Additional Tier 1 (AT1)(1) subordinated debt has been subject to high volatility since the start of the year. Below we attempt to explore what we believe to be one of the contributory factors, regulatory uncertainty.
In this article we review the complex rules governing the distribution of profits to shareholders, bonuses to employees, and coupon payments to holders of AT1 debt. We then present the European Banking Authority’s (EBA) ‘clarifications’ and the areas in which the European Parliament has called for further work.
EQUITY TIER 1 CAPITAL(1) REQUIREMENTS: AN OVERVIEW
SUMMARY
Whilst the regulatory uncertainty currently hovering over both the banking sector and the rules governing AT1 instruments is not necessarily good news, the pragmatic approach adopted by the political authorities and the financial supervisors in an effort to find a solution is, we believe, reassuring.
(1) see Glossary of Terms
THE EBA’S CLARIFICATIONS
SEVERAL POSSIBLE SOLUTIONS
SAME RULES, DIFFERENT INTERPRETATIONS ACROSS EUROPE
Glossary of Terms
Subordinated debt: a debt instrument where holders are only repaid after senior debt holders. In the case of financial institutions, several types of instruments called Tier 1 or Tier 2 exist. Their characteristics vary according to their particular issue details and degree of subordination. These instruments can be used for bail-ins.
Senior debt: a debt instrument where holders are repaid before subordinated debt holders. Financial institutions commonly use these securities to secure funding on the financial markets. These instruments can be used for bail-ins.
Equity Tier 1 capital: shareholder equity and retained earnings. Banks are required to have enough equity Tier 1 capital put aside to cover potential losses.
CET1 (Common Equity Tier 1): a term used to designate banks’ equity Tier 1 capital. It is expressed in absolute terms or as a percentage ratio of risk-weighted assets.
AT1 (Additional Tier 1): a Tier 1 subordinated debt instrument where holders are repaid before shareholders but after all other types of debt holders. These instruments are subject to specific risk of coupon non-payment as well as principal write-downs under certain circumstances.
Tier 2: a Tier 2 subordinated debt instrument where holders are repaid before shareholders and Tier 1 debt holders but after all other types of debt holders.
Bail-in: the bail-in principle seeks to recapitalise a financial institution by calling upon shareholders and creditors. After shareholders, subordinated instruments are the first to be called upon and are either converted into equity or their principal amounts are written down. Senior debt is also bail-inable if necessary.
(1) see Glossary of Terms
The opinion expressed above is dated April 2016 and is liable to change
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