BKLM392000 - Loss absorbing instruments issued by overseas subsidiaries: Loss absorbing instruments

FA11/SCH19/PARA15V(2), in conjunction with para 15V(4) and SI2020/1188/REGS2-4, defines loss absorbing instruments so as to include instruments issued in accordance with UK or overseas regulatory requirements for the purpose of satisfying loss absorbing capacity or recapitalisation requirements in the banking sector.

The definition applies for the purposes of both

  • Identifying loss absorbing instruments issued by overseas subsidiaries, which are the starting point for calculating the reduction in chargeable equity and liabilities at para 15N(1) Step 3, and
  • Identifying loss absorbing instruments issued by the UK sub-group or entity, in order to stream and cap the reduction (BKLM393000 Loss absorbing instruments issued by overseas subsidiaries: amount of reduction).

However, some further conditions apply which are specific to each of these two different purposes.

General conditions for loss absorbing instruments

For the purposes of the reduction in chargeable equity and liabilities at para 15N(1) Step 3, an instrument is “loss absorbing” if it satisfies a loss absorbing capacity or recapitalisation requirement (para 15V(2)).

A loss absorbing capacity or recapitalisation requirement is defined at para 15V(4):

  • The requirement must be imposed in relation to either Tier one capital equity and liabilities or other instruments issued by the entity,
  • It must be imposed by an authority in the exercise of its regulatory functions under the law of the United Kingdom or of a country or territory outside the United Kingdom, and
  • It must be a “relevant requirement”.
“Relevant requirements” (SI 2020/1188 Regulation 2)

A relevant requirement will be a requirement set for the purpose of satisfying loss absorbing capacity or recapitalisation requirements in the banking sector. The precise conditions depend on whether the requirement was set by the UK regulatory authority or by an overseas regulatory authority.

Where the requirement is set by the UK regulatory authority, the Bank of England, it should be a requirement

  • Imposed by a direction under section 3A of the Banking Act 2009, which enables the Bank to direct relevant persons to maintain a minimum requirement for own funds and eligible liabilities (MREL), and
  • Imposed for the purpose of complying with the duties set out in Part 9 of the Bank Recovery and Resolution (No. 2) Order 2014, which requires the Bank to set MREL and makes some further specifications with regard to MREL.

A relevant requirement also includes a requirement imposed by a UK regulatory authority under Articles 92 or 92a of the UK Capital Requirements Regulation (CRR).

Where the requirement is set by an overseas regulatory authority, it should be a requirement imposed under a comparable scheme and for a comparable purpose to those set out above in respect of the Bank of England. In these cases, there is no need to determine whether it is precisely equivalent to requirements set in the UK. The legislation is not prescriptive but looks to the existence and purpose of regulatory requirements as they apply to the issuer of the instrument.

Tier one capital equity and liabilities (SI 2020/1188 Regulation 3)

The starting point for determining Tier one capital equity and liabilities for these purposes is the same as for the Bank Levy more broadly, as defined at para 30 with reference to Article 25 of the CRR.

As set out at BKLM331150, for the purposes of the Levy, all entities and groups calculate their Tier one capital on the same basis. To achieve this, the CRR is treated as applying to all entities and groups as if the Prudential Regulation Authority (PRA) were their competent authority, to the extent that this is not otherwise the case.

The calculation of Tier one capital equity and liabilities may mean that a regulatory capital deduction is required under Article 36(1)(i) or Article 56(d) of the CRR for investments in loss absorbing instruments issued by non-UK resident subsidiaries, even though such a deduction would not be required when looking at the consolidated regulatory position of the relevant chargeable UK sub-group or entity. This is because the regulatory treatment of the entities in a banking group may differ from the treatment of group entities for Bank Levy purposes. Therefore SI2020/1188/REG3 applies so that where Tier one capital, as defined in para 30, has been reduced by these deductions, the amount of the reduction is available for deduction under para 15W(7)(a) and para 15X(1)(a).

In the context of the reduction at para 15N(1) Step 3, these rules also ensure that equity and liabilities of overseas subsidiaries are appropriately streamed and capped. It prevents groups from setting instruments issued by overseas subsidiaries that would be Tier one capital under the CRR against other liabilities of a UK entity that are not Tier one capital. (BKLM393000 Loss absorbing instruments issued by overseas subsidiaries: amount of reduction).

References to revoked articles in the Capital Requirements Regulation

SI2020/1188/REG3 refers to the provisions of Article 36 of the Capital Requirements Regulation which (as a matter of UK law) were revoked by SI 2021/1078 and should be read as reference to the corresponding provisions in the PRA’s CRR Rules in the PRA Rulebook from 1 January 2022.

Loss absorbing instruments issued by overseas subsidiaries

A loss absorbing instrument issued by an overseas subsidiary can only be taken into account when calculating the reduction at para 15N(1) Step 3 if it meets conditions to be a “qualifying” loss absorbing instrument (para 15W(3), 15X(1)). In practice, this allows the legislation to set further conditions that are specific to loss absorbing instruments issued by overseas subsidiaries.

Para 15W(4)(a) and (5) delineate the overseas subsidiaries in question, by making the following requirements for a “qualifying” loss absorbing instrument:

  • The instrument must be issued by a non-UK resident entity,
  • That non-UK resident entity must be a subsidiary of a UK resident entity (para 15W(a)),
  • The UK-resident entity must be a member of the relevant group (para 15W(5)(a), BKLM241000) (that is, the group covered by the Bank Levy, which will be one of the four types of group specified at FA11/SCH19/PART3), and
  • If the relevant group is a relevant non-banking group (para11, BKLM241000), the UK resident entity must also be a UK resident bank or a subsidiary of a UK resident bank (para15W(5)(b), BKLM243000).

In addition, para 15W(4)(b) makes some further requirements for loss absorbing instruments issued by overseas subsidiaries, for them to be “qualifying” loss absorbing instruments:

  • The instrument, or an asset representing the instrument, must be held by a UK resident entity,
  • for the purpose of satisfying a relevant requirement imposed on a member of the relevant group.

These requirements are in addition to the general conditions set out above. They expand the general requirement that loss absorbing instruments satisfy a relevant requirement by looking more specifically to identify the instrument issued by an overseas subsidiary with an instrument held in the UK, and by looking to the purpose for which the UK entity holds the instrument.

Banks’ wider regulatory capital requirements can inform whether this test is met. It may be appropriate to look to the requirements of regulators beyond that of the entity’s country of residence. An instrument might, for example, be issued by a Hong Kong subsidiary of a UK entity, which is itself a subsidiary of a US parent. In that case, it is possible that regulatory loss absorbing capacity and recapitalisation requirements of all three territories may apply to determine what loss absorbing instruments it is appropriate for the Hong Kong entity to issue and how these are held by the group. The full circumstances should be considered in order to determine what relevant requirements apply.

Loss absorbing instruments issued by UK entities

For the reduction at para 15N(1) Step 3 to be available, the liabilities of the chargeable UK sub-group or entity must include loss absorbing instruments that (para 15W(7)):

  • Meet the general conditions discussed above,
  • Are not excluded equity and liabilities for the purposes of the Bank Levy, as defined at para 30 with reference to Article 25 of the CRR (BKLM331150), and
  • Are in issuance for the purposes of satisfying a relevant requirement imposed on a member of the relevant group.

As with loss absorbing instruments issued by an overseas subsidiary, when considering the purpose for which an instrument is in issuance, it may be appropriate to look to the requirements of regulators beyond the issuing entity’s country of residence. The full circumstances should be considered in order to determine what relevant requirements apply.

The aim of the reduction is to identify and give relief in respect of loss absorbing instruments issued by UK members of the relevant group which fund loss absorbing instruments of overseas subsidiaries, and which might otherwise count towards chargeable equity and liabilities. There is therefore no reduction available in respect of excluded equity and liabilities, which already fall outside the chargeable equity and liabilities of the group.