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Measurement of capital - frequently asked questions

The following frequently asked questions (FAQs) provide information to assist regulated entities in complying with Prudential Standards APS 111 Capital Adequacy: Measurement of Capital, GPS 112 Capital Adequacy: Measurement of Capital, and LPS 112 Capital Adequacy: Measurement of Capital (the capital requirements), with respect to the requirements for Common Equity Tier 1 (CET1) Capital instruments, Additional Tier 1 (AT1) Capital instruments, Tier 2 (Tier 2) Capital instruments, and Mutual Equity Interests (MEIs).  

The references for APS 111 are to the 1 January 2022 version. The references for GPS 112 are to the July 2019 version and LPS 112 are to the January 2013 version (the versions in force as at 1 January 2022).

These FAQs are not exhaustive. Regulated entities are encouraged to contact APRA if they have questions regarding the interpretation of the relevant prudential standards.

The FAQs do not currently apply to capital instruments that are issued by Private Health Insurers (PHIs). In November 2018 APRA announced a review of the Capital standards applying to PHIs and a Discussion Paper Private Health Insurance Capital Standards Review was issued in December 2019.  In these papers, APRA indicated that it would use the Life and General Insurance Capital (LAGIC) framework as a starting basis for the revised PHI capital standards. APRA is planning to issue a PHI capital framework consultation paper with further details in December 2021.  PHIs may refer to the FAQs for guidance on the capital instrument eligibility assessment process. 

These FAQs are for clarification purposes only and are not legal advice. APRA encourages you to obtain professional advice about the application of any legislation or prudential standard to your particular circumstances. You should also exercise skill and care when relying on any materials contained in these FAQs. APRA disclaims any liability for any loss or damage arising out of any use or reliance on these FAQs. The FAQs may include links to external websites that are beyond APRA’s control.  APRA accepts no responsibility for the accuracy, completeness or currency of any externally linked or referenced material in these FAQs.

The numbering of these questions is fixed and will not change as new questions are added.  

Updated: 7 December 2021.

Glossary

Acronym

 

ADI

authorised deposit-taking institution

APS 111

Prudential Standard APS 111 Capital Adequacy: Measurement of Capital (1 January 2022)

APS 222

Prudential Standard APS 222 Associations with Related Entities (1 January 2022)

AT1

Additional Tier 1 Capital as defined in APS 111, GPS 112 or LPS 112, as applicable.

Capital instruments

All capital instruments eligible to be included in Common Equity Tier 1 Capital, Additional Tier 1 Capital and Tier 2 Capital.

CET1

Common Equity Tier 1 Capital as defined in APS 111, GPS 112 or LPS 112, as applicable.

GPS 112

Prudential Standard GPS 112 Capital Adequacy: Measurement of Capital (1 July 2019)

LPS 112

Prudential Standard LPS 112 Capital Adequacy: Measurement of Capital (1 January 2013)

MCN

maximum conversion number

MEIs

Mutual equity interests as defined in APS 111 Attachment I.

NOHC

Non-operating holding company

Tier 2

Tier 2 Capital as defined in APS 111, GPS 112 or LPS 112 as applicable.

1. Information relevant for APRA’s assessment of the eligibility of capital instruments

 

References:

  • APS 111 paragraphs 14, 15, 25 to 27, 37(e), Attachment B, Attachments E to I;
  • GPS 112 paragraph 11, 23(f), Attachment A, Attachments C to G, Attachment I;
  • LPS 112 paragraph 13, 25(f), Attachment A, Attachments C to G. 

1.1: What information will facilitate APRA’s assessment of the eligibility of a capital instrument? (Updated December 2021)

In assessing the eligibility of an existing or proposed capital instrument, APRA will wish to review a complete set of relevant documents for that capital instrument. This includes:

  • a statement of compliance (refer to FAQ 1.2);
  • the prospectus, information memorandum or any other investor disclosure document;
  • any other terms and conditions of the instrument.  For AT1 and Tier 2 capital instruments this may include a deed poll or trust deed.  For CET1 capital instruments, this is likely to include the constitution, and any shareholder agreements;
  • the term sheet, pricing supplement, final terms and/or subscription agreement (as applicable); 
  • relevant opinions (e.g. accounting, tax and legal – refer to FAQ 1.4), rulings, advices and waivers (as applicable); and
  • any ancillary and supporting agreements (e.g. agency agreement, dealer agreement, any other agreements which impose benefits or obligations linked to the capital instrument) (refer to FAQ 1.8).

The above is not an exhaustive list, and APRA may request additional documents as needed.

APRA’s assessment will be facilitated if all documentation for a proposed capital instrument is in the form of well-developed draft documents which are consistent with each other and prior documents. Where amendments have been made to a base document over time, please provide a consolidated copy of the current draft document, with new clauses/content identified. In addition, please provide an explanation of the rationale behind the insertion of new clauses/content or innovative features and how they are consistent with the prudential requirements.

Drafting errors in the documentation or lack of an adequate explanation of the rationale behind inclusion of new clauses/content or innovative features will inevitably lead to delays in APRA’s assessment process as the errors will need to be rectified and the documents resubmitted and an explanation for the changes provided.

When submitting documents for assessment, please also include Capital.Submissions@apra.gov.au in the email to your supervision team.

1.2: What information is sought in a statement of compliance? (Updated December 2021)

To assist APRA’s assessment of a capital instrument, the statement of compliance is expected to:

  • separately address each required capital eligibility criterion set out in the relevant prudential standard, including the attachments to the prudential standard;
  • clearly set out references to supporting transaction documents and opinions; and
  • relate to the final issue documents or at least well-developed draft versions.

Simple answers to a criterion such as “compliant”, “non-compliant”, “yes”, “no” or “n/a” are not considered by APRA to be sufficient.  APRA expects that evidence of compliance will include references to supporting transaction documents and opinions, and/or statements of intent or affirmation, along with any necessary explanations.

A senior executive of the entity should sign and date the statement of compliance, acknowledging responsibility for the assessment when making their submission.

1.3: What additional information may be sought when APRA is assessing a capital instrument? (Updated December  2021)

Where there are multiple entities involved in the instrument (including at conversion or write-off), diagrams depicting the interactions between entities in various scenarios and accompanying accounting entries may assist APRA’s assessment.

If a CET1 capital instrument is to be issued by a subsidiary within a Level 2 general insurance group or a capital instrument is to be issued by a subsidiary within an ADI Level 2 group, the regulated entity will need to determine the impact on regulatory capital of the minority interest restrictions. Provision of the full calculation will facilitate APRA’s review - refer also to FAQ 2.1. (Note: The minority interest restrictions on AT1 and Tier 2 capital instruments do not apply to general insurers. There are no minority interest restrictions on capital instruments for life insurers.) 

1.4: What independent expert opinions are needed to facilitate APRA’s assessment of the eligibility of a capital instrument? (Updated December  2021)

APRA may request that an entity provide an accounting opinion, a legal opinion and a tax opinion for a CET1 capital instrument which contains innovative features.  

For any new or revised AT1, Tier 2 or MEI capital instrument, APRA expects provision of opinions from independent experts on the:

  • accounting treatment;
  • tax treatment; and
  • legal status of the instrument in all relevant jurisdictions.

Opinions need to be timely and able to be relied upon by APRA to its satisfaction. For this reason, opinions ideally will be addressed to APRA. Alternatively, where opinions are addressed to the entity, APRA expects the opinion will include a statement that the advice may be relied upon by APRA for the purpose of assessing capital eligibility under the relevant prudential standards.  The relevant engagement letters also need to be consistent with this reliance statement. 

If an entity wishes to rely on an opinion provided previously, the signatory will need to confirm that the opinion remains valid in relation to the proposed capital instrument.

1.5: What matters will APRA look for in an opinion on the accounting treatment of a capital instrument? (Updated December 2021)

To facilitate assessment of whether the instrument will meet the requirements of the relevant prudential standards, the accounting opinion will need to address whether:

  • the instrument constitutes equity or is a liability for accounting purposes;
  • conversion of the instrument will generate an unequivocal increase in CET1 capital under Australian Accounting Standards on a Level 1 and Level 2 basis (as relevant);
  • write-off of the instrument will generate an unequivocal increase in CET1 capital under Australian Accounting Standards on a Level 1 and Level 2 basis (as relevant); and
  • an approval from APRA for any reserve generated by conversion or write-off under an accounting treatment which is not specifically identified as eligible CET1 capital is required.

An accounting opinion will generally be requested for MEIs but generally not for an equity instrument that clearly complies with the requirements for CET1 capital.

1.6: What matters will APRA look for in an opinion on the tax treatment of a capital instrument? (Updated December 2021)

To facilitate assessment of whether the instrument will meet the requirements of the relevant prudential standards, at a minimum the tax opinion will need to address any adverse tax consequences (including potential tax liabilities and tax offsets) which may arise as a result of conversion or write-off of the instrument, any outcomes from tax consolidation arrangements, as well as any other relevant issues. 

If the opinion concludes that there are potential tax implications arising from the primary means of loss absorption (whether conversion or write-off) including reductions in deferred tax assets, increases in deferred tax liabilities, or other offsets arising from conversion or write-off, the regulated entity will need to determine its best estimate of the offset value and consequently the net amount of CET1 capital that will be generated by full conversion or write-off of the instrument. This estimate can take account of the fact that net deferred tax assets are already deducted from CET1 capital. This analysis will typically involve scenario analysis demonstrating the potential impact of the conversion or write-off. The regulated entity will also need to determine how this best estimate will be updated during the life of the instrument. 

1.7: What matters will APRA look for in an opinion on the legal status of a capital instrument? (Updated December 2021)

To facilitate assessment of whether the instrument will meet the requirements of the relevant prudential standards, the legal opinion will need to address whether:

  • the issue of the instrument is legally permitted and in compliance with applicable law, including the issuer’s constitution; 
  • the issuer has obtained all approvals and authorisations required in relation to the issue of the instrument and the performance of the terms of the instrument;
  • the instrument will constitute valid and legally binding obligations of the issuer, enforceable in accordance with the terms of the instrument, including subordination; 
  • the conversion/write-off arrangements are legally effective and there are no legal impediments to those arrangements operating in accordance with their terms; and
  • the laws of any foreign jurisdiction applying to the instrument could prevent it from satisfying the qualifying criteria for the relevant category of capital under the relevant prudential standards. See also FAQ 9.1.

A legal opinion will generally not be needed for ordinary shares that comply with the requirements for CET1 capital.  For mutual ADIs, additional opinions in respect of instruments that convert to MEIs will be sought. (See FAQ 11.1 below.)

1.8: What is the relevance of ancillary agreements (including agency agreements, agreements with dealers and shareholders etc.) to assessing the eligibility of a capital instrument? (Updated December 2021)

The capital instrument is assessed taking into account all documentation, investor disclosures and any other agreements that may impact the eligibility of the capital instrument for a particular category of capital.  For example, APRA considers whether there are provisions in any documents related to an instrument that may hinder recapitalisation of the regulated entity or any other members of the group to which the issuer belongs.

In addition, APRA assesses whether ancillary documentation is consistent with, and appropriately supports, the operation of the instrument in accordance with its terms. Where conversion into ordinary shares or MEIs is the principal loss absorbing mechanism, APRA expects entities to have a documented process in place to be followed by issuers, fiscal agents, registrars or any other party for the effective conversion within the required timeframe. An entity is expected to provide this documentation to APRA upon request.

1.9: What does APRA consider when determining whether other related transactions affect the overall economic substance of a capital instrument? (Added December 2021)

The components of the entity’s capital must satisfy eligibility requirements in both form and substance. APRA expects that only genuine additions to the capital resources available to an entity or its consolidated group will be included in an entity’s regulatory capital. For example, an entity could report, in its capital base, ordinary shares held by a parent entity that the parent entity funded out of debt. However, where the entity may come under pressure to pay dividends to enable the parent entity to meet its debt obligations, the form of the capital instrument reported by the entity would not accord with its economic substance. In such a case, the ordinary shares could not reasonably be considered to satisfy the requirements for that category of regulatory capital. Separate agreements which have the effect of changing the characteristics of a capital instrument, for example by impacting on effective returns, or undermining the effectiveness of subordination provisions may also be considered to affect the overall economic substance.

1.10: When will APRA want to review documentation for a CET1 capital instrument?  (Added December 2021)

Examples of when APRA will want to review documentation for CET1 capital instruments include: 

  • when the entity is not listed and the constitution or other constituent documents has not previously been reviewed for compliance with the CET1 capital requirements; 
  • prior to the entity being licensed; or
  • if there are amendments to the constitution or other documentation that may impact on the category of capital being raised.

1.11: What are the consequences if an entity enters an arrangement or amends an agreement that impacts the eligibility of a capital instrument? (Added December 2021)

APRA expects that all agreements relating to capital instruments will be consistent with the prudential requirements for capital instruments.   It is the responsibility of an entity to ensure that it does not amend any agreements, or enter other arrangements, which undermine the eligibility of any capital instrument.  If such an amendment or arrangement is made, the instrument is not eligible as capital from the date the amendment was made or the arrangement was entered into. Particular care should be taken where new or amended agreements assert predominance over other previous agreements. If capital instrument documentation is amended then the entity must ensure it takes due care and diligence to minimise the risk of a breach of its prudential capital requirements.

2. Minority Interests

 

References:

  • APS 111 Attachment C and D;
  • APS 222;
  • GPS 112 Attachment I.

2.1: How is the eligible regulatory capital of an ADI or general insurer attributable to third parties/minority interests calculated? (Updated December 2021)

Under the relevant prudential standards, eligible regulatory capital issued by a fully consolidated subsidiary of an ADI or general insurer to third parties may be included in regulatory capital at Level 2, subject to the deduction of any surplus capital amount above the minimum regulatory requirements. 
For general insurers, the minority interest restrictions only apply to CET1 capital. However, for ADIs, minority interest restrictions apply to CET1, AT1, Tier 2 and Total Capital. Where applicable, the ADI or general insurer will need to undertake an analysis of the implications for the amount of eligible capital under the relevant prudential standards and verify the calculation. If a minority interest calculation is required for an ADI, the calculation needs to be completed at each tier of capital, regardless of the tier of capital of the minority interests. 

For capital instruments issued by a subsidiary of an ADI, the ADI will also need to consider the implications under APS 111 Attachment D (Regulatory adjustments) and APS 222 in the event of conversion/write-off.

3. Conversion requirements for AT1 and Tier 2 capital instruments

 

References:

  • APS 111 Attachments E, F, G and H; 
  • GPS 112 Attachments C, E, G and I;
  • LPS 112 Attachments C, E and G.

3.1: How does the conversion formula need to operate for determining the number of CET1 capital instruments issued on conversion of an AT1 or Tier 2 capital instrument?

Under the relevant prudential standards, the conversion formula must be fixed in the issue documentation.

To ensure that conversion can occur immediately when required, APRA expects that, by applying the conversion formula, the number of shares to be received upon conversion is capable of being ascertained immediately, objectively and without further steps.

In cases where the issuer of ordinary shares is not listed, and a traded share price is not available, APRA expects it will be necessary to refer to the book value of ordinary shares as reported in the most recently available reports. Proposals for the directors or a third party to determine the valuation following the occurrence of a relevant trigger event will not be considered by APRA as acceptable.

If it is possible for the book value of ordinary shares to be equal to or less than zero, the terms would usually state that a maximum number of shares to be received upon conversion will apply in such cases. 

For instruments which are, or may be, issued in foreign currency the method for determining the exchange rate at relevant times will need to be clear. In addition, APRA expects issuers to ensure that the exchange rate used is (a) the prevailing exchange rate for calculating the conversion number, and (b) the issue date exchange rate for calculating MCN.

APRA expects issuers to ensure that there is a method for determining the exchange rate at the time of a trigger event if markets are closed at the intended time of conversion and that any calculations for the adjustment of the conversion formula are also fixed in the issue documentation. See also 3.2.

In the case of MEIs, refer to 11.1.

3.2: Under what circumstances can the ordinary share price at time of issue be adjusted when calculating the maximum number of ordinary shares to be received upon conversion of an AT1 or Tier 2 capital instrument?

Under the relevant prudential standards, the formula for determining the maximum number of ordinary shares received upon conversion must be set out in the issue documentation, based on the ordinary share price at the time of issue. The maximum number of ordinary shares received upon conversion needs to be capable of being ascertained immediately, objectively and without further steps.

The allowable adjustments to the ordinary share price at the time of issue, as set out in the relevant prudential standards, are designed to reflect transactions that change the number of shares on issue without involving any exchange of value and have no impact on the capital base. Transactions involving cash payments or other compensation to or by holders of ordinary shares, or to or by the issuer of ordinary shares, are excluded. For example, rights issues, off-market buy-backs, return of capital and payments of special dividends must not give rise to any adjustment.

3.3: What happens if the issuer is acquired by a third party and any future conversion of an AT1 or Tier 2 capital instrument is to be into ordinary shares of the acquirer?

If an issuer wishes to enable an acquirer to issue shares upon conversion of a capital instrument following an acquisition event (instead of converting the instrument prior to that event), the terms of the instrument need to provide for all amendments required to issue the shares in compliance with the relevant prudential standards, including amendments to trigger events, MCNs etc., and for recapitalisation of the regulated entity. 

3.4: What is considered immediate conversion or write-off of an AT1 or Tier 2 capital instrument for the purposes of the relevant prudential standards? (Updated December 2021)

Under the relevant prudential standards, immediate conversion or write-off must occur when the regulated entity reaches a loss absorption trigger point or when the regulated entity is notified that APRA considers it would become non-viable. The instrument must enable conversion or write-off to occur at any time of the day during a business day or on a day that is not a business day.

If conversion has not been fully effected, for any reason, within 5 business days of the relevant loss absorption trigger event, the terms need to unambiguously provide for write-off (including termination of the right to receive ordinary shares, principal and interest) as at the time of the relevant trigger event.

3.5: Do all the requirements under the relevant prudential standards apply to additional tranches issued under the same terms and conditions (i.e. tap or tranche issues) as an initial issuance? (Added June 2019)

Yes. Each additional issuance needs to separately comply with all the requirements under the relevant prudential standards.
    
This includes, for example, the minimum period from the additional tranche issue date to the first call date and the maximum number of ordinary shares (or MEIs) into which an instrument can convert (it’s MCN).  

In an additional tranche, the MCN set at the time of the initial issuance will be used, so that the tranches are fungible. That number must not exceed the price of the instrument in the additional tranche divided by 20 per cent of the issuer’s ordinary share price at the time of issue of the additional tranche. If the MCN set at the time of the initial issuance is the maximum permitted under the relevant prudential standard, an additional fungible tranche will be possible only if the issuer’s ordinary share price at the time of issue of the additional tranche is equal to or lower than the share price at the initial issuance date.

 4.    Cross-default provisions in relation to AT1 and Tier 2 capital instruments 

 

References:

  • APS 111 Attachments E paragraphs 19 and 36, and Attachment G paragraphs 19 and 35;
  • APS 222 paragraph 16(b);
  • GPS 112 Attachments C paragraph 12 and, E paragraph 11;
  • LPS 112 Attachments C paragraph 12 and E paragraph 11.

4.1: What is required of an issuer in relation to the cross-default clauses requirement contained in the relevant prudential standards? 

Under the relevant prudential standards, the issuer needs to ensure that there are no cross-default clauses in the documentation of any debt instrument or other capital instruments of the issuer that link performance of the issuer’s obligations under a capital instrument to default by the issuer, or another party, under any of its other obligations. 

It is not sufficient to simply state that there are no cross-default clauses contained in the capital instrument being assessed as this statement does not cover clauses in other instruments. Difficulties arising with performance of any obligations under a capital instrument must not lead to default on other debt or capital obligations. For purposes of APRA’s assessment of the eligibility of a capital instrument, confirmation of this can be provided by the issuer as part of the statement of compliance referred to in 1.2 above. 

For ADIs, these provisions on cross default clauses are in addition to the general prohibition on cross default clauses involving related entities set out in APS 222.

 5.    Incentives to redeem AT1 and Tier 2 Capital instruments

 

References:

  • APS 111 Attachments E paragraphs 6, 23, 24 and G paragraphs 6, 22, 23;
  • GPS 112 Attachments C paragraphs 1(e), 4, 5 and E paragraphs 1(e), 4, 5;
  • LPS 112 Attachments C paragraphs 1(e), 4, 5 and E paragraphs 1(g), 4, 5.

5.1: What is considered an incentive to redeem under the relevant prudential standards?

Under the relevant prudential standards, AT1 and Tier 2 capital instruments cannot contain step-ups in interest rates or other incentives to redeem. APRA considers the following provisions as examples of incentives to redeem, in addition to those specifically identified in the standards:

  • APRA considers mandatory conversions and options for investors to require a conversion (other than in relation to unanticipated changes of control) incentives to redeem. However, conversions where there is a minimum of 2 years from the date the issuer may call the instrument to the date the conversion may be exercised are not considered incentives to redeem. APRA has concerns that an impending exercise of such options may trigger a pre-emptive redemption, repayment or repurchase by the issuer. 
  • In certain circumstances minimum and maximum interest rates can act as a step-up and therefore are considered by APRA to be incentives to redeem.
  • An option to redeem (as opposed to automatic conversion) following a change of control event is also considered by APRA to be an incentive to redeem.

5.2: When is a change in the reference rate used in calculating the distribution rate not regarded as an incentive to redeem? (Updated December 2021)

A change in the reference rate used in calculating the distribution from one type of rate to another type of rate (e.g. from a fixed rate to a floating rate, or to a different fixed rate basis) on an AT1 or Tier 2 capital instrument may not be regarded as an incentive to redeem where the issuer ensures that there is no amendment to the margin over the reference rate. For example, a sufficient condition for a change to be acceptable is if the margin associated with the initial rate at the time the instrument is priced and the margin applying during the subsequent new rate period are the same. In each case, the margin needs to be measured relative to a current reference rate with the same tenor as the period for which the rate is being set, and assuming no change in the basis. 

APRA also expects that the type of credit risk underlying the reference rate will not change e.g. it will always be a relevant bank swap rate, or always a government bond/note rate.

Terms providing for the use of replacement reference rates and margins following the termination of the specified reference rate used to set the distribution rate may create an incentive to redeem at the time of implementation. Such terms should generally provide that the replacements are subject to no objection from APRA at the time of the change. 

5.3: Is it appropriate for an entity to redeem a capital instrument and replace it with a similar capital instrument, but with a higher margin? (Added December 2021) 

As a general rule, APRA does not consider it appropriate for an entity to redeem a capital instrument and replace it with a capital instrument of the same category of capital with a higher margin on the same underlying reference rate. For example, this would include an increase in margin due to a change in the credit quality of the entity as indicated by an external credit assessment institution; or a change in market conditions. In any such circumstances, the issuer would need to satisfy APRA as to the economic and prudential rationale and that such an action will not create an expectation that other instruments will be called in similar circumstances.

6.    Optional Redemption of AT1 and Tier 2 capital instruments 

 

References:

  • APS 111 Attachments E paragraphs 7, 26 and 27 and G paragraphs 7, 25 and 26; 
  • GPS 112 Attachments C paragraphs 1(f), 7 and E paragraphs 1(f), 7;
  • LPS 112 Attachments C paragraphs 1(f), 7 and E paragraphs 1(f), 7.

6.1: What criteria apply to a call in respect of a tax event or a regulatory event? (Updated December 2021)

Under the relevant prudential standards, an AT1 or Tier 2 capital instrument may only provide for a call within the first five years of issuance as a result of a tax or regulatory event. APRA expects a tax event or a regulatory event, after which an instrument may be called, to be:

  • confined to changes in law (and related judicial and administrative actions);
  • confined to changes that have occurred or will occur, as opposed to changes that may occur;
  • related only to changes in tax or regulation;
  • related to the specific instrument; 
  • related only to jurisdictions relevant to the specific instrument;
  • not expected at the time of issue; and
  • changes which have a more than de minimis adverse impact on the issuer, and not a holder, of the instrument.

Approval to redeem early will not be granted if APRA considers the regulated entity was in a position to anticipate the event when the instrument was issued.

6.2: Can a call notice in an AT1 capital or Tier 2 capital instrument be revocable?

The documentation needs to be clear that when a loss absorption trigger point is reached or a non-viability trigger event occurs, the loss absorption provisions will operate without regard to any notification of early redemption.

6.3: Are issuer call options, other than for tax or regulatory reasons, permitted within five years from the date on which the issuer irrevocably receives the proceeds of payment for the instrument? (Added June 2019)

No. An instrument may only be callable at the initiative of the issuer and only after a minimum of five years from the date on which the issuer irrevocably receives the proceeds of payment for the instrument. APRA would not typically agree to amendments to the terms of existing instruments to permit the call or redemption of an instrument at any time before the minimum five year period ends.

7. Distributions on AT1 capital instruments

 

References:

  • APS 111 Attachment E paragraphs 9, 21;
  • GPS 112 Attachment C paragraphs 1(h), 2;
  • LPS 112 Attachment C paragraphs 1(h), 2.

7.1: Are there any restrictions on the dividend ‘stopper’ provisions that may be contained in an AT1 capital instrument?

The relevant prudential standards limit the use of dividend stoppers within AT1 capital instruments. In implementing these, APRA expects issuers to ensure that any restriction on the payment of distributions to holders of CET1 capital instruments is subject to an exception for any distributions or other payments which it is legally obliged to make as at the time the restriction comes into force.

APRA also expects regulated entities to ensure that any restriction on the payment of these distributions, or any restriction on redemptions or buybacks of CET1 capital instruments, does not apply to (1) any existing holding company of the issuer, or (2) any potential future holding company of the issuer, where the holding company does not undertake the role of issuer of the instrument. This includes situations where a future holding company is substituted as the issuer of ordinary shares on conversion, but not as the issuer of the instrument.

8. Marketing of capital instruments (Updated December 2021)

 

References:

  • APS 111 paragraph 23, 24, Attachment B paragraph 2, Attachment E paragraph 38 and G paragraph 37;
  • GPS 112 paragraph 12, Attachment C paragraph 13 and Attachment E paragraph 12;
  • LPS 112 paragraph 14, Attachment C paragraph 13 and Attachment E paragraph 12.

8.1: What information is considered by APRA when assessing whether the marketing or additional documentation in relation to a capital instrument suggests that the instrument does not meet the appropriate capital criteria? (Updated December 2021)

The relevant prudential standards require that capital instruments must be marketed in accordance with their prudential treatment. All marketing documentation issued by or on behalf of an issuer is relevant for this purpose. 

Material produced by third parties (such as media, dealers, investors) suggesting that an instrument has lesser capital attributes than its prudential classification should be followed up and addressed by the regulated entity to the extent they are aware, and to the extent feasible. This might include, for example, material that:

  • suggests AT1 capital instruments are not permanent, such as references to term to maturity or maturity date or that APRA will approve redemption; 
  • provides for payments to investors that do not meet the criteria for the category of capital (for example: arrangements to compensate for loss of value on the capital instrument; payments made under other contracts where a condition is that the investor holds a capital instrument; guarantees of payment of the value of an instrument; etc); 
  • indicates a ranking or subordination of any capital instrument that is inconsistent with the relevant prudential standard.

9.    Use of laws of a foreign jurisdiction in AT1 and Tier 2 capital instruments

 

References:

  • APS 111 Attachment E paragraph 40 and G paragraph 39; 
  • GPS 112 Attachment C paragraph 15 and E paragraph 14;
  • LPS 112 Attachment C paragraph 15 and E paragraph 14.

9.1: What is required to comply with the relevant prudential standards in relation to the laws of foreign jurisdictions?

Where a capital instrument is subject to the laws of a jurisdiction other than Australia or its territories, the relevant prudential standards require a regulated entity to ensure that the instrument still satisfies the qualifying criteria under these standards. In addition, the loss absorption and non-viability provisions in the instrument must be subject to Australian law. This means that the regulated entity needs to ensure that the laws of the foreign jurisdiction do not override the provisions within the instrument designed to meet the criteria for inclusion in the relevant category of capital. Acceptable evidence of this would typically include a legal opinion confirming:

  • that the laws of the foreign jurisdiction will not override Australian Law in relation to the loss absorption and non-viability provisions;  
  • whether there are known impediments to the terms of the instrument operating as intended; and
  • whether there are any conflicts between the relevant laws of the foreign jurisdiction and the relevant laws of Australia or its territories. 

10. Default and Winding-up in relation to Tier 2 capital instruments

 

References:

  • APS 111 Attachment G paragraph 9;
  • GPS 112 Attachment E paragraph 1(h);
  • LPS 112 Attachment E paragraph 1(j).

10.1:    What is considered irrevocable winding-up for the purposes of the provisions of the relevant prudential standards permitting acceleration of repayment?  

Under the relevant prudential standards, a Tier 2 capital instrument must confer no rights on holders to accelerate repayment except in bankruptcy (including wind-up) and liquidation. Wind-up must be irrevocable. 

For the purposes of its definition within a Tier 2 capital instrument, APRA considers wind-up to be irrevocable when there has been an effective resolution by shareholders or members for winding-up, or a court order for winding-up has been made and that time for an appeal of the decision has passed.

 11. Mutual Equity Interests

 

References:

  • APS 111 Attachment I paragraph 4.

11.1: What needs to be considered when a mutual ADI is applying for approval to issue an instrument that converts to MEIs or to directly issue MEIs? (Updated December 2021)

The issue by an ADI of an instrument that converts to MEIs has additional considerations compared to the issue of an instrument that converts to ordinary shares. The ADI needs to ensure that the terms of the instrument, the MEIs and its Constitution align and meet the requirements of APS 111. These additional considerations also apply to direct issuance of MEIs.

An ADI seeking approval for such issuance will need to provide to APRA full documentation of the instruments, as outlined in FAQ 1.1, including the MEIs. It will also need to provide any proposed modifications to its Constitution. 

As part of the opinions referred to in FAQs 1.4 and 1.7, an ADI issuing a MEI or an instrument that converts to a MEI will need legal advice to confirm whether or not any modifications to its Constitution, or other aspects of the issuance, would have the effect that the ADI would cease to be a mutual ADI and therefore be ineligible to issue MEIs.  The legal advice should also consider whether the proposed instrument meets the requirements in the Corporations Act 2001 (Cth) relating to mutual capital instruments, if relevant. 

APRA also expects that the Internal Capital Adequacy Assessment Process (ICAAP) of any ADI seeking to directly issue MEIs would need to appropriately address the issuance. This would include exploring in detail the potential investor base, the ADI’s ability to pay expected distributions, and the potential impact on the issuing ADI’s long-term growth based on a range of anticipated distribution rates.

11.2:    How do the provisions for the distribution of residual assets operate to ensure that MEIs are most subordinated and any surplus is distributed proportionately between the MEIs and members? [Deleted June 2019]

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11.3: How much MEI capital can an ADI issue? (Updated December 2021)

In APS 111 Attachment I paragraph 4, APRA has specified that the amount of MEIs on issue eligible for inclusion in CET1 capital is no more than 25 per cent of CET1 capital. For the purposes of determining the limit usage, CET1 capital is the amount before applying regulatory adjustments, and including the eligible amount of MEIs. As an example, if a mutual ADI has not issued MEIs and has existing CET1 capital of $30 million (gross of regulatory adjustments), it could issue $10 million of MEIs which would be eligible as CET1 capital. This is because the amount of MEIs issued ($10 million) is 25% of the new total CET1 capital ($40 million).

MEIs on issue that are in excess of the limit on eligibility for inclusion in CET1 capital may still be counted towards meeting the issuing ADI's AT1 and Total capital requirements. There is no specific requirement to also meet the criteria for inclusion in AT1 capital instrument criteria set out in APS 111 Attachment E but APRA expects that, as higher quality capital, the terms and conditions of MEIs would not contain any provisions that conflict with these criteria.

A calculation of the estimated limit usage should be included in the Statement of Compliance.

11.4: In what circumstances can an ADI buyback, repurchase or redeem a MEI? (Added June 2019)

APRA envisages that approval for an ADI to buyback, repurchase or redeem a MEI would only be given in exceptional circumstances. An ADI seeking such approval must provide compelling reasons to APRA supporting its request. 

Typically, applications for capital reductions would only be anticipated when an ADI’s ICAAP clearly identifies a strategic need to reduce capital through these means as part of its capital management planning. It is not intended that the capital reduction process will be used to facilitate the redemption of capital instruments with respect to ad hoc requests on behalf of individuals or groups of investors.

APRA would not support ADIs that do not otherwise operate trading books making a market and trading in MEIs. Such trading by ADIs could be used to provide a mechanism for redemption, as well as potentially giving rise to investor expectations that an ADI will support its own MEIs. Subject to ASIC and other regulatory requirements being met, APRA has no objection to mutually owned ADIs providing a mechanism or platform to facilitate transfers between willing buyers and sellers.  

11.5: How can distributions on MEIs be set? (Added June 2019)

Distributions on MEIs are entirely discretionary, and subject to the limits set out in APS 111. This does not prevent an ADI from using an external benchmark or index in calculating a distribution on MEIs, so long as issue documentation and marketing material do not indicate that the distribution rate will be a set amount, such as a specified margin above the bank bill swap rate applied to the face value of the instrument. That is, to appropriately reflect the equity nature of MEIs and the discretionary nature of all distributions, any reference to determining distributions by reference to a benchmark or index should be illustrative only. 

12. Ordinary Shares that are eligible CET1 capital instruments

 

References:

  • APS 111 Attachment B paragraphs 1(b), 1(c), 1(e), 1(g);
  • GPS 112 Attachment A paragraphs 1(a), 1(b), 1(e), 1(g);
  • LPS 112 Attachment A paragraphs 1(a), 1(b), 1(e), 1(g).

12.1: What is required for an instrument to represent the most subordinated claim in liquidation of the issuer? (Added December 2021)

The prudential standards require that ordinary shares that qualify as CET1 capital instruments represent the most subordinated claim in the liquidation or winding-up of the issuer. If an instrument ranks as an equally most subordinated claim, it would not be compliant with that requirement. 

12.2: What claims do holders of ordinary shares that qualify as CET1 capital have on the residual assets of the issuer in liquidation? (Added December 2021)  

The prudential standards require that distributions to holders of ordinary shares that qualify as CET1 capital in a liquidation or winding-up must be in proportion to the holder’s share of issued capital.  That is, a holder’s claim should be proportionate to the number of ordinary shares the holder owns, not the amount (i.e. issue price) the holder paid for them.

12.3: How are dividends distributed to holders of ordinary shares that qualify as CET1 capital? (Added December 2021)  

The prudential standards require that dividends paid to holders of ordinary shares that qualify as CET1 capital instruments are not linked to the amount paid up on issuance, and there are no preferential distributions.  That is, an equal dividend is paid on each instrument, rather than the dividend being based on the price of the instrument.  However, if the investor has not paid the full amount for an instrument (e.g. a partially paid share), then the dividend may be adjusted accordingly.

13.   ADI Non-viability triggers  

 

References:

  • APS 111 Attachment H paragraphs 2(b) and 2(c). 

13.1    How should parent entity non-viability triggers apply to local ADI subsidiaries of foreign regulated entities? (Added December 2021)

Where an AT1 or Tier 2 capital instrument is issued by an ADI to its foreign parent or another member of its group and will not be recognised as part of group capital, APRA does not insist that the instrument include a non-viability event which is triggered by the home regulator of the foreign parent.  

13.2 How should non-viability triggers apply to instruments issued by ADIs which are members of Level 2 groups? (Added December 2021)

Where a capital instrument is issued by an ADI subsidiary of an authorised NOHC, and the instrument will not be included in the Level 2 group capital, then the instrument need not include a non-viability event which is triggered by the non-viability of the Level 2 group.  

 14.    Life Insurance capital instruments

 

References:

  • LPS 112 Attachment E paragraph 1(d) and Attachment G paragraphs 3, 4, 5 and 7.

14.1: What non-viability trigger events are expected in a Life Insurance AT1 or Tier 2 capital instrument? (Added December 2021)

An AT1 capital instrument must contain non-viability trigger events for the company and each statutory fund.

A Tier 2 capital instrument must contain non-viability trigger events for the company and the statutory fund to which the Tier 2 capital instrument is allocated.

14.2: What instruments need to be converted or written-off in a statutory fund non-viability event? (Added December 2021)

AT1 capital instruments issued at the company level need to be converted or written-off prior to the conversion or write-off of any Tier 2 capital instruments referable to a statutory fund.  

For Tier 2 capital instruments, if one statutory fund is determined to be non-viable, Tier 2 capital instruments referable to any other statutory fund which is considered viable do not need to be converted or written-off at the same time.

The amount to be converted or written off is the amount necessary to enable APRA to conclude that the life company or statutory fund is viable without further conversion or write off (as relevant).  Partial conversion or write off will not be permitted where a public sector injection of funds is deemed necessary.

14.3: What subordination is required in a Life Insurance capital instrument? (Added December 2021)

A Tier 2 capital instrument issued by a Life Insurance Company needs to meet the subordination requirements in LPS 112 and the Life Insurance Act 1995.  

In the case of a Tier 2 instrument issued by a statutory fund, APRA expects a mechanism is in place to ensure that holders of Tier 2 capital instruments referable to that statutory fund are not paid out amounts in a winding up in priority to the senior creditors of the life company including policyholders in other statutory funds.

15 General Insurance capital instruments

 

References:  

  • GPS 112 Attachment C paragraph 1(b) and Attachment E paragraph 1(b). 

15.1 What subordination is required in a General Insurance capital Instrument? (Added December 2021)

A capital instrument needs to be effectively subordinated to all senior creditors of the General Insurance Company.  APRA expects a mechanism is in place to ensure that holders of these instruments are not paid out of Assets in Australia in priority to any senior creditors.