Insurance (prudential standard) determination No. 7 of 2006 - Prudential Standard GPS 110 - Capital Adequacy
Hybrid Capital InstrumentsHybrid Capital Instruments
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To qualify as Upper Tier 2 capital, an insurer must ensure that an instrument satisfies the following criteria:F[19]F
(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; 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) the instrument is not redeemable at the option of the holder and has no other provisions which require future redemption by the issuer; and
(ii) redemption at the option of the issuer is permitted, provided the redemption or call option is subject to APRA’s 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. Should this occur, APRA will consider the instrument to be 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;
(c) cumulative dividend or interest payments on the instrument are permitted subject to paragraph 29 of this Attachment;
(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, including satisfying the criteria specified in paragraph 30 of this Attachment;
(e) 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, including that issue documentation clearly:
(i) indicates the subordinated nature of the instrument to prospective holders; and
(ii) 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;
(f) 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;
(g) 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 formulae) at the time of issue;
(h) 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 35 of this Attachment for further detail);
(i) 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 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;
(j) 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). There are no cross-default clauses in the documentation of any debt instruments of the issuer linking the issuer’s obligations under the instrument to default by another party, related or otherwise;
(k) 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; and
(l) where the instrument is issued indirectly through an SPV, it also satisfies the criteria set out in paragraph 45 of this Attachment.
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.
An insurer must inform APRA of any subsequent modification of the terms or conditions of the instrument. In assessing whether the subsequent modification of the terms or conditions of the instrument affects its eligibility to continue qualifying as Upper Tier 2 capital, APRA will have regard to both the form and substance of the instrument as modified. An insurer must:
(a) provide APRA with copies of documentation associated with the modification of the instrument; and
(b) where the terms and conditions of the instrument as modified depart from established precedent, consult APRA and provide APRA with adequate time to review the instrument in advance of the modification to ensure the eligibility of the instrument for inclusion in the insurer’s capital base.
For the purposes of subparagraph 26(c) of this Attachment:
(a) the instrument must allow the issuer an option to defer servicing obligations where profitability does not justify a dividend or interest payment (refer to paragraph 37 of this Attachment);
(b) where perpetual cumulative preference shares do not provide the issuer with the option to defer or reduce dividends when profitability does not justify payment, such shares are to be treated as a Lower Tier 2 capital instrument;
(c) although any 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;
(d) 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;
(e) 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
(f) 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.
For the purposes of subparagraph 26(d) of this Attachment, the issuer must ensure that:
(a) the instrument (both principal and any unpaid dividends or interest) is treated as a specific class of share capital or member’s 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 member’s interest of the issuer in this situation;
(b) 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
(c) issue documentation makes explicit that:
(i) the issuer has the right to defer dividend or interest payments on the instrument;
(ii) failure of the issuer to make a scheduled dividend or interest payment on the instrument does not constitute an event of default; and
(iii) 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.
Lower Tier 2 capital
To qualify as Lower Tier 2 capital, an insurer must ensure that an instrument satisfies 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; and
(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 is drawn down in a series of tranches, the minimum original maturity of each tranche is five years from the date of drawdown (refer to paragraph 34 of this Attachment for further detail);
(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;
(d) the instrument does 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;
(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, are 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. Paragraph 36 of this Attachment provides further detail in relation to step-ups;
(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 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, 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, including that issue documentation clearly:
(i) indicates the subordinated nature of the instrument to prospective holders, and
(ii) 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;
(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;
(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 15(1) of the 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). There are no cross-default clauses in the documentation of any debt instruments of the issuer linking the issuer’s obligations under the instrument to default by another party (related or otherwise);
(m) where the instrument is issued indirectly through an SPV, it must also satisfy the criteria set out in paragraph 45 of this Attachment.
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.
An insurer must inform APRA of any subsequent modification of the terms or conditions of the instrument. In assessing whether the subsequent modification of the terms or conditions of the instrument affects its eligibility to continue qualifying as Lower Tier 2 capital, APRA will have regard to both the form and substance of the instrument as modified. An insurer must:
(a) provide APRA with copies of documentation associated with the modification of the instrument; and
(b) where the terms and conditions of the instrument as modified depart from established precedent, consult APRA and provide APRA with adequate time to review the instrument in advance of the modification to ensure the eligibility of the instrument for inclusion in the insurer’s capital base.
For the purposes of subparagraph 31(b) of this Attachment:
(a) where the instrument 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;
(b) where the instrument 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
(c) 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