prior to the calculation of risk-based capital ratios at Level 2; that is, any retained earnings, other reserves or minority interests of these entities included in Common Equity Tier 1 Capital, and any other items impacting on any other Level 2 category of capital as a result of the accounting consolidation, must be removed from that category for capital adequacy purposes. Goodwill and any other intangible component of the investments in non-consolidated subsidiaries must be deducted from the ADI’s Common Equity Tier 1 Capital at Level 2.
In considering whether a facility, including a guarantee, provided to a related entity constitutes capital support, APRA will have regard to, amongst other things, whether:
the facility represents a recognised capital instrument or is otherwise accepted as standing in place of capital required to be held by a related entity; or
the provider of the facility, in terms of either repayment or maturity, ranks below other senior unsecured or unsubordinated creditors; or
the facility is provided by an ADI or other member of a Level 2 group and the funding provided flows through one member of the group (including any SPV) to another member of the group and the funding received by the second entity meets either (a) or (b).
In considering whether a facility (including a guarantee) provided to an unrelated entity[24] represents capital support, APRA will have regard to, amongst other things, whether:
the facility represents a recognised capital instrument or is otherwise accepted as standing in place of capital required to be held by the entity; or
the provider of the facility is subordinated to other creditors, and the facility is not otherwise captured by provisions in APS 112 or APS 113 that consider the level of subordination in determining capital requirements for such facilities.
If a facility covered in paragraphs 12 or 13 represents a form of capital support, it must be considered for the purposes of this Prudential Standard to form part of an ADI’s equity holdings. Investments that are not deducted from Common Equity Tier 1 Capital must be risk-weighted at 400 per cent.
Holdings of own capital instruments
Unless otherwise indicated, an ADI must deduct from the corresponding category of capital, holdings of its own capital instruments, whether held directly or indirectly[25], unless otherwise exempted in writing by APRA or unless eliminated under Australian Accounting Standards from the relevant category of capital. This deduction must include any capital instruments that the ADI (or other members of the Level 2 group) could be contractually obliged to purchase, regardless of whether the holdings are recorded in the banking or trading book. An ADI must also deduct all of the unused portion of any trading limit agreed with APRA.
Unless otherwise indicated, the gross long positions of own capital instruments may be deducted net of short positions in own capital instruments only if the short positions involve no counterparty risk. An ADI must look through holdings of index securities to determine exposures of own ordinary shares to be deducted[26].
For the purposes of this Prudential Standard, an ADI or member of a group headed by an ADI may, as a result of membership of a dealer panel, trading or other activities agreed with APRA, undertake limited purchases of its own Common Equity Tier 1 Capital instruments, Additional Tier 1 Capital instruments and Tier 2 Capital instruments or capital instruments issued by other members of the Level 2 group to which it belongs. Such purchases are subject to a limit as agreed with APRA, and the amount equal to the limit (or alternatively any actual holdings plus unused limit) must be deducted from Common Equity Tier 1 Capital, Additional Tier 1 Capital and Tier 2 Capital as appropriate, both at Level 1 and Level 2. This requirement does not apply to holdings of capital instruments by members of a group on behalf of third parties.
Regulatory adjustments to Common Equity Tier 1 Capital
An ADI must make the following regulatory adjustments to determine Common Equity Tier 1 Capital at both Level 1 and Level 2.
Asset impairment
An ADI must deduct any identified impairment of an asset where the impairment has not already been taken into account in profit and loss.
Cash flow hedge reserve
An ADI must eliminate the amount of the cash flow hedge reserve that relates to the hedging of items that are not recorded at fair value on the balance sheet (including projected cash flows)[27].
Covered bonds excess assets in cover pools
An ADI must deduct the total value of assets in Australia held in cover pools securing the issue of covered bonds by the ADI that are in excess of eight per cent of the ADI’s assets in Australia.
Deferred tax assets and deferred tax liabilities
An ADI must deduct from its Common Equity Tier 1 Capital the net amount of its:
deferred tax assets; less
deferred tax liabilities.
An ADI must net these items on a consistent basis for the purposes of this Prudential Standard. In the event that deferred tax liabilities exceed the amount of deferred tax assets, the excess cannot be added to Common Equity Tier 1 Capital (i.e. the net deduction is zero).
Netting of deferred tax assets and deferred tax liabilities must only be applied where:
an ADI or member of a group that the ADI heads has a legally enforceable right to set-off current tax assets against current tax liabilities where they relate to income taxes levied by the same taxation authority and the taxation authority permits the ADI or group members to make or receive a single net payment; and
the deferred tax assets and deferred tax liabilities relate to income taxes levied by the same authority on either:
1. the same taxable member of a group; or
2. different taxable members of a group for which group policies and procedures have been established that provide for the relevant group members to settle current tax assets and liabilities on a net basis, or to realise the assets and liabilities simultaneously, in each future period in which significant amounts of deferred tax assets or liabilities are to be settled or recovered; and
3. for direct or indirect subsidiaries of the ADI incorporated outside Australia for which:
it is claimed current tax assets and liabilities will be settled on a net basis; and
netting may have a material impact on any amount of deferred tax assets, an ADI may be required to deduct from its capital;
the group headed by the ADI must have written opinions from relevant external auditors and legal advisors that the relevant tax authorities allow, or would allow, netting of deferred tax assets and deferred tax liabilities. An ADI must provide relevant written auditor or legal opinions to APRA, if requested.
An ADI must:
have procedures in place to monitor changes in relevant laws and taxation practices that may affect the written opinions it is required to obtain covering netting of deferred tax assets and deferred tax liabilities; and
ensure that the written opinions are updated in the event of changes in laws or taxation practices overseas that could materially impact on overseas taxation authorities continuing to allow netting of deferred tax assets and deferred tax liabilities.
Equity holdings and other capital support provided to commercial (non-financial) entities
An ADI must deduct direct, indirect[28] and synthetic equity exposures (as defined in paragraphs 49 to 52 of APS 113)[29], guarantees and other forms of capital support (refer to paragraphs 9 to 14)[30] provided to commercial (non-financial) institutions. This includes:
equity exposures, guarantees and other forms of capital support held in the banking book; and
underwriting positions in equities held for more than five working days.
An ADI is not required to deduct:
equity exposures in the ADI’s trading book. Such exposures must be treated in accordance with the provisions of APS 116;
underwriting positions of equities held for five working days or less. Such exposures must be risk-weighted at 300 per cent if listed and at 400 per cent if unlisted; or
equity exposures held under a legal agreement on behalf of a third party, even if held in the name of the ADI (or other member of the Level 2 group), where the third party derives exclusively and irrevocably all the gains and losses of such exposures and investments.
Fair value gains and losses arising from changes in own creditworthiness
An ADI must eliminate all unrealised gains and losses that have resulted from changes in the fair value of liabilities (including capital instruments)[31], due to changes in the ADI’s own creditworthiness.
Goodwill and other intangibles
An ADI must deduct the following net of any associated deferred tax liability that would be extinguished if the assets involved become impaired or derecognised under Australian Accounting Standards:
goodwill and any other intangible assets[32] arising from an acquisition, net of adjustments to profit or loss reflecting any changes arising from ‘impairment’ of goodwill (at Level 1, intangibles also include the intangible components of investments in subsidiaries that could arise in relation to acquisitions); and
other intangible assets net of adjustments to profit or loss reflecting amortisation and impairment. Intangible assets are as defined in Australian Accounting Standards and include capitalised expenses, capitalised transaction costs and mortgage servicing rights. These expenses include:
1. loan/lease origination/broker fees and commissions that are capitalised as an asset which are to be set off against the balance of upfront loan/lease origination/broker fees and commissions associated with the lending portfolios that are treated as deferred income and recognised as a liability. The positive balance of the net loan/lease origination/broker fees and commissions must be deducted from Common Equity Tier 1 Capital. A negative balance may be added to Common Equity Tier 1 Capital provided the net deferred income satisfies the criteria in this Prudential Standard. Otherwise, a negative balance must not be added to capital;
2. costs associated with debt raisings and other similar transaction-related costs that are capitalised as an asset;
3. costs associated with issuing capital instruments if not already charged to profit and loss;
4. capitalised information technology software costs;
5. start-up and other establishment costs of a securitisation that are capitalised as an asset, and are to be set-off against the balance of fee income relating to securitisation schemes recognised and deferred as a liability. Any positive net balance must be deducted from Common Equity Tier 1 Capital (refer to Prudential Standard APS 120 Securitisation (APS 120)). Any up-front fee income received in excess of the capitalised securitisation establishment cost may be added to Common Equity Tier 1 Capital provided it meets the criteria in paragraph 22 of this Prudential Standard; and
6. other capitalised expenses including capitalised expenses of a general nature such as strategic business development initiatives. These also include, in addition to the above listed items, other forms of transaction costs and like costs that are required to be deferred/capitalised and amortised as part of the measurement of assets and liabilities under Australian Accounting Standards.
The balance of any transaction costs and like items that are capitalised and deferred as an asset must be netted off against the balance of any income deferred as a liability relating to the products giving rise to the capitalised transaction costs (i.e. only deferred costs and income in particular product portfolios may be netted). Any net balance of capitalised transaction costs must be deducted from Common Equity Tier 1 Capital in accordance with this Prudential Standard. Any surplus of up-front fee income received over deferred costs may be included in Common Equity Tier 1 Capital provided the up-front fee income received satisfies the criteria in paragraph 22 of this Prudential Standard. Otherwise, up-front fee income received must not be added to capital.
Guarantees
An ADI must deduct any guarantee, or credit derivative covering a credit exposure of the ADI, that provides for a materiality threshold below which no payment will be made in the event of a loss (refer to APS 112 and APS 113 for limits on the amounts an ADI is required to deduct).
Industry support schemes
An ADI must deduct any non-repayable loans advanced by another ADI under APRA’s certified industry support arrangements.
Securitisation
An ADI must deduct:
the value of securitisation exposures subject to capital deduction under APS 120;
any increase in Common Equity Tier 1 Capital arising from any gain on sale (refer to APS 120);
any capitalised expected future income relating to securitisation activities prior to it being irrevocably received; and
the difference between the book value and the value realised for transfers of exposures to a special purpose vehicle (SPV) where the realised value is less than the book value, unless the difference has been written off to the ADI’s profit and loss (refer to APS 120).
Shortfall in provisions for credit losses
An ADI must deduct the shortfall in the stock of eligible provisions under the IRB approach to credit risk (refer to APS 113).
Specific provisions
An ADI must deduct specific provisions (refer to APS 220), including that portion of collective provisions deemed to be a specific provision for regulatory purposes and any prescribed provisions that have not already resulted in a charge to profit and loss by way of establishment of a provision in audited published financial accounts.
Superannuation funds
An ADI must deduct any surplus in a defined benefit fund, of which the ADI is an employer-sponsor, unless otherwise approved in writing by APRA. The surplus must be net of any associated deferred tax liability that would be extinguished if the assets involved become impaired or derecognised under Australian Accounting Standards. An ADI may apply to APRA to include a surplus as an asset for capital adequacy purposes where the ADI (or member of the ADI’s group) employer-sponsor is able to demonstrate unrestricted and unfettered access to a fund surplus in a timely manner. Subject to APRA approval, an ADI may include the surplus in its risk-weighted assets at a 100 per cent risk weight rather than deducting the surplus.
An ADI must deduct any deficit in a defined benefit superannuation fund of which an ADI (or at Level 2 any member of the Level 2 group) is an employer-sponsor and that is not already reflected in Common Equity Tier 1 Capital.
Other adjustments
An ADI must deduct any other deductions required under any other ADI Prudential Standard.
APRA may require an ADI to deduct from Common Equity Tier 1 Capital at Level 2 an amount to cover undercapitalisation of a non-consolidated subsidiary (or subsidiaries). An ADI may be required to provide to APRA details of, amongst other things, the:
size and scale of the operations of the non-consolidated subsidiary;
materiality of the subsidiary’s operations to group income and strategic outlook;
level of net tangible assets of the subsidiary;
risk profile of the subsidiary;
level of exposure of the ADI on a Level 1 basis and of the Level 2 group to the subsidiary; and
size of any identified capital shortfall and the likelihood of such a shortfall being remedied within a reasonable period of time.
Attachment E
Criteria for inclusion in Additional Tier 1 Capital
To qualify as Additional Tier 1 Capital, an instrument must satisfy the following minimum criteria:
the instrument must be paid-up and the amount must be irrevocably received by the issuer;
the instrument represents, prior to any conversion to Common Equity Tier 1 Capital (refer to Attachment F, Attachment J and Attachment K), the most subordinated claim in liquidation of the issuer after Common Equity Tier 1 Capital instruments[33];
the paid-up amount of the instrument, or any future payments related to the instrument, is neither secured nor covered by a guarantee of the issuer or related entity[34], or other arrangement that legally or economically enhances the seniority of the holder’s claim[35]. The instrument may not be secured or otherwise subject to netting or offset claims on behalf of the holder or issuer of the instrument;
the principal amount of the instrument is perpetual (i.e. it has no maturity date);
the instrument contains no step-ups or other incentives to redeem. The issuer and any other member of a group to which the issuer belongs must not create an expectation at issuance that the instrument will be bought back, redeemed or cancelled. The contractual terms of the instrument must not provide any feature that might give rise to such an expectation[36];
the instrument may only be callable at the initiative of the issuer and only after a minimum of five years from the date on which the issuer irrevocably receives the proceeds of payment for the instrument. The issuer:
1. must receive prior written approval from APRA to exercise a call option. For instruments issued by subsidiaries not regulated by APRA included in a Level 2 group, prior written approval from APRA must also be obtained;
2. must not do anything that creates an expectation that a call will be exercised; and
3. must not exercise a call unless:
the issuer, prior to or concurrent with the exercise of the call, replaces the instrument with a capital instrument of the same or better quality, and the replacement of the instrument is done under conditions that are sustainable for the income capacity of the issuer; or
the ADI meets the requirements relating to reductions in capital in APS 110.
An instrument may provide for multiple call dates after five years. However, the specification of multiple call dates must not act to create an expectation that the instrument will be redeemed upon any call date;
issuers must not assume, or create market expectations, that supervisory approval will be forthcoming for the issuer to redeem, call or purchase an instrument;
an issuer must:
have full discretion at all times to cancel distributions/payments on the instrument. Any waived distributions are non-cumulative (i.e. are not required to be made up by the issuer at a later date). The instrument must not provide for payment of a higher dividend or interest rate if dividend or interest payments are not made on time, or a reduced dividend or interest rate if such payments are made on time;
ensure that cancellation of discretionary distributions/payments is not an event of default. Holders of the instruments must have no right to apply for the winding-up or administration of the issuer, or cause a receiver, or receiver and manager, to be appointed in respect of the issuer on the grounds that the issuer fails to make, or is or may become unable to make, a distribution on the instruments;
have full access to cancelled distributions/payments to meet obligations as they fall due; and
ensure that cancellation of distributions/payments do not impose restrictions on the issuer, or any other member of the group to which the issuer belongs, except in relation to distributions/payments or redemptions/buybacks on Common Equity Tier 1 Capital instruments;
distributions on the instrument are paid out of distributable items of the issuer, and the instrument must not provide for payments to investors other than in the form of a cash payment. The level of distributions must not be tied or linked to the credit standing of the issuer. All distributions are subject to the restrictions applied under APS 110;
the instrument cannot have a credit sensitive distribution/payment feature (i.e. a distribution/payment that is based in whole or part on the credit standing of the issuer or the group or any other member of the group to which it belongs). However, an instrument may utilise a broad index as a reference rate for distribution or payments calculation purposes. Where an issuer is a reference entity in the determination of the reference rate, the reference rate must not exhibit any significant correlation with the issuer’s credit standing. APRA will not allow inclusion of an instrument as part of Additional Tier 1 Capital where it considers that the reference rate is sensitive to the credit standing of the issuer;
the instrument cannot contribute to liabilities exceeding assets if such a balance sheet test forms part of any national insolvency law applying in the jurisdiction of issue. In such cases, the issue documentation must specify that the insolvency law that applies is the place of incorporation of the issuer[37];
an instrument that is classified as a liability under relevant accounting standards[38] must comply with the loss absorption requirements in Attachment F;
the instrument is directly issued by the issuer, and, except where otherwise permitted in this Prudential Standard, the issuer, any other member of a group to which the issuer belongs, or any related entity[39], cannot have purchased or directly or indirectly[40] funded the purchase of the instrument;
the instrument has no features that hinder recapitalisation of the issuer, or any other members of the group to which the issuer belongs. This includes features that require the issuer to compensate investors if a new instrument is issued at a lower price during a specified timeframe;
where the terms of the instrument provide the ability (even in contingent circumstances) to substitute the issuer (i.e. to replace the ADI with another party), the relevant documentation must set out the mechanism to ensure that there will be a simultaneous capital injection into the ADI to replace the transferred capital instrument. Any replacement capital injection must occur at least simultaneously with the substitution and must be unconditional. The capital injection must be of equal or better quality capital and at least the same amount as the original issue, unless otherwise approved by APRA in writing;
the instrument does not contain any terms, covenants or restrictions that could inhibit the issuer’s ability to be managed in a sound and prudent manner, particularly in times of financial difficulty, or restrict APRA’s ability to resolve any problems encountered by the issuer;
the rate of dividend or interest on the instrument, or the formulae for calculating dividend or interest payments, must be predetermined and set out in the issue documentation;
where an issue of an instrument involves the use of an SPV, the issue of the instrument is subject to Attachment I;
the instrument includes provisions addressing loss absorption at the point of non-viability as required by Attachment J;
the instrument is clearly and separately disclosed in the issuer’s financial statements and, at Level 2, in any consolidated financial statements; and
issue documentation clearly indicates:
the subordinated nature of the instrument and that neither the issuer nor the holder of the instrument is allowed to exercise any contractual rights of set-off;
if relevant, the application of requirements for loss absorption required under Attachment F;
the application of requirements for loss absorption at the point of non-viability under Attachment J; and
where the instrument is classified for accounting purposes as a liability, it does not represent a deposit liability of an issuing ADI.
In accordance with paragraph 1(h) above, failure to make a distribution or payment must not trigger any restrictions on the issuer other than its ability to pay a distribution on Common Equity Tier 1 Capital instruments[41] or to redeem such instruments. Such ‘stopper’ provisions must not:
impede the full discretion of the issuer at all times to cancel distributions/payments on the instrument or act in a way that could hinder the recapitalisation of the issuer;
prevent payment on another instrument where such payment was not fully discretionary;
prevent distribution to holders of Common Equity Tier 1 Capital instruments for a period that extends beyond the point in time the distributions/payments on the Additional Tier 1 Capital instruments are resumed; or
impede the normal operation of the issuer or any restructuring activity (including acquisitions or disposals).
A ‘stopper’ provision may, however, act to prohibit actions that are equivalent to payment of dividend or interest, such as an ADI undertaking discretionary buybacks of ordinary shares.
An instrument must not include any provision that permits an optional distribution or payment to be made. Any structuring of a distribution or payment as a bonus payment to make up for unpaid distributions or payments is also prohibited.
For the purposes of paragraph 1(e) above, an incentive or expectation to call or otherwise redeem an Additional Tier 1 Capital instrument includes, but is not limited to:
a call option combined with a requirement, or an investor option, to convert the instrument into ordinary shares[42] if the call is not exercised; or
a call option combined with a change in reference rate where the credit spread over the second reference rate is greater than the initial payment rate less the swap rate (i.e. the fixed rate paid to the call date to receive the second reference rate).
A call option and a provision to convert into ordinary shares will not constitute an incentive to redeem provided there is at least two years from the date upon which the ADI may have an option to call the instrument to the nearest subsequent date upon which that conversion option may be exercised.
Calling an instrument and replacing it with an instrument with a higher credit spread or that is otherwise more expensive may create the expectation that the issuer will exercise a call option on other outstanding Additional Tier 1 Capital instruments or Tier 2 Capital instruments with call options, unless the issuer can satisfy APRA as to the economic and prudential rationale and that such an action will not create an expectation that other instruments will be called in similar circumstances.
An instrument may only provide for a call within the first five years of issuance as a result of a tax or regulatory event. APRA will not permit such a call if it forms the view that the ADI was in a position to anticipate the tax or regulatory event when the instrument was issued. In order for a call to be exercised the issuer must comply with the provisions in paragraph 1(f)(i) to (iii) above.
Where an Additional Tier 1 Capital instrument provides for conversion into ordinary shares[43], the issue documentation must:
specify the number of ordinary shares to be received upon conversion, or specify the conversion formula for determining the number of ordinary shares received;
provide for the number of ordinary shares to be received under the formula specified in (a) to be fixed; and
set the maximum number of ordinary shares received so as not to exceed the price of the Additional Tier 1 Capital instrument at the time of its issue divided by 20 per cent of the ADI’s[44] ordinary share price[45] at the same time. In calculating the ordinary share price at time of issue, adjustments may be made for subsequent ordinary share splits, bonus issues and share consolidations.
Conversion must generate an unequivocal addition to Common Equity Tier 1 Capital of the ADI under Australian Accounting Standards.
The instrument must not include a mechanism that would require a holder to sell the instrument to the issuer or a related entity of the issuer other than as part of a call option or redemption of the instrument. A mechanism that requires a holder to sell the instrument to a nominated party other than the issuer or a related entity of the issuer will not constitute an incentive to redeem provided there is at least two years from the date upon which the holder is required to sell the instrument to the nearest subsequent date upon which conversion may be exercised.
Where an instrument is drawn down in a series of tranches, it must meet the requirements in this Prudential Standard as if each tranche is a separate Additional Tier 1 Capital instrument in its own right.
There must be no cross-default clauses in the documentation of any debt or other capital instrument of the issuer linking the issuer’s obligations under the instrument to default by the issuer under any of its other obligations, or default by another party, related or otherwise.
The instrument must be marketed in accordance with its prudential treatment and must not include any ‘repackaging’ arrangements that have the effect of compromising the quality of the capital raised. If a prospectus or other offer documentation, or marketing of the instrument could be reasonably held to suggest to investors that the instrument has attributes of a lower level of capital than claimed by the issuer (or Level 2 group) for prudential purposes, the instrument will be ineligible to be included in the ADI’s Additional Tier 1 Capital.
The instrument may be subject to the laws of a jurisdiction other than Australia or its territories, except that the terms and conditions of the instrument that relate to:
loss absorption conversion or write-off (where relevant); and
non-viability conversion or write-off
must be subject to the laws of Australia or its territories.
Where the instrument is subject to the laws of a jurisdiction other than Australia or its territories, the ADI must also ensure that the instrument satisfies all relevant qualifying criteria for Additional Tier 1 Capital under the laws of that jurisdiction.
APRA may require the ADI to provide an independent expert opinion, addressed to APRA by a firm or practitioner of APRA’s choice and at the ADI’s expense, confirming that the instrument meets the requirements in paragraphs 14 and 15 of this Attachment.
Attachment F
Loss absorption requirements: Additional Tier 1 Capital
An Additional Tier 1 Capital instrument classified as liabilities under Australian Accounting Standards must include a provision whereby it will be immediately and irrevocably:
converted into the ordinary shares of the ADI or its parent entity, which must be listed at the time the instrument is issued[46]; or
converted into mutual equity interests; or
written off
when the issuing ADI’s Level 1 or Level 2 Common Equity Tier 1 Capital ratio falls to or below 5.125 per cent of total risk-weighted assets (the loss absorption trigger point).
To qualify as eligible Additional Tier 1 Capital at Level 2, an instrument issued by an ADI or a fully consolidated subsidiary of a Level 2 group must provide for conversion or write-off of the instrument upon the Level 2 group reaching the loss absorption trigger point. An instrument may also provide for conversion or write-off should a host regulatory authority of an issuing subsidiary determine a loss absorption event in respect of the subsidiary.
The amount of an Additional Tier 1 Capital instrument that may be recognised in the ADI’s Tier 1 and Total Capital is the minimum level of Common Equity Tier 1 Capital that would be generated by full conversion or write-off of the instrument. Where an instrument provides for write-off as the primary loss absorption mechanism, the amount recognised must account for potential taxation liabilities or other potential offsets at the time of issuance. Adjustments must be updated over time to reflect the best estimates of the offset value.
Where an ADI’s Level 1 or Level 2 Common Equity Tier 1 Capital reaches the loss absorption trigger point, the aggregate amount of Additional Tier 1 Capital outstanding to be converted or written off must be sufficient to return the Common Equity Tier 1 Capital ratio of the ADI and Level 2 group to above 5.125 per cent of total risk-weighted assets, if possible.
Conversion or write-off must generate an unequivocal addition to Common Equity Tier 1 Capital of the ADI under Australian Accounting Standards.
Where an Additional Tier 1 Capital instrument provides for conversion into ordinary shares (or mutual equity interests), the ADI must ensure that, at the time of issue and on a continuing basis, there are no legal or other impediments to issuing the relevant number of shares (or mutual equity interests) and all necessary authorisations have been obtained to effect conversion.
Where, following a trigger event, conversion of an Additional Tier 1 Capital instrument:
is not capable of being undertaken;
is not irrevocable; and
will not result in an immediate and unequivocal increase in Common Equity Tier 1 Capital of the ADI,
the amount of the instrument must immediately and irrevocably be written off in the accounts and result in an unequivocal addition to Common Equity Tier 1 Capital.
Where an Additional Tier 1 Capital instrument provides for conversion into ordinary shares when the loss absorption trigger point is breached, the issue documentation must:
specify the number of ordinary shares to be received upon conversion, or specify the conversion formula for determining the number of ordinary shares received;
provide for the number of ordinary shares to be received under the formula specified in (a) to be fixed; and
set the maximum number of ordinary shares received so as not to exceed the price of the Additional Tier 1 Capital instrument at the time of issue divided by 20 per cent of the ADI’s[47] ordinary share price[48] at that same time. In calculating the ordinary share price at time of issue, adjustments may be made for subsequent ordinary share splits, bonus issues and share consolidations.
For mutually owned ADIs, where an Additional Tier 1 Capital instrument provides for conversion into mutual equity interests when the loss absorption trigger point is breached, the issue documentation must:
specify the number of mutual equity interests to be received upon conversion, or specify the conversion formula for determining the number of mutual equity interests received;
provide for the number of mutual equity interests to be received under the formula specified in (a) to be fixed; and
set the maximum number of mutual equity interests received such that the aggregate nominal value of the interests received cannot exceed, at the date of conversion, the nominal value of the Additional Tier 1 Capital instrument converted.
In issuing Additional Tier 1 Capital instruments an ADI may, within each category of capital:
differentiate between instruments as to whether an instrument is required to convert or be written-off in the first instance;
provide for a ranking under which Additional Tier 1 Capital instruments will be converted or written off; and
where conversion or write-off of capital instruments is required at Level 2, the Level 2 group may provide for a ranking under which Additional Tier 1 Capital instruments issued by individual members of the group may need to be converted or written off. This would be subject to any requirements for conversion or write-off of Additional Tier 1 Capital instruments required to be undertaken on a Level 1 basis.
Where issue documentation provides for a hierarchy of conversion or write-off, the terms attached to such a hierarchy must not impede the ability of the capital instrument to be immediately converted or be written off.
For the purposes of conversion or write-off of an Additional Tier 1 Capital instrument, the amount to be converted or written off will be the face value of the instrument recorded in the books of the ADI or subsidiary, where relevant.
Where an Additional Tier 1 Capital instrument provides for a write-off mechanism, this mechanism must be structured so that:
the claim of the instrument on liquidation of the issuer is reduced to, or below, the value of the written-off instrument;
the amount of the instrument that may be paid if a call is exercised is irrevocably reduced to the written-off amount of the instrument;
there is an immediate and unequivocal addition to the Common Equity Tier 1 Capital of the ADI; and
the distribution/payments payable on the instrument must be permanently reduced (i.e. distributions/payments must be calculated at no more than the rate set for the written-off value of the instrument).
The contractual terms and conditions of an instrument must not provide for any residual claims on the issuer that are senior to ordinary shares of the ADI (or mutual equity interests), or the parent entity, in the event that a trigger point is reached and conversion or write-off is undertaken.
An ADI must notify APRA immediately, in writing, when its Level 1 or Level 2 Common Equity Tier 1 Capital ratio falls to or below 5.125 per cent of total risk-weighted assets.
A stapled security structure consisting of the issue of a preference share and a stapled instrument of another form may be included in Additional Tier 1 Capital for both Level 1 and Level 2, subject to satisfying the following additional minimum criteria:
the preference share is issued directly by an ADI and is ‘stapled’ to securities issued directly by an overseas branch of the ADI. The stapled structure must not involve use of SPVs and must be simple and transparent;
at least one of the preference share and the security to which it is stapled must be fully paid-up. Any partly paid preference share or stapled security is eligible only to the extent that it has been paid-up;
the preference share and the instrument to which it is stapled must each individually satisfy the criteria in this Prudential Standard for an Additional Tier 1 Capital instrument;
the terms and conditions of the stapled security must substantially mirror those of the preference share such that the stapled security operates effectively as if it was a preference share;
the preference share and the instrument to which it is stapled must not be traded separately and are to remain stapled together until an ‘unstapling event’ occurs;
‘unstapling’ at the option of the issuer is permitted. The instrument documentation must clearly stipulate the events that will cause the preference share to be ‘unstapled’ resulting in the stapled security being extinguished, leaving the holder of the stapled security holding the preference share instead. Unstapling must take place if:
1. a loss absorption trigger point is reached in accordance with Attachment F;
2. a non-viability trigger event occurs in accordance with Attachment J;
3. proceedings for the liquidation of the ADI have commenced;
4. APRA issues a recapitalisation direction to the ADI in accordance with subsection 13E(1) of the Banking Act; or
5. APRA appoints a statutory manager to the ADI pursuant to subsection 13A(1) of the Banking Act;
to reduce the inherent legal risk associated with unstapling of the structure, the issue documentation must ensure the clarity, consistency and certainty with which the contractual terms and conditions are specified, and specifically that:
1. all entities involved in the stapled structure have the capacity and power to issue the instruments and perform obligations under them;
2. the rights and obligations created by the preference share and the stapled security are legally valid, binding and enforceable on all parties in all jurisdictions where they are issued;
3. the stapled security will be extinguished and holders of the stapled security will hold the underlying preference share upon the occurrence of an unstapling event; and
4. the ‘unstapling’ mechanism will take effect as contemplated in the issue documentation even if the ADI or another entity has become, or is likely to become, insolvent, including where it is in administration, receivership, winding up or where a statutory manager has been appointed under the Banking Act.
Where necessary, APRA may require an ADI to obtain independent legal opinion confirming the above; and
adequate internal policies and controls must be in place such that the unstapling procedures are correctly followed.
A preference share and instrument to which it is stapled must be issued by the same issuer but they need not be issued in the same jurisdiction.
Attachment H
Criteria for inclusion in Tier 2 Capital
To qualify as Tier 2 Capital, an instrument must satisfy the following minimum criteria:
the instrument must be paid-up and the amount must be irrevocably received by the issuer;
the instrument represents, prior to any conversion to Common Equity Tier 1 Capital (refer to Attachment J and Attachment K), the most subordinated claim in liquidation of the issuer after Common Equity Tier 1 Capital instruments and Additional Tier 1 Capital instruments[49];
the paid-up amount of the instrument, or any future payments related to the instrument, is neither secured nor covered by a guarantee of the issuer or related entity[50], or other arrangement that legally or economically enhances the seniority of the claim[51]. The instrument may not be secured or otherwise subject to netting or offset of claims on behalf of the holder or issuer of the instrument;
the principal amount of the instrument:
1. has a minimum maturity of at least five years; and
2. is only recognised in Tier 2 Capital (and so in Total Capital) in the five years prior to maturity on a straight-line amortised basis (refer to paragraph 2 of this Attachment);
the instrument contains no step-ups or other incentives to redeem. The issuer and any other member of a group to which the issuer belongs must not create an expectation at issuance that the instrument will be bought back, redeemed or cancelled before its contractual maturity. The contractual terms of the instrument must not provide any feature that might give rise to such an expectation[52];
the instrument may only be callable at the initiative of the issuer and only after a minimum of five years from the date on which the issuer irrevocably receives the proceeds of payment for the instrument. The issuer:
1. must receive prior written approval from APRA to exercise a call option. For instruments issued by subsidiaries not regulated by APRA included in a Level 2 group, prior written approval from APRA must also be obtained;
2. must not do anything that creates an expectation that a call will be exercised; and
3. must not exercise a call unless:
the issuer, prior to or concurrent with the exercise of the call, replaces the instrument with a capital instrument of the same or better quality, and the replacement of the instrument is done at conditions that are sustainable for the income capacity of the issuer; or
the ADI meets the requirements relating to reductions in capital in APS 110.
An instrument may provide for multiple call dates after five years. However, the specification of multiple call dates must not act to create an expectation that the instrument will be redeemed upon any call date;
issuers must not assume, or create market expectations, that supervisory approval will be forthcoming for the issuer to redeem, call or purchase an instrument;
the instrument must confer no rights on holders to accelerate the repayment of future scheduled payments (coupon or principal) except in bankruptcy (including wind-up) and liquidation. Wind-up of the ADI must be irrevocable (that is, either by way of a court order or an effective resolution by shareholders or members). The making of an application to wind-up or the appointment of a receiver, administrator, or official with similar powers, including the exercise of APRA’s powers under section 13A(1) of the Banking Act, must not be sufficient to accelerate repayment of the instrument;
the instrument must not provide for payment to investors other than in the form of a cash payment;
the instrument cannot have a credit sensitive distribution/payment feature (i.e. a distribution/payment that is based in whole or part on the credit standing of the issuer or the group or any other member of the group to which it belongs). However, an instrument may utilise a broad index as a reference rate for distribution or payments calculation purposes. Where an issuer is a reference entity in the determination of the reference rate, the reference rate must not exhibit any significant correlation with the issuer’s credit standing. APRA will not allow inclusion of an instrument as part of Tier 2 Capital where it considers that the reference rate is sensitive to the credit standing of the issuer;
the instrument is directly issued by the issuer, and, except where otherwise permitted in this Prudential Standard, the issuer, any other member of a group to which the issuer belongs, or any related entity[53], cannot have purchased or directly or indirectly[54] funded the purchase of the instrument;
the instrument has no features that hinder recapitalisation of the issuer, or any other members of the group to which the issuer belongs. This includes features that require the issuer to compensate investors if a new instrument is issued at a lower price during a specified timeframe;
where the terms of the instrument provide the ability (even in contingent circumstances) to substitute the issuer (i.e. to replace the ADI with another party), the relevant documentation must set out the mechanism to ensure that there will be a simultaneous capital injection into the ADI to replace the transferred capital instrument. Any replacement capital injection must occur at least simultaneously with the substitution and must be unconditional. The capital injection must be of equal or better quality capital and at least the same amount as the original issue, unless otherwise approved by APRA in writing;
the instrument does not contain any terms, covenants or restrictions that could inhibit the issuer’s ability to be managed in a sound and prudent manner, particularly in times of financial difficulty, or restrict APRA’s ability to resolve any problems encountered by the issuer;
the rate of dividend or interest on the instrument, or the formulae for calculating dividend or interest payments, must be predetermined and set out in the issue documentation;
where an issuer defaults under the terms of the instrument, remedies available to the holders must be limited to actions for specific performance, recovery of amounts currently outstanding or the winding-up of the issuer. The amounts that may be claimed in the event that the issuer defaults may include any accrued unpaid dividends and interest, including payment of market interest on these unpaid amounts. All such unpaid dividends and interest must be subordinated to the claims of depositors and other creditors of the issuer;
the instrument must not provide for payment of a higher dividend or interest rate if dividend or interest payments are not made on time, or a reduced dividend or interest rate if such payments are made on time;
where an issue of an instrument involves the use of an SPV, the issue of the instrument is subject to Attachment I;
the instrument includes provisions addressing loss absorption at the point of non-viability in accordance with Attachment J;
the instrument is clearly and separately disclosed in the issuer’s financial statements and, at Level 2, in any consolidated financial statements; and
issue documentation clearly indicates:
the subordinated nature of the instrument, and that neither the issuer nor the holder of the instrument is allowed to exercise any contractual rights of set-off;
the application of requirements relating to loss absorption at the point of non-viability under Attachment J; and
the instrument does not represent a deposit liability of an issuing ADI.
The amount of the instrument eligible for inclusion in Tier 2 Capital is to be amortised on a straight-line basis at a rate of 20 per cent per annum over the last four years to maturity as follows:
Years to Maturity
Amount Eligible for Inclusion in Tier 2 Capital
More than 4
100 per cent
Less than and including 4 but more than 3
80 per cent
Less than and including 3 but more than 2
60 per cent
Less than and including 2 but more than 1
40 per cent
Less than and including 1
20 per cent
Where an instrument is drawn down in a series of tranches, it must meet the requirements in this Prudential Standard as if each tranche is a separate Tier 2 Capital instrument in its own right and the minimum original maturity of each tranche must be five years from the time proceeds of the issue are irrevocably received by the issuer.
For the purposes of paragraph 1(e) above, an incentive or expectation to call or otherwise redeem a Tier 2 Capital instrument includes, but is not limited to:
a call option combined with a requirement, or an investor option, to convert the instrument into ordinary shares[55] if the call is not exercised; or
a call option combined with a change in reference rate where the credit spread over the second reference rate is greater than the initial payment rate less the swap rate (i.e. the fixed rate paid to the call date to receive the second reference rate).
A call option and a provision to convert into ordinary shares will not constitute an incentive to redeem provided there is at least two years from the date upon which the ADI may have an option to call the instrument to the nearest subsequent date upon which that conversion option may be exercised.
Calling an instrument and replacing it with an instrument with a higher credit spread or that is otherwise more expensive may create the expectation that the issuer will exercise a call option on other outstanding Tier 2 Capital instruments and Additional Tier 1 Capital instruments with call options, unless the issuer can satisfy APRA as to the economic and prudential rationale and that such an action will not create an expectation that other instruments will be called in similar circumstances.
An instrument may only provide for a call within the first five years of issuance as a result of a tax or regulatory event. APRA will not permit such a call if it forms the view that the ADI was in a position to anticipate the tax or regulatory event when the instrument was issued. In order for a call to be exercised the issuer must comply with the provisions in paragraph 1(f)(i) to (iii) above.
Where a Tier 2 Capital instrument provides for conversion into ordinary shares[56], the issue documentation must:
specify the number of ordinary shares to be received upon conversion, or specify the conversion formula for determining the number of ordinary shares received;
provide for the number of ordinary shares to be received under the formula specified in (a) to be fixed; and
set the maximum number of ordinary shares received so as not to exceed the price of the Tier 2 Capital instrument at the time of its issue divided by 20 per cent of the ADI’s[57] ordinary share price[58] at the same time. In calculating the ordinary share price at time of issue, adjustments may be made for subsequent ordinary share splits, bonus issues and share consolidations.
Conversion must generate an unequivocal addition to Common Equity Tier 1 Capital of the ADI under Australian Accounting Standards.
The instrument must not include a mechanism that would require a holder to sell the instrument to the issuer or a related entity of the issuer other than as part of a call option or redemption of the instrument. A mechanism that requires a holder to sell the instrument to a nominated party other than the issuer or related entity of the issuer will not constitute an incentive to redeem provided there is at least two years from the date upon which the holder is required to sell the instrument to the nearest subsequent date upon which conversion may be exercised.
There must be no cross-default clauses in the documentation of any debt or other capital instrument of the issuer linking the issuer’s obligations under the instrument to default by the issuer under any of its other obligations, or default by another party, related or otherwise.
The instrument must be marketed in accordance with its prudential treatment and must not include any ‘repackaging’ arrangements that have the effect of compromising the quality of the capital raised. If a prospectus or other offer documentation or marketing of the instrument could be reasonably held to suggest to investors that the instrument has attributes other than those claimed by the issuer (or Level 2 group) for prudential purposes, the instrument is ineligible to be included in the ADI’s Tier 2 Capital.
The instrument may be subject to the laws of a jurisdiction other than Australia or its territories, except that the terms and conditions of the instrument that relate to non-viability conversion or write-off must be subject to the laws of Australia or its territories.
Where the instrument is subject to the laws of a jurisdiction other than Australia or its territories, the ADI must also ensure that the instrument satisfies all relevant qualifying criteria for Tier 2 Capital under the laws of that jurisdiction.
APRA may require the ADI to provide an independent expert opinion, addressed to APRA by a firm or practitioner of APRA’s choice and at the ADI’s expense, confirming that the instrument meets the requirements in paragraphs 13 and 14 of this Attachment.
Attachment I
Criteria for capital issues involving special purpose vehicles
The following requirements must be met for capital instruments issued through an SPV to qualify as Regulatory Capital:
the SPV issuing the instrument is a single purpose non-operating entity established for the sole purpose of raising capital for the ADI[59] and the SPV would, in accordance with Australian Accounting Standards, be fully consolidated in the Level 2 group;
capital instruments issued by the ADI to the SPV, and capital instruments issued by the SPV, to investors must meet the requirements of this Prudential Standard for Additional Tier 1 and Tier 2 Capital set out in Attachment E and Attachment H of this Prudential Standard, as appropriate;
capital instruments issued by the SPV must not be funded, directly or indirectly, by the ADI or any other member of a group to which the ADI belongs. Similarly, the ADI or other member of a group to which it belongs may not provide any funding to the SPV itself, other than to cover its administrative operating expenses;
the only asset[60] of the SPV is its investment in capital instruments issued by the ADI for which it raises capital. The SPV must have no material liabilities other than its issued capital instruments;
instruments issued by the ADI to the SPV, and by the SPV to third party investors, must:
1. be of the same category of Regulatory Capital (e.g. both Additional Tier 1 Capital instruments, or both Tier 2 Capital instruments);
2. if Tier 2 Capital instruments, have the same maturity; and
3. have terms and conditions that mirror each other;
the proceeds from the issue of a capital instrument by the SPV must be immediately and directly invested in, and available without limitation to, the ADI.
where a loss absorption trigger point is reached (Attachment F) or a non-viability trigger event occurs (Attachment J), the instruments issued to the SPV, and by the SPV to investors, must be subject to conversion or write-off into ordinary shares (or mutual equity interests) in accordance with the requirements in those Attachments. In such circumstances, investors in instruments issued by the SPV irrevocably cease to have any claims on the SPV or the ADI;
where capital instruments issued by an SPV are converted into ordinary shares of the ADI (or mutual equity interests) or parent entity, such conversions are subject to the requirements (including limits) covering conversion set out in Attachments E, F, H and J; and
the main features of the instrument issued by the SPV and the structure of the issue are transparent and capable of being understood by investors. An issue is not eligible for inclusion in an ADI’s Additional Tier 1 Capital or Tier 2 Capital, at Level 1 or Level 2, where the complexity of its structure raises doubt over the legal and regulatory risk associated with it.
An SPV may be established to issue tranches of one instrument where the only change in the terms and conditions of the tranches is a variation in distribution or payments to be made on the instrument. An SPV may not issue different forms of an instrument even if they belong to the same category of capital instruments.
The amount of capital issued by consolidated subsidiaries to third parties through an SPV that may be included in Tier 1 Capital or Total Capital is to be determined in accordance with Attachment C of this Prudential Standard.
Attachment J
Loss absorption at the point of non-viability: Additional Tier 1 and Tier 2 Capital instruments
An Additional Tier 1 Capital or Tier 2 Capital instrument must include a provision under which, on the occurrence of a non-viability trigger event (as defined in paragraphs 3, 4 and 5 of this Attachment), it will be immediately and irrevocably:
converted into the ordinary shares of the ADI or its parent entity, which must be listed at the time the instrument is issued[61];
converted into mutual equity interests; or
written off.
The amount of an instrument that may be recognised in the ADI’s Tier 1 and Total Capital on the occurrence of a non-viability trigger event is the minimum level of Common Equity Tier 1 Capital that would be generated by full conversion or write-off of the instrument. Where an instrument provides for write-off as the primary loss absorption mechanism, the amount recognised must account for potential taxation liabilities or other potential offsets at the time of issuance. Adjustments must be updated over time to reflect the best estimates of the offset value.
A non-viability trigger event in relation to an ADI is the earlier of:
the issuance of a notice, in writing, by APRA to the ADI that conversion or write-off of capital instruments is necessary because, without it, APRA considers that the ADI would become non-viable; or
a determination by APRA, notified to the ADI, in writing, that without a public sector injection of capital, or equivalent support, the ADI would become non-viable.
A non-viability trigger event in relation to instruments issued by a fully consolidated subsidiary of an ADI is the earlier of:
a non-viability trigger event in relation to a parent ADI set out in paragraph 3 of this Attachment;
the issuance of a notice by an host regulator of an overseas subsidiary that conversion or write-off of capital instruments issued by a fully consolidated subsidiary of an ADI is necessary because, without it, the host regulator considers that the subsidiary would become non-viable; or
a determination by the host regulator, that without a public sector injection of capital, or equivalent support, the overseas subsidiary would become non-viable.
A non-viability trigger event in relation to instruments issued by a locally incorporated subsidiary ADI of a foreign bank is the earlier of:
a non-viability trigger event in relation to the subsidiary ADI set out in paragraph 3 of this Attachment;
the issuance of a notice by the home regulator of the foreign bank to the foreign bank that conversion or write-off of capital instruments is necessary because, without it, the foreign bank or its subsidiary ADI would become non-viable; or
a determination by the home regulator of the foreign bank, that without a public sector injection of capital, or equivalent support, the foreign bank or its subsidiary ADI would become non-viable.
Conversion or write-off need only occur to the extent necessary to enable APRA to conclude that the ADI is viable without further conversion or write-off. In such circumstances, conversion or write-off would need to fully exhaust Additional Tier 1 Capital instruments before involving Tier 2 Capital instruments. APRA will not approve partial conversion or partial write‑off in those exceptional circumstances where a public sector injection of funds is deemed necessary.
The amount of conversion or write-off of capital instruments undertaken in accordance with this Attachment will be subject to the requirements applied by the relevant regulator.
An ADI may provide for Additional Tier 1 Capital instruments to be converted or written off prior to any conversion or write-off of Tier 2 Capital instruments. In these circumstances, conversion or write-off of Tier 2 Capital instruments will only be necessary to the extent that conversion of Additional Tier 1 Capital instruments has not resulted in APRA withdrawing the notice issued to the ADI under paragraph 3 of this Attachment.
Conversion or write-off must generate an unequivocal addition to Common Equity Tier 1 Capital of the ADI under Australian Accounting Standards.
Where an Additional Tier 1 Capital instrument or Tier 2 Capital instrument provides for conversion into ordinary shares (or mutual equity interests), the ADI must ensure that, at the time of issue and on a continuing basis, there are no legal or other impediments to issuing the relevant number of shares (or mutual equity interests) and all necessary authorisations have been obtained to effect conversion.
Where, following a trigger event, conversion of a capital instrument:
is not capable of being undertaken;
is not irrevocable; or
will not result in an immediate and unequivocal increase in Common Equity Tier 1 Capital of the ADI,
the amount of the instrument must immediately and irrevocably be written off in the accounts of the ADI and result in an unequivocal addition to Common Equity Tier 1 Capital.
Where an Additional Tier 1 or Tier 2 Capital instrument provides for conversion into ordinary shares when the non-viability trigger point is reached, the issue documentation must:
specify the number of ordinary shares to be received upon conversion, or specify the conversion formula for determining the number of ordinary shares received;
provide for the number of ordinary shares to be received under the formula specified in (a) to be fixed; and
set the maximum number of ordinary shares received so as not to exceed the price of the Additional Tier 1 or Tier 2 Capital instrument at the time of its issue divided by 20 per cent of the ADI’s[62] ordinary share price[63] at the same time. In calculating the ordinary share price at time of issue, adjustments may be made for subsequent ordinary share splits, bonus issues and share consolidations.
For mutually owned ADIs, where an Additional Tier 1 or Tier 2 Capital instrument provides for conversion into mutual equity interests when the non-viability trigger point is reached, the issue documentation must:
specify the number of mutual equity interests to be received upon conversion, or specify the conversion formula for determining the number of mutual equity interests received;
provide for the number of mutual equity interests to be received under the formula specified in (a) to be fixed; and
set the maximum number of mutual equity interests received such that the aggregate nominal value of the instruments received cannot exceed, at the date of conversion, the nominal value of the Additional Tier 1 or Tier 2 Capital instrument converted.
Where issue documentation provides for a hierarchy of conversion or write-off, the terms attached to such a hierarchy must not impede the ability of the capital instrument to be immediately converted or written off.
Issuing Additional Tier 1 or Tier 2 Capital instruments may, within each category of capital:
differentiate between instruments as to whether an instrument is required to convert or be written off in the first instance;
provide for a ranking under which Additional Tier 1 and Tier 2 Capital instruments will be converted or written off; and
where conversion or write-off of capital instruments is required at Level 2, the Level 2 group may provide for a ranking under which Additional Tier 1 and Tier 2 Capital instruments issued by individual members of the group may need to be converted or written off. This would be subject to any requirements for conversion or write-off of capital instruments required to be undertaken on a Level 1 basis.
For the purposes of conversion or write-off of an Additional Tier 1 or Tier 2 Capital instrument, the amount to be converted or written off will be the face value of the instrument recorded in the books of the ADI or subsidiary, where relevant.
Where an Additional Tier 1 or Tier 2 Capital instrument provides for a write-off mechanism, this mechanism must be structured so that:
the claim of the instrument on liquidation of the issuer is reduced to, or below, the value of the written-off instrument;
the amount of the instrument that may be paid if a call is exercised is irrevocably reduced to the written-off amount of the instrument;
there is an immediate and unequivocal addition to the Common Equity Tier 1 Capital of the ADI; and
the distribution/payments payable on the instrument must be permanently reduced (i.e. distributions/payments must be calculated at no more than the rate set for the written-off value of the instrument).
The contractual terms and conditions of the issue of an instrument must not provide for any residual claims on the issuer that are senior to ordinary shares of the ADI (or mutual equity interests), or the parent entity, in the event that a trigger point is reached and a conversion or write-off is undertaken.
Attachment K
Mutual equity interests
Mutual equity interests can only be issued by a mutually owned ADI.
Mutual equity interests can only be issued in accordance with the contractual terms of an eligible Additional Tier 1 Capital instrument (refer to Attachment E) or an eligible Tier 2 Capital instrument (refer to Attachment H). These terms must provide for issue of mutual equity interests only as a result of conversion of:
(a) an eligible Additional Tier 1 Capital instrument in accordance with paragraph 1(b) of Attachment F or paragraph 1(b) of Attachment J; or
(b) an eligible Tier 2 Capital instrument in accordance with paragraph 1(b) of Attachment J.
Mutual equity interests must, on issue, satisfy all the requirements in:
this Attachment; and
(b) in Attachment B, except for paragraphs 1(b) and 1(e).
For the purposes of paragraph 1(h) of Attachment B, mutual equity interests must rank equally and proportionately with members’ interests[64] forming part of the issuer’s Common Equity Tier 1 Capital (if any) in absorbing losses:
(a) on a going-concern basis; and
(b) as the most subordinated claim in the event of the wind-up or liquidation of the issuer.
The holder of mutual equity interests is entitled to a claim on residual assets that is proportional to its share of the sum of (i) the aggregate notional subscription price paid for all mutual equity interests, and (ii) the aggregate subscription price paid for all other members’ interests[65] (whether or not forming part of the issuer’s Common Equity Tier 1 Capital), subject to:
all senior claims[66] having been repaid and satisfied in full in the wind-up or liquidation of the issuer;
a cap equal to the aggregate nominal dollar value of the Additional Tier 1 and Tier 2 Capital instruments prior to their conversion into the mutual equity interests held by that holder.
If the cap specified in sub-paragraph (b) is reached, the holder of mutual equity interests has no further claim on the remaining residual assets, which are to be distributed to the holders of other members’ interests (whether or not forming part of the issuer’s Common Equity Tier 1 Capital) in accordance with their respective entitlements.
The items described in paragraphs 19(c)_(retained earnings) and (d) (undistributed current year earnings) of this Prudential Standard do not constitute members’ interests for the purposes of this Attachment, notwithstanding that they form part of the issuer’s Common Equity Tier 1 Capital. Withdrawable or redeemable members’ interests do not form part of an issuer’s Common Equity Tier 1 Capital. Members’ interests would include, however, any issued investor shares (as referred to in Australian Securities and Investments Commission (ASIC) Regulatory Guide 147 Mutuality – Financial Institutions (RG 147, or any replacement regulatory guide issued by ASIC) where such shares satisfied the requirements of Attachment B.
Distributions on mutual equity interests must be paid out of distributable items (including retained earnings) of the issuer and the issue terms of mutual equity interests must not provide for payment to holders other than in the form of a cash payment. The level of distributions must not be tied or linked in the terms of issue, or otherwise by declaration of the issuer, to the amount paid up at issuance of mutual equity interests, or the value of the Additional Tier 1 or Tier 2 Capital instruments that were converted, or to the credit standing of the issuer.
The issue terms of mutual equity interests must provide that the amount of any distributions paid on all mutual equity interests, and any investor shares issued (as referred to in RG 147, or any replacement regulatory guide released by ASIC) cannot, in aggregate, exceed 50 per cent of the issuer’s net profit after tax for the annual period in which the distribution is made and dividends must be payable only out of that period’s profits.
An issuer must obtain any necessary member’ approvals of the way the issuer calculates any dividends payable on mutual equity interests, and when such dividends might be paid under the issue terms of the mutual equity interests. Initial approvals must be obtained before the relevant Additional Tier 1 Capital or Tier 2 Capital instruments are issued. Subsequent changes, if any, to the calculation or timing of the payment of dividends under the issue terms of mutual equity interests must be approved by members before payments are made pursuant to those changes. A mutually owned ADI must ensure that any method of calculating dividend payments, and the timing of payments, do not give rise to any breaches of requirements in this Prudential Standard.
For the purposes of paragraph 1(c) of Attachment B, an issuer may retain the option to undertake a discretionary repurchase of mutual equity interests, subject to:
the application of paragraphs 33 to 36 of APS 110;
no specified dates or events being set for exercise of any option to repurchase mutual equity interests. However, the issue terms for mutual equity interests may provide for the option of discretionary repurchase, subject to prior APRA approval, in the event that the issuer is merged with, or its business transferred to, another ADI or it undertakes demutualisation;
the amount that an issuer may pay for the repurchase of mutual equity interests cannot exceed the nominal value of the Additional Tier 1 Capital or Tier 2 Capital instrument from which it derived;
the terms upon which an issuer may undertake a discretionary repurchase of mutual equity interests must:
1. be consistent with the issuer’s constitution;
2. if required by the issuer’s constitution, be. approved by members prior to any such repurchase (whether as part of their overall approval for the issue of mutual equity interests or otherwise); and
3. comply with any relevant provisions of the Corporations Act
Prior to the issue of any eligible Additional Tier 1 or Tier 2 Capital instrument whose terms provide for conversion to mutual equity interests, the issuer must:
have a constitution that permits the issue of mutual equity interests and the terms of the issue must be consistent with the issuer’s constitution;
have obtained approval from its members, if required by the issuer’s constitution, to the issue of mutual equity interests if the events prescribed in paragraph 1(b) of Attachment F or paragraph 1(b) of Attachment J were to occur;
have obtained approval from members, if required by the issuer’s constitution, for the terms of issue of mutual equity interest.; and
have obtained any relief considered by the ADI to be necessary under Part 5 of Schedule 4 of the Corporations Act for the issuance of mutual equity interests.
Mutual equity interests must carry no voting or other rights beyond any claim on the residual assets as provided for in paragraph 5 of this Attachment or as otherwise required by the Corporations Act.
An issuer must obtain APRA’s approval, prior to issue, for:
any Additional Tier 1 Capital or Tier 2 Capital instruments that provide for conversion of such instruments into mutual equity interests; and
the issue terms of the mutual equity interests.
In seeking approval under paragraph 12, a prospective issuer must satisfy APRA that the issue of mutual equity interests would not trigger any provisions under Part 5 of Schedule 4 of the Corporations Act. An issuer must advise APRA if it applies to ASIC for any relief from the provisions in Part 5 of Schedule 4 of the Corporations Act.
In seeking approval, an issuer must also provide APRA with a certificate signed by the issuer’s Chief Executive Officer certifying that the issuer of mutual equity interests has complied with paragraph 10 of this Attachment. APRA may give a copy of such a certificate to ASIC.
Where an issuer seeks relief from ASIC from the provisions in Part 5 of Schedule 4 of the Corporations Act, the issuer must certify to ASIC that the issue of Additional Tier 1 and Tier 2 Capital instruments, as well as the potential issue of mutual equity interests themselves, is consistent with the issuer’s Internal Capital Adequacy Assessment Process (ICAAP) required under APS 110.
Attachment L
Transitional arrangements for capital instruments
Instruments eligible for transition
Non-common Equity Tier 1 and Tier 2 Capital instruments, including instruments issued by fully consolidated subsidiaries that are held by third parties, that do not fully meet the criteria in Attachments E and H may be eligible for transition in accordance with this Attachment.
Capital instruments issued before 17 December 2009 that complied with APRA’s prudential capital requirements in force at the time of issue may be eligible for the transitional arrangements provided in this Prudential Standard. However, if the instrument had a call and a step-up (or other incentive to be redeemed) after 12 September 2010 and before 1 January 2013, it must be fully derecognised in the relevant category of Regulatory Capital.
Instruments issued after 17 December 2009 and before 1 January 2013 that do not include a step-up or other incentive to redeem, but otherwise complied with APRA’s prudential capital requirements in force at the time of issue, may be eligible for the transitional arrangements provided in this Prudential Standard.
APRA may, however, determine in writing whether an instrument is eligible (or not) for the transitional arrangements provided in this Prudential Standard.
Transitional arrangements
Capital instruments approved by APRA for transitional arrangements under paragraph 12 of this Attachment (transitional instruments) will be phased out from inclusion in Regulatory Capital from 1 January 2013. Such instruments may be included in the relevant category of Regulatory Capital until their first available call date (if any), or as determined, in writing, by APRA.
The amount of transitional instruments that may be included in Regulatory Capital is determined by reference to the ‘base amount’ of Additional Tier 1 or Tier 2 Capital (refer to paragraphs 7 to 12 of this Attachment). The proportion of the base amount that may be included in Regulatory Capital is amortised over nine years, commencing at 90 per cent of the base amount on 1 January 2013, with the cap reducing by 10 percentage points on 1 January of each of the following years.
Table 1 sets out the amortisation schedule for the phase-out of transitional instruments.
Table 1: Transitional arrangements for capital instruments
Year commencing
Percentage of base amount of transitional instruments that may be included in Additional Tier 1 and Tier 2 Capital under the phase-out arrangements.
1 January 2013
90
1 January 2014
80
1 January 2015
70
1 January 2016
60
1 January 2017
50
1 January 2018
40
1 January 2019
30
1 January 2020
20
1 January 2021
10
1 January 2022
0
Base amount
The base amount is calculated for each category of capital and is the sum of the nominal amounts of transitional instruments within that class that are outstanding on 31 December 2012.
The base amount must not include: existing Tier 1 and Tier 2 Capital instruments ineligible for recognition under the January 2012 version of APS 111 because of the limits for recognition or the amortisation requirements of that Prudential Standard.
Where a Tier 2 Capital instrument has started to amortise prior to 1 January 2013 in accordance with the January 2012 version of APS 111:
only the amortised amount of that capital instrument as at 1 January 2013 may be included in the base amount; and
the amount of the instrument eligible to be included in Tier 2 Capital will continue to be amortised at 20 per cent per annum.
In calculating the base amount, an ADI must use the value of Additional Tier 1 Capital instruments and Tier 2 Capital instruments in the ADI’s balance sheet as at 1 January 2013. In calculating the amount of foreign currency denominated Additional Tier 1 Capital and Tier 2 Capital instruments eligible to be included under the relevant cap, the amount of the capital instruments reported would be the amount of such instruments that would be reported by the ADI as outstanding in its financial statements (adjusted for any amortisation arrangement applicable to Tier 2 Capital instruments) as at 31 December 2012.
The base amount remains unchanged even where an instrument:
is redeemed;
meets its first call date; or
is included in Tier 2 Capital and its recognition in capital is amortised in accordance with this Prudential Standard.
An ADI may replace such an instrument with the amounts of other transitional instruments not already included in Regulatory Capital, up to the capped amount applying to the year in which the instrument is redeemed or derecognised.
Notification and approval requirement
An ADI must, prior to 1 January 2013, obtain APRA’s written approval for:
any transitional instruments; and
the total base amounts of Additional Tier 1 and Tier 2 Capital
in order for the transitional arrangements to apply to the capital instruments.
The ADI must also notify APRA of the first available call date for each instrument included in the base amount.
[1] ‘Going-concern capital’ refers to capital against which losses can be written off while an ADI continues to operate. Going-concern capital will also absorb losses should the ADI ultimately fail.
[2] ‘Gone-concern capital’ refers to capital that would not absorb losses until such time as an ADI is wound up or the capital is otherwise written off or converted into ordinary shares or mutual equity interests..
[3] This must also be read to refer to any holding company that heads the Level 2 group and is fully consolidated in the Level 2 group.
[4] This includes cumulative unrealised gains or losses on effective cash flow hedges as defined in Australian Accounting Standards.
[7] Capital instruments include all capital instruments eligible to be included in Common Equity Tier 1 Capital, Additional Tier 1 Capital and Tier 2 Capital.
[8] These vehicles exclude any SPV, such as a trust, involved with employee share‑based remuneration schemes.
[9] Refer to subsection 11AF(2) of the Banking Act.
[10] ‘Accounting practice’ means Australian Accounting Standards or, if these do not provide relevant guidance, a generally used accounting treatment.
[11] In cases where capital instruments have a permanent write-off feature, this criterion is still deemed to be met by ordinary shares.
[12] In the case of mutual equity interests, refer paragraph 4 of Attachment K.
[13] At Level 2, these must be Australian Accounting Standards.
[14] A related entity is one over which an ADI or parent entity of the ADI exercises control or significant influence and can include a parent company, a sister company, a subsidiary or any other affiliate. This does not preclude a parent entity of the ADI from holding the instrument where the instrument is directly issued by the ADI to the parent entity.
[15] This excludes full recourse lending to a borrower to fund the purchase of a well-diversified and well-collateralised portfolio that may include the capital instrument.
[20] At Level 1, this includes all financial institutions that are affiliates of the ADI at Level 1. An affiliate for these purposes is defined as a company that controls, or is controlled by, or is under common control with, the ADI. Control of a company is defined as: (i) ownership, control, or holding power to vote 20 per cent or more of a class of voting securities of the company; or (ii) consolidation of the company with the ADI for financial reporting purposes.
[21] Indirect holdings represent exposures that will result in a loss to the ADI substantially equivalent to any loss in the direct holding. This excludes, for example, full recourse lending to a borrower to purchase a well diversified and well collateralised portfolio that may include the relevant exposures.
[22] ‘Net long positions’ are the gross long positions net of the short positions in the same underlying exposures where the maturity of the short positions either match the maturity of the long positions or have residual maturities of at least one year. They include netting positions in physical instruments and derivatives over the same underlying exposure (including those associated with looking through holdings of index securities).
[23] An ‘equivalent overseas deposit-taking institution’ in this Prudential Standard refers to an overseas financial institution that is subject to equivalent minimum prudential standards and level of supervision as an ADI.
[24] This does not apply to guarantees provided to non-related Registrable Superannuation Entities (RSEs) or RSE licensees.
[26] Gross long positions in own ordinary shares resulting from holdings of index securities may be netted against short positions in own ordinary shares resulting from short positions in the same underlying index. In such cases, short positions may involve counterparty risk (which will be subject to the relevant counterparty credit risk charges outlined in APS 112 and APS 113).
[27] Any gains on hedges are to be deducted and any losses on hedges added back.
[29] This excludes holdings of subordinated debt in commercial (non-financial) entities. Refer to Attachment A to APS 112. All other holdings of capital instruments, including preference shares, even if classified as debt, must be deducted from Common Equity Tier 1.
[31] Additional Tier 1 Capital and Tier 2 Capital instruments must continue to be measured for capital adequacy purposes at their contractual values. Additional Tier 1 Capital and Tier 2 Capital instruments can be hedged in accordance with accounting standards.
[32] Includes goodwill and intangibles attributable to investments in subsidiaries, joint ventures and associates. For the purposes of this Prudential Standard, a joint operation (as defined under Australian Accounting Standard AASB 11) is to be treated as a joint venture.
[33] Where an issuer is a holding company, the subordination applicable must apply to all general creditors of the holding company.
[35] This would preclude any provision of support (including contribution of reserves) to any SPV used to issue capital instruments that form part of an ADI or Level 2 group’s issue of Additional Tier 1 and Tier 2 Capital instruments.
[36] Conversion from a fixed rate to a floating rate (or vice versa) in combination with a call option without any increase in the credit spread is not considered an incentive to redeem. However, the ADI must not otherwise do anything to create an expectation that the call will be exercised.
[37] If an overseas branch of an ADI issues in a foreign jurisdiction where insolvency law is different from the jurisdiction where the parent ADI is based, issue documentation must specify that the insolvency law in the parent’s jurisdiction will apply.
[41] Any reference to Common Equity Tier 1 Capital instruments in this paragraph includes a reference to mutual equity interests issued in accordance with Attachment K.
[42] For the avoidance of doubt, reference to ‘ordinary shares’ in this paragraph, and in paragraphs 5 and 8 of this Attachment, does not refer to mutual equity interests issued in accordance with Attachment K.
[43] Conversion must be into the ordinary shares of the ADI or its parent entity, which must be listed at the time of issue. For an unlisted ADI with no listed upstream entity at the time the instrument is issued, the instrument is to be converted into the unlisted ordinary shares of the ADI. Where an unlisted ADI issues the instrument to its listed parent entity, conversion may be into the unlisted ordinary shares of the ADI.
[44] Reference to ADI captures any entity whose ordinary shares are issued as a result of conversion provisions.
[45] For an unlisted ADI that has no listed parent entity at the time of issue, the ordinary share price is based on the book value per share at the time of issue.
[46] For an unlisted ADI with no listed upstream entity at the time the instrument is issued, the instrument is to be converted into the unlisted ordinary shares of the ADI. Where an unlisted ADI issues the instrument to its listed parent entity, conversion may be into the unlisted ordinary shares of the ADI.
[47] Reference to ADI captures any entity whose ordinary shares are issued as a result of conversion provisions.
[48] For an unlisted ADI that has no listed parent entity at the time of issue, the ordinary share price is based on the book value per share at the time of issue.
[49] Where an issuer is a holding company the subordination applicable must apply to all general creditors of the holding company.
[52] Conversion from a fixed rate to a floating rate (or vice versa) in combination with a call option without any increase in the credit spread is not considered an incentive to redeem. However, the ADI must not otherwise do anything to create an expectation that the call will be exercised.
[55] For the avoidance of doubt, reference to ‘ordinary shares’ in this paragraph and paragraphs 5 and 8 of this Attachment does not refer to mutual equity interests issued in accordance with Attachment K.
[56] Conversion must be into the ordinary shares of the ADI or its parent entity, which must be listed at the time of issue. For an unlisted ADI with no listed upstream entity at the time the instrument is issued, the instrument is to be converted into the unlisted ordinary shares of the ADI. Where an unlisted ADI issues the instrument to its listed parent entity, conversion may be into the unlisted ordinary shares of the ADI.
[57] Reference to ADI captures any entity whose ordinary shares are issued as a result of conversion provisions.
[58] For an unlisted ADI that has no listed parent entity at the time of issue, the ordinary share price is based on the book value per share at the time of issue.
[59] In this Attachment reference to an ADI includes a standalone ADI, an ultimate holding company or an operating subsidiary included in the Level 2 group.
[60] Assets that relate to the operation of the SPV may be excluded from this assessment if they are de minimis.
[62] Reference to ADI captures any entity whose ordinary shares are issued as a result of conversion provisions.
[63] For an unlisted ADI that has no listed parent entity at the time of issue, the ordinary share price is based on the book value per share at the time of issue.
[66] This would include members’ interests that are not eligible to form part of the issuer’s Common Equity Tier 1 Capital in relation to the payment of an amount equal to the subscription price paid for the interests.