Banking (prudential standard) determination No. 4 of 2007 - Prudential Standard APS 111 - Capital Adequacy: Measurement of Capital
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To qualify as Residual Tier 1 capital at Level 1 and Level 2, an instrument must satisfy the following criteria:[24]
(a) the instrument is unsecured and paid up:
(i) any partly paid issue is eligible only to the extent that it has been paid up. Subject to paragraph 4(d) of this Attachment, unpaid perpetual non-cumulative preference shares issued through “stapled” structures are permitted; and
(ii) only the proceeds of the issue that have been received by the issuer are permitted to count as capital;
(b) the instrument is perpetual (i.e. it does not have a maturity date):
(i) the instrument is not redeemable at the option of the holder and has no provisions which require future redemption by the issuer;
(ii) redemption at the option of the issuer is permitted, provided the redemption or call option is subject to APRA’s prior written approval at the time of exercise and it does not operate in conjunction with any other feature that creates or signals a de facto tenor of the instrument. If this occurs, APRA will consider the instrument to be a dated instrument and ineligible for inclusion as Tier 1 capital. Issue documentation must give clear and prominent notice to prospective investors that the issuer’s right to exercise any such option to redeem or purchase the instrument is subject to APRA’s prior written approval;
(c) the instrument does not impose any fixed servicing costs on the issuer:
(i) dividend or interest payments to the holders of the instrument are at the discretion of the issuer. The issuer is able to waive any dividend or interest payments on the instrument and alter the timing of payments;
(ii) any unpaid dividends or interest are non-cumulative (i.e. not required to be made up by the issuer at a later date). The instrument, both in form and substance, does not provide for cumulative dividend or interest payments. For example, the instrument does 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. Any special or optional dividends or interest payments on the instrument outside of normal scheduled payments require APRA’s prior written approval;
(iii) the non-payment of a dividend or interest on the instrument does not trigger any restrictions on the issuer other than its ability to pay dividends on ordinary shares, or purchase shares (outside normal trading operations) or retire other shares or pay dividends or interest on more junior capital instruments;
(iv) the instrument does not provide for payment of any form of compensation to investors other than by way of a distribution of profits. Any such profit distribution is in the form of a cash dividend or interest payments. Payment in kind is not permitted;
Part Attachment A - Banking (prudential standard) determination No. 4 of 2007 - Prudential Standard APS 111 - Capital Adequacy: Measurement of Capital - Attachment A | Zoe
(v) dividend or interest payments on the instrument are not linked to the credit standing of the issuer. However, linking dividend or interest payments on the instrument to movements in general market indices is permitted; and
(vi) the rate of dividends or interest on the instrument, or the formulae for calculating dividend or interest payments on the instrument, is predetermined and set out in the issue documentation;
(d) the instrument is able to absorb losses incurred by the issuer on a going concern basis and in the winding-up of the issuer. This includes the following provisions:
(i) the instrument (both principal and any unpaid dividends or interest) is treated as a specific class of share capital or members’ interest of the issuer. The contractual rights of the holders of the instrument to receive and enforce any payments under the instrument are consistent with the intention that the instrument functions as if it constituted a specific class of share capital or members’ interest of the issuer;
(ii) the issuer does not have any liability to make a dividend or interest payment on the instrument if making the payment would result in the issuer becoming, or being likely to become, insolvent for the purposes of the Corporations Act 2001 (Corporations Act) or, where the issuer is incorporated in a foreign jurisdiction, for the purposes of equivalent corporate insolvency law of that jurisdiction; and
(iii) issue documentation makes explicit that:
(A) payment of dividends or interest on the instrument is at the discretion of the issuer;
(B) failure of the issuer to make a dividend or interest payment on the instrument does not constitute an event of default;
(C) holders 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 dividend or interest payment under the instrument; and
(D) holders of the instrument will have no offsetting rights or claims on the issuer in the event that the issuer cancels or suspends dividend or interest payments on the instrument;
(e) the instrument is subordinated in right of repayment of principal, interest and dividends to all depositors and other creditors of the issuer and the issue documentation:
(i) clearly indicates the subordinated nature of the instrument to prospective holders, and precludes the exercise of any contractual rights of set-off between the instrument and any claims by the issuer on the holders of the instrument;
(ii) clearly indicates that the instrument does not represent a deposit liability of an ADI;
(iii) does not contain any clauses that could trigger early repayment of debt (e.g. cross-default clauses, negative pledges, restrictive covenants); and
(iv) states that the only form of default under the instrument is the winding up of the ADI and that the occurrence of such an event does not prejudice the subordination of the instrument;
(f) the instrument, where drawn down in a series of tranches, meets the requirements in this Prudential Standard as if each tranche is a capital issue in its own right;
(g) 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 (e.g. clauses preventing further senior debt issues are prohibited);
(h) there are no cross-default clauses in the documentation of any debt or capital instruments 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; and
(i) the instrument is marketed in line with its prudential treatment and does not include any “repackaging” arrangements which have the effect of compromising the permanency of capital raised. If the prospectus or other offering documentation or marketing of the instrument suggests to investors that the instrument has attributes of a lower level of capital than claimed for prudential treatment, APRA will treat the instrument as an instrument falling into that lower level of capital for prudential purposes.
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 under the laws of that jurisdiction. APRA may require the ADI to provide an independent legal opinion addressed to APRA by a firm or practitioner of APRA’s choice, at the expense of the ADI, confirming that the instrument meets all or any of such criteria.
An ADI must seek APRA’s written approval for any subsequent modification of the terms or conditions of the instrument which may affect its eligibility to continue qualifying as Non-innovative Residual Tier 1 capital or Innovative Tier 1 capital.
Non-innovative Residual Tier 1 capital
To qualify as Non-innovative Residual Tier 1 capital at Level 1 and Level 2, perpetual non-cumulative preference shares, in addition to the criteria set out in paragraph 1 of this Attachment, must also satisfy the following criteria:
(a) the preference shares have not been issued indirectly through an SPV. An indirect issue is not eligible for inclusion in Non-innovative Residual Tier 1 capital although the preference shares may be included in Innovative Tier 1 capital provided they also satisfy the criteria set out in Attachment C and the relevant criteria in this Attachment;
(b) the preference shares do not provide for any step-up in dividends. A conversion from fixed to floating rate (or vice-versa) or a switch in index basis, where there is no change in the effective margin included in the rate of dividend, is not considered a step-up;
(c) conversion of the preference shares into ordinary shares is permitted, subject to the following criteria:
(i) conversion cannot occur at the option of the holder;
(ii) the conversion formula for determining the number of ordinary shares received upon conversion of a preference share must be fixed in the issue documentation and must include a cap on the maximum number of ordinary shares that holders will receive upon conversion;
(iii) for the purposes of paragraph 4(c)(ii) of this Attachment, the maximum number of ordinary shares received upon conversion of each preference share must not exceed the ratio of the price of the preference share at issue divided by 50 per cent of the price of the ordinary share at time of issue of the preference shares. For these purposes, in calculating the ordinary share price at time of issue, adjustments may be made for subsequent ordinary share splits, bonus issues and similar transactions;
(iv) the conversion is not structured in a way that would effectively provide for a return of capital or compensation for unpaid dividends; and
(v) any exercise of the conversion option by the issuer is subject to APRA’s prior written approval. Approval is not required for any mandatory conversions whose terms were agreed to by APRA prior to issuance of the preference shares;
(d) perpetual non-cumulative preference shares issued through “stapled” structures are permitted at both Level 1 and Level 2, subject to the following conditions:
(i) the preference shares are issued directly by an ADI and are “stapled” to securities (stapled securities) issued directly by an overseas branch of the ADI. The stapled structure must not involve any use of SPVs and must be simple and transparent;
(ii) either or both of the preference shares and the stapled securities are paid up. Any partly paid preference shares or stapled securities are eligible only to the extent that they have been paid up;
(iii) the preference shares and the stapled securities are not traded separately and are stapled together unless and until an “unstapling event” occurs;
(iv) the terms and conditions of the stapled securities mirror substantially those of the preference shares such that the stapled securities operate effectively as if they were the preference shares. Accordingly, the terms and conditions of the stapled securities do not compromise the Tier 1 qualities of the underlying preference shares;
(v) “unstapling” of the preference shares and the stapled securities at the option of the issuer is permitted. The instrument documentation must clearly stipulate the events that will cause the preference shares to be “unstapled” resulting in the stapled securities being extinguished and the holders of the stapled securities holding the preference shares instead. “Unstapling” must take place where:
(A) proceedings for liquidation of the ADI commence; or
(B) APRA appoints a statutory manager to the ADI pursuant to sub-section 13A(1) of the Banking Act;
(vi) issue documentation requires holders of the stapled securities to hold the underlying preference shares upon the occurrence of an unstapling event. Where necessary, APRA may require an independent legal opinion confirming this result (refer to paragraph 2 of this Attachment). To reduce the inherent legal risk associated with unstapling of the structure, the ADI must ensure the clarity, consistency and certainty with which the contractual terms and conditions are specified in the issue documentation, in particular that:
(A) all entities involved in the stapled structure have the capacity and power needed to issue the relevant instruments and perform obligations under them;
(B) the rights and obligations created by the preference shares and the stapled securities are legal, valid, binding and enforceable on all relevant parties in all relevant jurisdictions; and
(C) the “unstapling” mechanism will take effect as contemplated in the issue documentation even if the ADI or other entity has become, or is likely to become, insolvent, including where it is in administration, receivership, winding up or where the ADI has had a statutory manager appointed under the Banking Act; and
(vii) adequate internal policies and controls are in place such that the unstapling procedures are correctly followed.
Innovative Tier 1 capital
To qualify as Innovative Tier 1 capital at Level 1 and Level 2, in addition to the criteria in paragraph 1 of this Attachment, an instrument must also satisfy the following criteria:
(a) where the instrument provides for a “step-up” in dividends or interest, the terms of the step-up are limited, fixed at the time of issue and subject to APRA’s prior written approval:
(i) a step-up in dividends or interest includes the following events:
(A) a change in margin on a floating rate instrument;
(B) a change in rate on a fixed rate instrument;
(C) a conversion from fixed to floating rate (or vice versa), with a change in the effective margin included in the rate of dividend or interest of the instrument; or
(D) a switch in the index basis (e.g. from a 3-month to 6-month floating rate or from a 3-month LIBOR to a 3-month BBSW) with a change in the effective margin included in the rate of dividend or interest of the instrument;
(ii) a moderate step-up in the rate of dividends or interest is permitted, provided the increase in dividends or interest is no greater than either:
(A) 100 basis points, less the swap spread between the initial index basis and the stepped-up index basis; or
(B) 50 per cent of the initial credit spread, less the swap spread between the initial index basis and the stepped-up index basis;
(iii) the issue documentation specifies which of the two measures in paragraph 5(a)(ii) of this Attachment is to apply to the instrument. Switching between measures is not allowed;
(iv) where the step-up involves a conversion from fixed to floating rate (or vice versa), as set out in paragraph 5(a)(i) of this Attachment, or a switch in index basis, the swap spread must be fixed as at the pricing date and reflect the differential in pricing on that date between the initial reference rate and the stepped-up reference rate;
(v) any step-up in dividends or interest must not be operative within the first 10 years from drawdown; and
(vi) in principle, only one step-up in dividends or interest is permitted over the life of the instrument. Exceptions for step-ups to be undertaken on multiple occasions (and/or for variable amounts) may be approved by APRA in writing at the time of issuing the instrument;
(b) a step-up in dividends or interest or an equity conversion is permitted in conjunction with an issuer call option, provided the step-up or equity conversion meets all relevant criteria in paragraphs 5(a) and 5(c) of this Attachment respectively and, where the application of a step-up or equity conversion is optional, the issue cannot mandate the exercise of the call option if the step-up or equity conversion is not applied;
(c) where the instrument provides for a mandatory conversion or an option to the holders or the issuer to convert into another form of eligible Tier 1 capital instrument, the instrument must not contain any conversion feature that effectively provides for a return of capital or compensation for unpaid dividends or interest. The rate of conversion in all circumstances must be fixed (e.g. by way of a formulae) at the time of issue; and
(d) where the instrument is issued indirectly through an SPV, it satisfies the criteria set out in Attachment C.