Featured Product

    EBA Issues Opinion to Address Risk Stemming from Legacy Instruments

    October 21, 2020

    EBA issued an opinion on prudential treatment of the legacy instruments as the grandfathering period nears an end on December 31, 2021. In the opinion, EBA has proposed policy options to address the risk that other layers of own funds or eligible liabilities instruments will be disqualified as the grandfathering period expires. To address this risk, EBA envisaged that institutions could either call, redeem, repurchase, or buyback the instrument or amend the Terms and Conditions of the relevant instrument. Another possible policy option is to keep the legacy instrument disqualified from own funds and total loss-absorbing capacity (TLAC)/Minimum Requirement for own funds and Eligible Liabilities (MREL)-eligible instruments, but to retain it in the balance sheet as a non-regulatory instrument, under strict conditions.

    To ensure that institutions had sufficient time to meet the required levels and definition of own funds, the Capital Requirements Regulation (CRR or Regulation 575/20131) introduced grandfathering provisions in 2013. Certain capital instruments that, at that time, did not comply with the new definition of own funds (referred to as legacy instruments) were grandfathered for a transition period, the objective being that they would be gradually phased out from own funds. The beneficial treatment provided by the grandfathering provisions will come to an end on December 31, 2021. In line with its mandate to monitor the quality of own funds and eligible liabilities instruments issued by institutions across EU, EBA has been working to assess the materiality of the outstanding amounts of legacy instruments and to understand institutions’ actions and intentions regarding the phasing out of these instruments at the end of the grandfathering period. In 2019,  EBA announced its intention to provide clarity on the appropriate prudential treatment to ensure a high quality of capital for EU institutions and a consistent application of rules and practices across EU.

    When reviewing EU institutions’ legacy instruments and examining the clauses that led to their grandfathering, EBA identified two key issues that could create the risk that other layers of own funds or eligible liabilities instruments will be disqualified. The first issue relates to the flexibility of distribution payments principle while the second one regards clauses that might contradict the eligibility criterion of subordination. For this reason, legacy instruments will need to be subject to different tests to be cascaded down into a lower category of capital or as eligible liabilities instruments without creating the risk. To address this risk and preserve the quality of regulatory capital, EBA proposed the following policy options:

    • Institutions can either call, redeem, repurchase, or buy-back the relevant instrument. Institutions are expected to undertake all possible efforts to execute any action that leads to the redemption of legacy instruments. In addition to the possibility to buyback, repurchase, or redeem the instruments, call options, when available, are expected to be exercised for grandfathered instruments. In this context, for instruments with an issuer’s call option in the short to medium term, EBA reasonably anticipates that institutions will use this possibility as a first option to address the risk and will call or redeem the instrument.
    • Institutions can amend the terms and conditions of the relevant instrument. Institutions might attempt to address the risk arising from contractual provisions contradicting the subordination requirement by promoting the instrument in the hierarchy of creditors, for example, by amending a legacy Additional Tier 1 instrument to rank pari passu with Tier 2 instruments; however, this would not exclude the need to assess any other relevant eligibility criteria, including those introduced by CRR2, beyond the criterion of subordination.
    • When it is not possible for institutions to pursue either of the above two options, or in case of residual amounts remaining from legacy instrument buybacks, institutions can keep the legacy instrument disqualified from own funds and TLAC/MREL-eligible instruments but to retain it in the balance sheet as a non-regulatory instrument, under strict conditions. Under this option, the instrument would be excluded from own funds and TLAC/MREL-eligible instruments while remaining in the balance sheet of the institution. EBA is aware of the limitations of this option, given that the risk of fully eligible own funds instruments is not completely addressed by the exclusion of legacy instruments from own funds and TLAC/MREL-eligible instruments. Nevertheless, EBA advises that this last option should be treated as a last resort option; it is intended as a backstop measure for legacy instruments if neither of the other options is available.  

    EBA will monitor the situation of the legacy instruments until the end of the grandfathering period and will focus on the use of the proposed options across jurisdictions to ensure a consistent application. EBA will also consider the transposition of specific provisions of Directive 2014/59/EU into national legislation and how this might alleviate concerns about the existence of risk linked to subordination aspects. The Board of Supervisors has adopted this opinion, which is addressed to competent authorities. 

     

    Related Links

    Keywords: Europe, EU, Banking, Legacy Instruments, Own Funds, Grandfathering period, CRR, Regulatory Capital, MREL, Basel, EBA

    Featured Experts
    Related Articles
    News

    PRA to Elaborate on Approach to Transposition of CRD5 by Mid-December

    PRA published a statement that explains when to expect further information on the PRA approach to transposing the Capital Requirements Directive (CRD5), including its approach to revisions to the definition of capital for Pillar 2A.

    November 30, 2020 WebPage Regulatory News
    News

    SRB Sets Out Work Program for 2021-2023

    SRB published the work program for 2021-2023, setting out a roadmap to further operationalize the Single Resolution Fund and to achieve robust resolvability of banks under its remit over the next three years.

    November 30, 2020 WebPage Regulatory News
    News

    EIOPA Consults on KPIs on Sustainability for Non-Financial Reporting

    EIOPA is consulting on the relevant ratios to be mandatorily disclosed by insurers and reinsurers falling within the scope of the Non-Financial Reporting Directive as well as on the methodologies to build these ratios.

    November 30, 2020 WebPage Regulatory News
    News

    US Agencies Issue Statement on LIBOR Transition

    US Agencies (FDIC, FED, and OCC) issued a joint statement encouraging banks to cease entering into new contracts that use USD LIBOR as a reference rate as soon as practicable and in any event by December 31, 2021, to facilitate an orderly LIBOR transition.

    November 30, 2020 WebPage Regulatory News
    News

    GHOS Endorses Coordinated Approach to Mitigate COVID Risks for Banks

    The Group of Central Bank Governors and Heads of Supervision (GHOS), the oversight body of BCBS, endorsed a coordinated approach to mitigate COVID-19 risks to the global banking system.

    November 30, 2020 WebPage Regulatory News
    News

    HM Treasury Extends Consultation Dates for FRF and Solvency II Reviews

    HM Treasury extended the consultation period on Phase II of the Future Regulatory Framework (FRF) Review, from January 19, 2021 to February 19, 2021.

    November 30, 2020 WebPage Regulatory News
    News

    ECB Publishes Guide on Management of Climate and Environmental Risks

    ECB finalized guidance on the way it expects banks to prudently manage and transparently disclose climate and other environmental risks under the current prudential rules.

    November 27, 2020 WebPage Regulatory News
    News

    BCBS Amends Capital Treatment of Non-Performing Loan Securitizations

    BCBS published a technical amendment to the capital treatment of securitizations of non-performing loans by banks.

    November 26, 2020 WebPage Regulatory News
    News

    PRA Policy on Stressed VaR and RNIV Calculations Under Market Risk

    PRA published the policy statement PS23/20 on the calculation of stressed value at risk (sVAR) and risks not in value at risk (RNIV) under the market risk framework.

    November 26, 2020 WebPage Regulatory News
    News

    BoE to Move Statistical Data Collection to BEEDs Portal

    BoE announced that the Data and Statistics Division is planning to move collection of statistical data to the BoE Electronic Data Submission (BEEDS) portal.

    November 25, 2020 WebPage Regulatory News
    RESULTS 1 - 10 OF 6179