Basel III Capital Framework: Basel Committee Issues Final Minimum Requirements for Regulatory Capital Instruments to Ensure Loss Absorbency at the Point of Bank Non-Viability

Sullivan & Cromwell LLP - January 14, 2011

Further to its August 2010 consultative document entitled Proposal to ensure the loss absorbency of regulatory capital at the point of non-viability, the Basel Committee on Banking Supervision issued its final Minimum requirements to ensure loss absorbency at the point of non-viability on January 13, 2011. The August 2010 proposal (the “Loss Absorbency Proposal”) required that all non-common Tier 1 and Tier 2 instruments – for example, non-cumulative perpetual preferred stock and subordinated debt – issued by an internationally active bank have a provision that requires such instruments, at the option of the relevant authority, to either be written off or converted into common equity upon the occurrence of certain “trigger events”. Trigger events are defined with reference to whether the bank would become “non-viable” absent the conversion/write-off or a public sector injection of capital. The January 13, 2011 minimum requirements (the “Final Loss Absorbency Requirements”) implement the Loss Absorbency Proposal largely as proposed, with one very important exception, namely that the write-off/conversion requirement will not apply if, subject to peer group review and disclosure, the governing jurisdiction of the bank has in place laws that:

  • require such Tier 1 and Tier 2 instruments to be written off upon the occurrence of a trigger event, or
  • otherwise require such instruments to fully absorb losses before tax payers are exposed to loss.

The Final Loss Absorbency Requirements specify that instruments issued on or after January 1, 2013 must meet the new criteria to be included in regulatory capital. Instruments issued prior to January 1, 2013 that do not meet the criteria, but that meet all of the entry criteria for Additional Tier 1 or Tier 2 capital, will be considered as an “instrument that no longer qualifies as Additional Tier 1 or Tier 2” and will be phased out from January 1, 2013 in accordance with the Basel III framework.