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For an instrument to qualify as Upper Tier 2 capital, an insurer must ensure that it satisfies the following criteria:[16]F
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the instrument is unsecured and paid up, and in particular:
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any partly paid issue is eligible only to the extent that it has been paid up; and
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only the proceeds of the issue that have been received by the issuer are permitted to count as capital;
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the instrument is perpetual and:
1. the instrument is not redeemable at the option of the holder and has no other provisions which require future redemption by the issuer; and
2. 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 its 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 treat the instrument as a dated instrument and ineligible for inclusion as Upper Tier 2 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;
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the instrument where drawn down in a series of tranches meets the requirements of this Prudential Standard as if each tranche were a separate capital issue in its own right;
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cumulative dividend or interest payments on the instrument are permitted subject to paragraph 8 of this Attachment;
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the instrument is able to absorb losses incurred by the issuer on a going concern basis and in the winding-up of the issuer, and in particular, satisfying the criteria specified in paragraph 9 of this Attachment;
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the instrument is subordinated in right of repayment of principal, interest and dividends to all policyholders and creditors of the issuer, except those creditors (not policyholders) expressed to rank equally with or behind the holders of the instrument and the issue documentation and, in particular, the instrument:
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clearly indicates the subordinated nature of the instrument to prospective holders;
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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;
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does not contain any clauses that could trigger early repayment of debt (e.g. cross default clauses, negative pledges, restrictive covenants);
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states that the only form of default under the instrument is the winding up of the insurer, provided such an event does not prejudice the subordination of the instrument; and
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states that the only remedies for an event of default are to prove for an unpaid amount contractually due in the event of liquidation or administration of the issuer;
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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 subsection 15(1) of the Act, are not sufficient to accelerate repayment of the instrument;
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where the instrument provides for a mandatory conversion or an option to the holders or the issuer to convert into share capital of the issuer, the instrument does not contain any conversion feature that effectively provides for a return of capital or compensation for unpaid dividends or interest. The rate of conversion is fixed (e.g. by way of a formula) at the time of issue;
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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 (refer to paragraph 14 of this Attachment for further criteria in relation to step-ups);
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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 specified in paragraphs 5(h), 5(i) and 14 of this Attachment 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;
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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);
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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;
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the instrument is marketed in line with its prudential treatment, and does not include any ‘repackaging’ arrangements that 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;
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the insurer must have satisfied itself (where appropriate by taking into account written opinion from relevant legal advisers), on reasonable ground, that at time of issue of the instrument, the right to defer dividend or interest payments as provided for in paragraph 9(c)(i) of this Attachment is binding on holders of the instrument. An insurer must, if required by APRA, be able to demonstrate grounds on which it satisfied itself in this regard; and
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where the instrument is issued indirectly through an SPV, it also satisfies the criteria set out in Attachment C.
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Where the instrument is subject to the laws of a jurisdiction other than a state or territory of Australia, an insurer must also ensure that the instrument complies with and is enforceable under the laws of that jurisdiction. APRA may require the insurer to provide confirmation by way of an independent legal opinion addressed to APRA by a firm or practitioner of APRA’s choice, at the expense of the insurer.
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An insurer must inform APRA of any subsequent modification of the terms or conditions of the instrument. An insurer must:
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provide APRA with copies of documentation associated with the modification of the instrument; and
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where the terms and conditions of the instrument as modified depart from established precedent:
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consult with APRA on the eligibility of the instrument as modified for inclusion in the insurer’s capital base in advance of the modification of the instrument; and
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provide APRA with all information it requires to assess the eligibility of the instrument as modified.
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For the purposes of paragraph 5(d) of this Attachment:
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the instrument must allow the issuer an option to defer dividend or interest payments where profitability does not justify a dividend or interest payment;[17]
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where an instrument does not provide the issuer with the option to defer or reduce dividends or interest when profitability does not justify payment, such an instrument must be assessed as a Lower Tier 2 capital instrument;
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while unpaid dividends or interest to the holders of the instrument can be accumulated, they must not be compounded. For example, the instrument must not provide for payment of a higher dividend or interest rate if dividend or interest payments are not made on time, nor a reduced dividend or interest rate if such payments are made on time;
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the non-payment of a dividend or interest on the instrument must 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;
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the instrument must not provide for payment of any form of compensation to investors other than by way of a distribution of profits. Any such profit distribution must be in the form of a cash dividend or interest payments. Payment in kind is not permitted;
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dividend or interest payments on the instrument must not be 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
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the rate of dividends or interest on the instrument, or the formulae for calculating dividend or interest payments on the instrument, are predetermined and set out in the issue documentation.
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For the purposes of paragraph 5(e) of this Attachment, the issuer must ensure that:
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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 in the event that the issuer’s retained earnings become negative. The contractual rights of the holders of the instrument to receive and enforce any payments under the instrument must be consistent with the intention that the instrument functions as if it constituted a specific class of share capital or members’ interest of the issuer in this situation;
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the issuer does not have any liability to make a scheduled 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 or, where the issuer is incorporated in a foreign jurisdiction, for the purposes of equivalent corporate insolvency law of that jurisdiction; and
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issue documentation makes explicit that:
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the issuer has the right to defer dividend or interest payments on the instrument in accordance with paragraphs 8(e) and/or 9(b) of this Attachment;
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failure of the issuer to make a scheduled dividend or interest payment on the instrument does not constitute an event of default; and
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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 scheduled dividend or interest payment under the instrument. However, in the event of liquidation, holders may claim previously deferred dividend and interest payments that remain unpaid.