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EBA Report Summary: Monitoring of Additional Tier 1 (AT1) Instruments in EU Institutions

Core Content

This report, issued by the European Banking Authority (EBA), is a second update on the monitoring of Additional Tier 1 (AT1) instruments issued by EU institutions. It aims to inform external stakeholders about the EBA's ongoing work in assessing the quality of these instruments and to highlight areas where the terms and conditions of AT1 instruments may need revision or avoidance.

Main Purpose

• To monitor the quality of AT1 instruments across the EU.
• To provide guidance on the design of terms and conditions for future issuances.
• To promote standardization and clarity in AT1 instrument structures.
• To ensure compliance with the Capital Requirements Regulation (CRR) and Regulatory Technical Standards (RTS).

Key Information

Regulatory Framework

• The CRR (Article 80) and Commission Delegated Regulation (EU) No 241/2014 (RTS) set the eligibility criteria and technical standards for AT1 instruments.
• The EBA has reviewed 33 AT1 issuances, totaling EUR 35.5 billion, issued between August 2013 and December 2015.
• Eleven of these were under a conversion mechanism, and twenty-two under a write-down mechanism.

Monitoring Approach

• The EBA uses a dynamic approach to assess the terms and conditions of selected AT1 issuances.
• The review focuses on identifying provisions that may raise prudential concerns or increase complexity.
• The EBA encourages standardization to reduce complexity and improve convergence among institutions.

Key Findings and Recommendations

Regulatory Calls

• Only full regulatory calls are acceptable.
• Partial calls due to write-downs or conversions are not eligible triggers.
• Tax calls should be based on a material and non-foreseeable change in tax treatment, not on minor risks.

Redemptions and Repurchases

• Redemptions should not be allowed after a trigger event notice.
• Provisions should not allow purchases at any time; they must comply with CRR and RTS limits.
• Market making is acceptable if it follows technical standards, but references to LMEs should be avoided.

Event of Default

• Non-payment of amounts due should not be considered an event of default.
• Interest cancellation and conversion should not trigger default.

Tax Gross Up Clauses

• Gross up clauses should be activated by a local tax authority decision.
• Increased payments should not exceed distributable items.
• Gross up on principal is not allowed.
• Withholding tax changes must result in an increase in the cost of the issuance to be considered material.

Write-Down or Conversion

• The one cent floor for write-downs should not be included in AT1 instruments.
• If included, the floor amount must not be part of CET1 capital.
• Instruments should have an emergency permanent write-down clause if conversion to shares is not feasible.
• Conversion should not be contingent on other events or obligations.

Contingent Clauses

• Contingent clauses that make interest payments mandatory upon loss of AT1 status are not acceptable.
• These clauses introduce complexity and may have unintended consequences.
• They could undermine regulatory flexibility and lead to financial innovation.
• The EBA recommends disallowing the use of contingent clauses in future AT1 instruments.

Formal Issues

• Prudential provisions should be clearly worded and not in italics.
• Avoid vague language such as "expected" or "if required by regulation".
• The trigger event should be defined clearly and should be calculable at any time.
• The definition should avoid references to "as determined by the bank" or specific reporting dates.

Provisions for Future Issuances

• The EBA warns against provisions that allow the issuer to increase the trigger level at any time, as this could be seen as a new issuance.
• Complexity in instrument design should be minimized.

Conclusion

The EBA emphasizes the importance of maintaining simplicity and clarity in the terms and conditions of AT1 instruments. While some provisions may offer benefits in terms of hedge accounting and tax treatment, they may also introduce complexity and uncertainty. The EBA recommends that future AT1 issuances should avoid certain clauses and follow standardized templates to ensure consistency and compliance with regulatory requirements. The report also highlights the need for further guidance and monitoring to refine the regulatory framework and improve the quality of AT1 instruments.