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IBF Summary of Comments on CEBS' Draft Proposal for a Common EU Definition of Tier 1 Hybrids

Core Content

The Irish Banking Federation (IBF) has provided detailed feedback on the CEBS draft proposal for a common EU definition of Tier 1 hybrid instruments. The IBF supports the European Commission's goal of harmonizing the treatment of hybrid instruments across the EU but expresses significant concerns regarding the prescriptive nature of the proposals, their potential impact on competitiveness, and the clarity of certain provisions.

Main Views and Key Concerns

1. High-Level Reactions

• Support for Integration: IBF supports the integration of the Sydney Press Release into EU legislation to ensure consistency in how hybrid instruments are treated across the EU.
• Overly Prescriptive: IBF believes CEBS is proposing an overly prescriptive set of guidelines that go beyond the principles of the Sydney Press Release, potentially putting EU issuers at a competitive disadvantage compared to non-EU counterparts.
• Competitive Disadvantage: The proposed write-down feature is unlikely to be well-received by investors, especially in the US market, where such provisions are not required. This could lead to a negative perception of EU hybrid instruments.

2. Terminology and Definition

• Hybrid Instruments: The IBF disagrees with the use of the term 'hybrids' to include non-cumulative perpetual preference shares, which are already classified as equity in Irish legislation.
• Grandfathering: IBF argues that existing hybrid instruments should continue to qualify as Tier 1 capital under the current rules, and that the grandfathering provisions should be unqualified to preserve the capital status of these instruments.

3. Permanence

• Support for Undated Instruments: IBF supports the requirement for instruments to be undated to qualify as Tier 1, but suggests that dated instruments with lock-in features should also be considered.
• Risk of Misinterpretation: The prescriptive approach to permanence may be misinterpreted, and IBF advocates for more flexible guidelines that allow for discretion in individual cases.

4. Loss Absorption

• Concern Over Write-Down and Conversion Provisions: The requirement for write-down or equity conversion features is seen as unnecessary and potentially harmful to the marketability of hybrid instruments.
• Impact on Capital Quality: These provisions may not enhance loss absorption and could even reduce the total Tier 1 capital, as the write-down would not reflect an actual capital reduction.
• Tax and Disclosure Issues: The equity conversion feature would lose tax-deductibility benefits, potentially leading to increased SPV issuance and complicating the market.
• US Market Impact: US institutional investors, particularly insurance companies, may classify these instruments as common equity, which would impose a high RBC charge and reduce demand.

5. Flexibility of Payment

• Support for Flexibility: IBF fully supports the CEBS proposal regarding flexibility of payment, as it is already a feature of all Irish hybrid issuance and is crucial for loss absorption.

6. Limits to Inclusion into Tier 1

• 15% Limit: IBF insists that the 15% limit should be applied at the time of issuance, as stated in the Sydney Press Release, to avoid complications in managing capital ratios during financial stress.
• Overall Limit: IBF recommends a single quantitative limit for all Tier 1 instruments, rather than a two-tiered approach, to simplify regulatory treatment and avoid volatility in capital ratios.
• Cliff Effect: The proposed two-tiered limit could lead to a "cliff effect" where institutions are forced to reduce their hybrid capital proportion during financial distress, increasing volatility and financial strain.

7. Grandfathering Provisions

• Limited Effectiveness: The current grandfathering provisions do not sufficiently protect existing hybrid instruments from losing their Tier 1 status.
• Permanent Grandfathering Needed: IBF suggests that a permanent grandfathering approach should be adopted to ensure continuity and avoid disruption to the market.
• Roll-On Effects: The proposals could lead to unintended consequences, such as instruments losing grandfathering status after conversion or replacement, which would negatively impact the capital structure of banks.

Conclusion

The IBF emphasizes the need for a balanced and flexible approach to defining Tier 1 hybrid instruments, one that maintains the benefits of these instruments while ensuring alignment with international standards. They stress that the current proposals may create unnecessary regulatory burdens and reduce market access for EU banks, particularly in comparison to non-EU jurisdictions.