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Summary of SGCIB's Response to CEBS's CP17: Common EU Definition of Tier 1 Hybrids

Core Content

SGCIB, the investment banking arm of Société Générale, has provided feedback on the CEBS Consultation Paper 17 (CP17), which aims to establish a common EU definition of Tier 1 hybrid capital instruments. The response emphasizes the importance of a clear, consistent, and investor-friendly framework for Tier 1 hybrids, while also highlighting the need for flexibility and clarity in regulatory and accounting practices.

Main Views

1. General Principles

• Public Disclosure and Understanding: SGCIB supports the idea of making Tier 1 information more accessible and understandable to investors. They suggest that detailed regulatory calculations should be included in annual and interim reports, which would be beneficial for market analysts and investors.
• Mandatory Convertible Securities: These should be recognized as Tier 1 hybrids, given their equity-like characteristics. SGCIB proposes that they be treated similarly to Tier 1 hybrids without redemption incentives until conversion.
• Permanence: The permanence of Tier 1 hybrids should be determined based on their economic benefit, not just legal structure. SGCIB believes that regulators should manage dilution on a case-by-case basis rather than imposing a general cap.
• Loss Absorbency: SGCIB advocates for loss absorption through conversion into non-cumulative preference shares rather than ordinary shares, to avoid accounting and tax complications. They also suggest that write-up and write-down mechanisms should be clarified, and that only conversion into preference shares or write-up/write-down should be accepted for loss absorption.
• Flexibility of Payments: SGCIB supports the use of ACSM (Accounting Capital Settlement Mechanism) as a non-cumulative method but raises concerns about its practical implications, including corporate law issues and the pressure it may place on share prices during stress periods.

2. Convergence on Quantitative Limits

• Mathematical Challenge: SGCIB highlights the potential for a "sliding effect" where regulatory limits can lead to a significant reduction in capital ratios during stress. They provide an example showing how a 10% loss can reduce the total capital by 30% under current proposed limits.
• Alternative Approaches:
  • Unique Limit for Tier 1 Hybrids: SGCIB prefers a single limit for all Tier 1 hybrids, ideally set at 50%, to ensure a level playing field across EU jurisdictions.
  • 50% Limit for Excess Capital: An alternative is to apply the 50% limit only to capital exceeding the required amount, which could help mitigate sliding effects but may complicate transparency and disclosure.

3. Grandfathering Features

• SGCIB believes the proposed grandfathering mechanisms are aligned with expectations and will allow banks to adjust their documentation in line with local legislation.
• They express confidence that the implementation timeline will provide sufficient time for market participants to adapt to the new rules.

Key Information

• Disclosure: Enhanced transparency on capital adequacy and instrument mechanisms is essential for investor confidence.
• Conversion Mechanisms: Conversion into non-cumulative preference shares is preferred over ordinary shares to avoid regulatory and tax complications.
• ACSM: While supported, SGCIB notes potential corporate law and market management issues with immediate exercise of ACSM.
• Regulatory Limits: A unique limit of 50% for Tier 1 hybrids is recommended to ensure consistency and fairness.
• Implementation: SGCIB encourages further bilateral consultations with CEBS to refine the proposal and ensure practicality.

Conclusion

SGCIB endorses the CEBS initiative to harmonize the definition of Tier 1 hybrids across the EU. They advocate for a balanced approach that ensures regulatory consistency, maintains a level playing field for banks, and addresses the concerns of investors and regulators. Their preference is for a unique 50% limit for Tier 1 hybrids, with a focus on preserving the fixed income nature of these instruments and avoiding unintended consequences from regulatory constraints.