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    OSFI to Recognize Limited Recourse Capital Notes as Regulatory Capital

    July 15, 2020

    OSFI published a letter and capital ruling that explains its considerations in determining that the Limited Recourse Capital Notes can qualify as Additional Tier 1 regulatory capital by the requesting bank and other federally regulated financial institutions, subject to certain limitations and disclosure requirements. A Canadian bank is now marketing this new financial instrument called a Limited Recourse Capital Note or LRCN. The bank had sought a ruling from OSFI regarding the regulatory capital treatment of the LRCNs. According to OSFI, the LRCN structure meets all of the criteria to be recognized as Additional Tier 1 regulatory capital by the bank and other federally regulated financial institutions.

    As per the capital ruling, recognition of the LRCNs as Additional Tier 1 capital (or AT1) will be subject to certain limitations. OSFI may add to, amend, or delete these limitations at any time. Limitations may also vary by issuer and/or issuance. The LRCNs can only be issued to institutional investors. The LRCNs and preferred shares must have a minimum par or stated value of $1,000 and be traded on institutional desks (that is, not exchange-listed). The LRCNs must have an initial term to maturity of at least 60 years. Unless the instrument has been replaced with an instrument of higher capital quality (that is, CET1-qualifying common shares or retained earnings), the issuer will only be permitted to redeem the LRCNs or preferred shares where the carrying cost of the LRCNs or preferred shares exceeds the cost of replacement capital of equivalent quality (that is, AT1). The LRCN issuance will be subject to a cap of 0.75% of risk-weighted assets (that is, 50% of the AT1 bucket) as measured on the date of issuance. In calculating this limit, the issuer should compare the aggregate of its outstanding and proposed issuance of LRCNs on the date of issuance to 0.75% of the risk-weighted assets. The limit should consider the issuer's capital at the last reporting date with adjustments for subsequent transactions, including issuance, redemptions, buybacks, and acquisitions. Furthermore, OSFI specifies that the disclosure and marketing of the LRCNs to investors must clearly disclose how the LRCNs' risks are equivalent to the risks of investing in directly issued Tier 1-qualifying Non-Viability Contingent Capital (NVCC) preferred shares.

    OSFI routinely assesses the quantity and quality of financial instruments that federally regulated financial institutions issue as regulatory capital and/or total loss absorbing capacity (TLAC). This is done to ensure that institutions maintain adequate capital and loss-absorbing capacity as required by their governing statutes and the OSFI guidance. OSFI has reviewed the quality of this structure relative to the eligibility criteria set out in Chapter 2 of the OSFI Capital Adequacy Requirements Guideline, with emphasis on economic substance over legal form. OSFI also considered the potential behavior and impact of the structure on financial stability, particularly in periods of stress.

     

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    Keywords: Americas, Canada, Banking, Regulatory Capital, Limited Recourse Capital Notes, LRCN, Additional Tier 1 Capital, Basel, Disclosures, CAR Guideline, OSFI

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