Banking (prudential standard) determination No. 4 of 2007 - Prudential Standard APS 111 - Capital Adequacy: Measurement of Capital
Lower Tier 2 capitalLower Tier 2 capital
Start here
Get a plain-English read of Lower Tier 2 capital
Turn the raw legal text into a practical explanation grounded in Banking (prudential standard) determination No. 4 of 2007 - Prudential Standard APS 111 - Capital Adequacy: Measurement of Capital.
To qualify as Lower Tier 2 capital at Level 1 and Level 2, an instrument must satisfy the following criteria:
(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;
(ii) only the proceeds of the issue that have been received by the issuer are permitted to count as capital;
(b) the instrument has a minimum term of five years. Where the instrument:
(i) is drawn down in a series of tranches, it must meet the requirements in this Prudential Standard as if each tranche is a separate capital issue in its own right and the minimum original maturity of each tranche must be five years from the date of drawdown;
(ii) provides holders with the right or option to demand repayment prior to maturity, the first possible repayment date is regarded as the effective maturity date of the instrument;
(iii) offers the issuer a redemption or call option prior to maturity, issue documentation must give clear and prominent notice to prospective investors that the issuer’s right to exercise any such option to repay, purchase, or otherwise redeem the instrument is subject to APRA’s prior written approval; and
(iv) the amount of the instrument eligible for inclusion in Lower 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 Lower 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
(c) issue documentation makes explicit that all scheduled dividend or interest payments on the instrument are conditional upon the issuer being solvent at the time of payment and no payment may be made unless the issuer is solvent immediately afterwards. Failure of the issuer to make any scheduled dividend or interest payments in this case does not constitute an event of default. An instrument may continue to accrue interest on any unpaid amounts. This can include interest on deferred interest payments;
(d) 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;
Part Lower Tier 2 capital - Banking (prudential standard) determination No. 4 of 2007 - Prudential Standard APS 111 - Capital Adequacy: Measurement of Capital - Lower Tier 2 capital | Zoe
(e) 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;
(f) 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;
(g) 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) 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) 50 basis points, less the swap spread between the initial index basis and the stepped-up index basis, for an issue with a maturity up to 10 years;
(B) 100 basis points, less the swap spread between the initial index basis and the stepped-up index basis, for an issue with a maturity of more than 10 years; or
(C) 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 three measures in paragraph 8(g)(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 noted in paragraph 8(g)(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 five 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;
(h) a step-up in dividends or interest is permitted in conjunction with an issuer call option, provided the step-up meets all relevant criteria set out in paragraph 8(g) of this Attachment and, where the application of a step-up is optional, the issue cannot mandate the exercise of the call option if the step-up is not applied. Otherwise, the instrument is deemed to mature on the date at which the step-up provisions take effect;
(i) the instrument is subordinated in right of repayment of principal and interest to all depositors and other creditors of the issuer, except those creditors (not depositors) expressed to rank equally with or behind the holders of the instrument and the issue documentation clearly indicates:
(i) 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; and
(ii) that the instrument does not represent a deposit liability of an ADI;
(j) in the event that the issuer defaults under the terms of the instrument, remedies available to the holders are limited to actions for specific performance, recovery of amounts currently outstanding or the winding-up of the issuer. The amounts which may be claimed in the event that the issuer defaults can include any accrued unpaid dividends and interest, including 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;
(k) the instrument does not provide for any accelerated repayment of principal, except in the event of liquidation or winding-up of the issuer. The winding-up must be irrevocable i.e. 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 are not sufficient to accelerate repayment of the instrument;
(l) 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);
(m) there are no cross-default clauses in the documentation of any debt or other 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;
(n) 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 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;
(o) any subsequent modification of the terms or conditions of the instrument, which may affect its eligibility to continue qualifying as Lower Tier 2 capital, is subject to APRA’s prior written consent; and
(p) where the instrument is issued indirectly through an SPV it must also satisfy the criteria set out in Attachment C.