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Allied Irish Banks, p.l.c. Summary on CEBS Draft Proposal for a Common EU Definition of Tier 1 Hybrids

Core Content

Allied Irish Banks, p.l.c. (AIB) has responded to the CEBS draft proposal for a common EU definition of Tier 1 hybrid capital instruments. The summary outlines AIB's concerns and positions regarding the regulatory changes suggested.

Main Observations

• Blurring of Equity and Tier 1 Capital: AIB believes the proposal blurs the distinction between equity and other Tier 1 capital, potentially leading to increased capital costs and reduced availability.
• Onerous Conditions on Hybrids: The draft proposal imposes overly strict conditions on hybrid instruments, making the distinction between core and non-core capital unnecessary. AIB argues that no regulatory limit on hybrids in Tier 1 is needed if the proposal is implemented without amendment.
• Competitive Disadvantage: AIB warns that the proposal may place European financial institutions at a competitive disadvantage compared to non-European counterparts, especially in the US market where no such changes are proposed.
• Lack of Evidence for Write-Downs: There is no evidence that write-down features have been utilized or that instruments without such features have not performed as expected. AIB questions the rationale for requiring all hybrids to have write-down features.

Terminology and Classification

• AIB does not agree with the classification of non-cumulative preference shares as hybrids, especially when issued by a licensed financial institution.
• Irish legislation allows for the issuance of redeemable preference shares, which can be repaid from profits or new share issues. AIB argues that this legislative structure should be sufficient to exclude such instruments from hybrid classification.
• AIB notes that the loss absorption, permanence, and flexibility of payment concepts are closely interwoven and cannot be clearly separated as the proposal attempts.

Part 1: Permanence

• AIB supports the 'call option' conditions in the Sydney Press Release (SPR) as sufficiently clear and does not require significant amendment.
• They have no objection to instruments being undated for Tier 1 qualification, but are concerned about the implications of dated instruments with lock-in features.
• AIB advocates for the ability to redeem hybrid instruments early, including within the first 5 years, for tax purposes, as this would not negatively impact the capital status.
• They oppose the use of regulatory recognition changes as a basis for redemption, arguing that once an instrument is approved as Tier 1, it should remain so regardless of regulatory updates.

Part 2: Loss Absorption

• AIB is skeptical of the rationale for the proposed change to loss absorption criteria, noting no cases where instruments failed to meet the SPR criteria.
• They believe that non-cumulative dividends, perpetual nature, and lack of liquidation rights are sufficient to meet loss absorption goals without requiring write-downs.
• AIB questions the practical application of write-downs, including how much should be written down and whether all hybrids should be treated equally.
• They argue that write-downs could distort accounting practices and that the feature does not improve the bank's ability to remain a going concern.

Part 3: Flexibility of Payment

• AIB supports the requirement for issuers to waive payments on a non-cumulative basis and for an unlimited period.
• They agree that if an institution breaches minimum capital requirements, it must waive payments on hybrid instruments.

Part 4: Limits to Inclusion in Tier 1

• AIB suggests that if the draft proposal is implemented without amendment, there would be no need to limit hybrids as a percentage of Tier 1 capital, as investors would treat them as equity.
• They believe that the proposed 70:30 ratio for core and hybrid capital is counterintuitive and creates a "cliff" effect during distress, increasing capital ratio volatility.
• AIB argues that the terms of hybrid instruments should be assessed at issuance and should not be affected by changes in core capital levels.

Part 5: Grandfathering

• AIB is concerned that the draft proposal would render all existing hybrid instruments ineligible, as none include write-down provisions.
• They believe that grandfathering should be unqualified, allowing existing instruments to continue to qualify as Tier 1 without restrictions.
• The proposed grandfathering rules are confusing, with conflicting statements about eligibility after call dates and over a 30-year period.
• AIB highlights that replacement preference shares, which are hybrids under CEBS definition, would not qualify as Tier 1 under the new rules, undermining their purpose.

Appendix 1: Example Scenario

• Company A has a Tier 1 ratio of 9%, with 70% core Tier 1 capital.
• After a €200m loss, the Tier 1 ratio drops to 6%, and hybrids are restricted to 50% of Tier 1, resulting in a Tier 1 ratio of 2.85%.
• AIB argues that this restriction is not aligned with the permanence of the hybrid instruments and could lead to unintended consequences, such as triggering coupon payments or limiting regulatory flexibility.

Key Recommendations

• CEBS should proceed with caution and engage with other supervisors before implementing changes.
• AIB supports a wait-and-see approach, suggesting that Europe should await the Basel review on eligible capital.
• The concept of write-downs should not be required for hybrid instruments.
• Hybrid instruments should be classified based on their terms at issuance and remain eligible regardless of subsequent changes in core capital.