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December 21, 2010
Basel III – Additional Tier 1 Going-Concern Capital and Tier 2 Capital

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1. INTRODUCTION

As Warren Buffett quipped, "Only when the tide goes out do you discover who's been swimming naked." Unfortunately, as a result of the recent financial crisis, we discovered that it was much of the global banking sector. Despite decades of reforms and initiatives to improve the regulatory capital base of the global banking system, the financial crisis revealed that the banking sector continued to rely on a capital base which was not only of insufficient quality to handle the challenges it would face, but also suffered from lack of harmonization and transparency. Learning from these lessons, the Basel Committee on Banking Supervision (the "Basel Committee") and its oversight body, the Group of Governors and Heads of Supervision (the "Group of Governors"), has worked to develop a reform program to address both firm-specific and broader, systemic risks to the banking sector. This program, which is referred to as "Basel III," while comprising a number of building blocks, places particular focus on the need of the banking sector to strengthen the quality, consistency and transparency of its regulatory capital base. Following the release of numerous consultative documents, lengthy negotiations and much speculation, on December 16, 2010 the Basel Committee released the text of the Basel III rules, which presents the details of the bank capital and liquidity reform package previously agreed by the Group of Governors and endorsed by the Group of Twenty Finance Ministers and Central Bank Governors (the "G-20") at its summit meeting in Seoul, South Korea on November 12, 2010. With such a critical step in the process of reforming the capital rules by which banks are required to operate now complete, the purpose of this Update is to examine the new capital standards, including recommended phase-in periods, with particular attention paid to Additional Tier 1 Going-Concern Capital and Tier 2 Capital.1

2. BACKGROUND

On December 17, 2009, the Basel Committee issued two consultative documents proposing reforms to bank capital and liquidity regulation: "Strengthening the Resilience of the Banking Sector"2 and "International Framework for Liquidity Risk Management, Standards and Monitoring."3 Following a public consultation period, the December 2009 proposals were subsequently amended and, on July 26, 2010, the Group of Governors announced that it had reached "broad agreement" on the overall design of the capital and liquidity reform package initially published in December 2009. This agreement did include a definition of capital, but, importantly, did not set out proposed minimum ratios for Common Equity Tier 1 Capital, Additional Tier 1 Going-Concern Capital or total capital (that is, Common Equity Tier 1 Capital and Additional Tier 1 Going-Concern Capital plus Tier 2 Capital, the three categories of regulatory capital available under Basel III’s new definition of capital). At its September 12, 2010 meeting, however, the Group of Governors published its “calibrated” capital standards for major banking institutions. The capital reforms reached as a result of these deliberations, together with the introduction of a global liquidity standard, constituted the core of the global financial reform package that was presented to the G-20 in Seoul. Following the G-20’s endorsement of the capital and liquidity reform package, on December 16, 2010 the Basel Committee released the text of the Basel III rules, which consists of two documents: "Basel III: A Global Regulatory Framework for More Resilient Banks and Banking Systems"4 and "Basel III: International Framework for Liquidity Risk Measurement, Standards and Monitoring."5 These two documents present the details of what the Basel Committee refers to as the "Basel III Framework." While national implementation of the Basel III Framework is scheduled to begin on January 1, 2013 (see Section 4 below for further discussion on phase-in periods), because the Basel Committee is not a regulatory body and is therefore unable to implement the proposed reforms itself, member countries will need to ensure they translate the Basel III Framework into national law before this date.6

3. THE NEW DEFINITION OF CAPITAL

(A) COMMON EQUITY TIER 1 CAPITAL & ADDITIONAL TIER 1 GOING-CONCERN CAPITAL

When the Basel Committee adopted Basel II, it expressly chose not to address the definition of capital.7 In the development of the Basel III Framework, however, the Basel Committee made clear that developing a new definition of capital was of paramount importance. In formulating this new definition, certain overarching objectives were used as a guide, including, among others, that Tier 1 capital must help a bank remain a going concern, that regulatory capital must be simple and harmonized across jurisdictions and that the transparency of capital must be improved.

With these objectives in mind, the Basel Committee reaffirmed its belief that common equity (which is subordinated to all other elements of funding, absorbs losses as and when they occur, has full flexibility of dividend payments and has no maturity date) is the highest quality component of capital (along with retained earnings), and, accordingly, should be the "predominant" form of Tier 1 capital for banks.8 The second and only other available category of Tier 1 capital under the Basel III Framework is Additional Tier 1 Going-Concern Capital. To qualify as Additional Tier 1 Going-Concern Capital, an instrument must:9

(i) be issued and paid-in;

(ii) be subordinate to depositors, general creditors and subordinated debt of the bank;

(iii) be neither secured nor covered by a guarantee of the issuer or a related entity or other arrangement that legally or economically enhances the seniority of the claim vis-à-vis the bank’s creditors;

(iv) be perpetual with no maturity date and no incentives to redeem (such as step-ups);

(v) be callable at the initiative of the issuer only after a minimum of five years, provided that:

(a) to exercise a call option the bank must receive prior supervisory approval;

(b) the bank must not do anything which creates an expectation that the call will be exercised; and

(c) the bank must not exercise a call option unless:

(1) it replaces the called instrument with capital of the same or better quality and the replacement of this capital is done at conditions which are sustainable for the income capacity of the bank; or

(2) the bank demonstrates that its capital position is well above the minimum capital requirements after the call option is exercised.

(vi) require that any repayment of principal (e.g., through redemption or a buy-back) be with prior supervisory approval and banks should not assume or create market expectations that supervisory approval will be given;

(vii) provide dividend / coupon payment discretion such that:

(a) the bank must have full discretion at all times to cancel distributions / payments (that is, no cumulative dividends, no distributions/payments in kind requirements and no “dividend pushers”);

(b) cancellation of discretionary payments must not be an event of default;

(c) the bank must have full access to cancelled payments to meet obligations as they fall due; and

(d) cancellation of distributions / payments must not impose restrictions on the bank except in relation to distributions to common stockholders

(viii) require that any dividends / coupons be paid only out of distributable items;

(ix) not have credit sensitive dividend features (that is, a dividend / coupon that is reset periodically based in whole or in part on the bank’s credit standing);

(x) not contribute to liabilities exceeding assets if such a balance sheet test forms part of national insolvency law;

(xi) if classified as a liability for accounting purposes, have principal loss absorption through either (a) conversion to common shares at an objectively determinable pre-specified trigger point or (b) a write-down mechanism which allocates losses to the instrument at a pre-specified trigger point,10 with the intention of:

(a) reducing the claim of the instrument in liquidation;

(b) reducing the amount re-paid when a call is exercised; and

(c) partially or fully reducing coupon / dividend payments on the instrument.

(xii) require that neither the bank nor a related party over which the bank exercises control or significant influence can purchase the instrument nor can the bank directly or indirectly fund the purchase of the instrument;

(xiii) not have any features that hinder recapitalization, such as provisions that require the issuer to compensate investors if a new instrument is issued at a lower price during a specified time frame; and

(xiv) if the instrument is not issued out of an operating entity or the holding company in the consolidated group (e.g., a special purpose vehicle (“SPV”), provide that the proceeds of the issue must be immediately available without limitation to an operating entity or the holding company in the consolidated group in a form which meets or exceeds all of the other criteria for inclusion in Additional Tier 1 Going-Concern Capital.

As a result of Additional Tier 1 Going-Concern Capital having to meet this criteria, "innovative" features, which have characterized a large proportion of issued Tier 1 capital instruments since the Basel Committee’s 1998 Sydney press release,11 will not be permitted and those in existence will be phased out (see Section 3(B) below for further discussion on the phase-out requirements). For example, instruments with a step-up provision (i.e., rate increases triggered if an instrument is not redeemed or converted by a particular date), which under Basel II could comprise 15% of Tier 1 capital, will not be eligible as Additional Tier 1 Going-Concern Capital given that item (iv) above states there must be no incentives to redeem. In addition, cumulative preferred stock, which contradicts requirement (vii) above (that is, that the issuer retain discretion over payments of dividends and full access to cancelled payments), will be excluded from Additional Tier 1 Going-Concern Capital. Most trust preferred securities will also be excluded from Additional Tier 1 Going-Concern Capital based on certain of their more common features, such as cumulative dividends and the existence of a maturity date, thereby conflicting with requirements (iv) and (vii) above. Preference shares may, however, depending on how they are structured, qualify as Additional Tier 1 Going-Concern Capital, along with certain contingent convertible capital securities or "CoCos" (see Section 4(D) below for further discussion on CoCos and other loss absorbing instruments).12

(B) TIER 2 CAPITAL

Under Basel II, Tier 2 Capital was divided into upper and lower tiers of capital. Upper Tier 2 Capital consisted of permanent cumulative preference shares and other undated instruments with a cumulative feature. Lower Tier 2 Capital consisted of instruments that were dated and subordinated. Under the Basel III Framework, however, Tier 2 Capital, or as the Basel Committee refers to it, "gone concern" capital, has been simplified. Under the Basel III Framework, there are no sub-categories of Tier 2 Capital (i.e., the distinction between upper Tier 2 and lower Tier 2 capital has been eliminated). Instead, Tier 2 Capital will be defined by reference to nine criteria, namely:13

(i) it must be issued and paid-in;

(ii) it must be subordinate to depositors and general creditors of the bank;

(iii) it must be neither secured nor covered by a guarantee of the issuer or related entity or other arrangement that legally or economically enhances the seniority of the claim vis-à-vis depositors and general bank creditors;

(iv) with regard to maturity:

(a) it must have a minimum original maturity of at least five years (note, unlike Additional Tier 1 Going-Concern Capital, the instrument does not need to be perpetual);

(b) recognition in regulatory capital in the remaining five years before maturity will be amortized on a straight line basis; and

(c) there can be no incentives to redeem (i.e., no step-up provisions).

(v) it must be callable at the initiative of the issuer only after a minimum of five years, provided that:

(a) to exercise a call option the bank must receive prior supervisory approval;

(b) the bank must not do anything which creates an expectation that the call will be exercised; and

(c) the bank must not exercise a call option unless:

(1) it replaces the called instrument with capital of the same or better quality and the replacement of this capital is done at conditions which are sustainable for the income capacity of the bank; or

(2) the bank demonstrates that its capital position is well above the minimum capital requirements after the call option is exercised.

(vi) it must be issued without the investor having any rights to accelerate repayment of future scheduled payments (whether coupons or principal), except in bankruptcy or liquidation;

(vii) it must be issued without credit sensitive dividend features (that is, a dividend / coupon that is reset periodically based in whole or in part on the bank’s current credit standing);

(viii) it must neither be knowingly purchased by the bank or a related party over which the bank exercises control or significant influence, nor be issued in circumstances where the bank directly or indirectly funds the purchase of the instrument; and

(ix) if the instrument is not issued out of an operating entity or the holding company in the consolidated group (e.g., a SPV), the proceeds of the issue must be immediately available without limitation to an operating entity or the holding company in the consolidated group in a form which meets or exceeds all of the other criteria for inclusion in Tier 2 Capital.

As a result of the above criteria – in particular, the prohibition on incentives to redeem – one of the most common forms of lower Tier 2 Capital (instruments with a ten year maturity, but with a step-up after five years) will no longer constitute Tier 2 Capital under the Basel III Framework. For instruments such as this, as well as other outstanding instruments that no longer qualify as Tier 2 Capital or Additional Tier 1 Going-Concern Capital under the Basel III Framework, a phase-out period will begin from January 1, 2013. From January 1, 2013 the nominal amount of such outstanding instruments for an issuer will be capped at 90%, with the cap reducing by 10% each subsequent year (i.e., there will be a ten year phase-out period for such instruments).14 This cap will be applied to Additional Tier 1 Going-Concern Capital and Tier 2 Capital separately and applies to the total amount of instruments outstanding that no longer meet the relevant qualification criteria.15

(C) TIER 3 CAPITAL

Under Basel II, short-term subordinated debt (i.e., debt with a minimum maturity of two years) could be recognized as Tier 3 Capital. Under the Basel III Framework, however, Tier 3 Capital has been abolished. The justification cited by the Basel Committee for this decision is to ensure that capital used to meet market risk requirements will be of the same quality as capital used to meet credit and operational risk requirements. Accordingly, only Common Equity Tier 1 Capital, Additional Tier 1 Going-Concern Capital and Tier 2 Capital will be relevant under the Basel III Framework.

(D) THE PROPOSAL TO ENSURE THE LOSS ABSORBENCY OF REGULATORY CAPITAL AT THE POINT OF NON-VIABILITY

On August 19, 2010, the Basel Committee issued a consultative document entitled "The Proposal to Ensure the Loss Absorbency of Regulatory Capital at the Point of Non-Viability."16 The proposal contemplates enhancing the entry criteria of regulatory capital to ensure all regulatory capital instruments issued by banks are capable of absorbing losses in the event that a bank is unable to support itself in the private market. If the proposal is implemented as currently drafted, it would require all Additional Tier 1 Going-Concern Capital and Tier 2 Capital instruments issued by internationally active banks to have a clause in their terms and conditions that requires them to be written-off (or be forced to be converted into common stock) upon the occurrence of a pre-specified "trigger event." Under the proposal, the trigger event would be the earlier of (a) a decision to provide public sector support without which the banking institution would become non-viable or (b) a decision by a relevant authority that a write-off, without which the banking institution would become non-viable, is necessary. The comment period for this proposal closed on October 1, 2010. While no subsequent substantive clarification on this proposal has been provided to date (much to the chagrin of market participants), the Basel Committee notes in the Basel III Framework that it is in the process of finalizing additional entry criteria for Additional Tier 1 Going-Concern Capital and Tier II Capital in relation to the proposal and that once finalized such criteria will be added to the Basel III Framework.17

4. CALIBRATED CAPITAL STANDARDS AND PHASE-IN PERIODS

On September 12, 2010, the Group of Governors published the much anticipated "calibrated" capital standards and transition periods that will apply under the Basel III package of capital reforms.18 The calibrated capital standards and transition periods announced by the Group of Governors were then endorsed by the G-20 in Seoul and incorporated into the Basel III Framework. These calibrated capital standards and transition periods are outlined below. We have also attached two charts that summarize the requirements (see Appendix A).

(A) COMMON EQUITY TIER 1 CAPITAL

Under Basel II, the minimum Tier 1 common equity ratio (that is, Tier 1 common equity to risk-weighted assets) was 2%. Basel III, however, significantly increases this requirement, mandating that the minimum Tier 1 common equity ratio be 4.5% and that the ratio be calculated after application of stricter capital deductions than applied prior to Basel III.19 Moreover, a common equity capital conservation buffer (as defined below) of 2.5% will be added to the Tier 1 common equity standard, thereby resulting in an effective Common Equity Tier 1 Capital requirement under Basel III of 7%. The new minimum requirement for common equity (excluding the capital conservation buffer) will be phased in beginning with a 3.5% requirement on January 1, 2013, increasing to 4% on January 1, 2014, with the full 4.5% requirement being applicable as of January 1, 2015. This increase in the Common Equity Tier 1 Capital requirement reflects the strong perception and realization on the part of the Basel Committee that the ability to absorb losses is one of the most important functions of capital and that common equity is better suited to do this than any other form of capital.

(B) TIER 1 CAPITAL

The minimum Tier 1 capital ratio (that is, the ratio of Common Equity Tier 1 Capital plus Additional Tier 1 Going-Concern Capital to risk-weighted assets) will increase from 4% to 6%. Taking into consideration the capital conservation buffer, however, the minimum Tier 1 capital ratio will effectively increase to 8.5% once the capital conservation buffer is fully implemented. The new minimum requirement for Tier 1 capital (excluding the capital conservation buffer) will be phased in beginning with a 4.5% requirement on January 1, 2013, increasing to 5.5% on January 1, 2014, with the full 6% requirement being applicable as of January 1, 2015. As a result of these changes, Additional Tier 1 Going-Concern Capital will be limited to 1% of risk-weighted assets for purposes of the minimum Tier 1 capital ratio in 2013 and 1.5% of risk-weighted assets for purposes of the minimum Tier 1 capital ratio in 2015, down from the 2% allowed under Basel II.20

(C) TOTAL CAPITAL

Under Basel III, the minimum total capital ratio (that is, the ratio of Common Equity Tier 1 Capital plus Additional Tier 1 Going-Concern Capital plus Tier 2 Capital to risk-weighted assets) remains unchanged from the Basel II requirement of 8% and, accordingly, requires no phase-in period. However, because of the requirements of the capital conservation buffer, the minimum total capital ratio will effectively increase to 10.5% once the capital conservation buffer is fully implemented. The difference between the 8.0% total capital requirement (excluding the capital conservation buffer) and the Tier 1 capital requirement (i.e., 6%, excluding the capital conservation buffer) can be met with Tier 2 Capital and other higher forms of capital, including Additional Tier 1 Going-Concern Capital.

(D) CAPITAL CONSERVATION BUFFER

The capital conservation buffer, which the Basel III Framework states must consist of Common Equity Tier 1 Capital, is a capital "cushion" to be maintained in excess of the Basel III minimum capital requirements discussed above. The capital conservation buffer is not intended to form part of the minimum capital requirement, but is intended to be available to absorb losses during times of financial distress. While banks will be permitted to draw on the capital conservation buffer during periods of stress, as regulatory capital levels approach the minimum requirements, certain constraints on discretionary distributions – such as dividend payments and employee bonuses – may be imposed based on how much capital is drawn from the capital conservation buffer. Any constraints imposed upon banks with capital levels at the top of the range of the capital conservation buffer are intended to be minimal as the Basel Committee does not want this buffer to be viewed as another minimum capital requirement. Under the Basel III Framework, the capital conservation buffer will be 2.5% of risk-weighted assets, with an initial requirement of 0.625% on January 1, 2016, which will be increased as time passes with full implementation on January 1, 2019. National authorities, however, have the discretion to impose shorter transition periods and are encouraged to do so "where appropriate." In addition, countries that experience excessive credit growth are encouraged to consider accelerating the build up of the capital conservation buffer (as well as the countercyclical capital buffer discussed below).

(E) COUNTERCYCLICAL CAPITAL BUFFER

The Basel Committee published a consultative document on July 16, 2010 entitled the "Countercyclical Capital Buffer Proposal"21 that set out an initial proposal for such a measure. The proposal was further expanded in both the Basel III Framework itself as well as in a document released by the Basel Committee on December 16, 2010 entitled "Guidance for National Authorities Operating the Countercyclical Capital Buffer."22 The Basel III Framework imposes at certain times an extension to the capital conservation buffer that will be triggered by a regulatory determination that a national market is experiencing excessive credit growth. The applicable regulator in the relevant jurisdiction must use macroeconomic tools to determine whether excessive credit growth that might result in increased systemic risk is occurring and, if deemed appropriate, announce the imposition of an additional capital buffer for that jurisdiction by up to 12 months in advance of such a buffer taking effect (decisions by a jurisdiction to decrease the level of the buffer will, however, take effect immediately). Consequently, under normal economic conditions the countercyclical capital buffer will be set at zero. Internationally active banks will determine if they are subject to a countercyclical capital buffer by examining the geographic locations of their private sector credit exposures (including non-bank financial sector exposures) and then calculating their overall countercyclical capital buffer requirement as a weighted average of the buffers that are being applied in jurisdictions to which they have exposure.

The Basel III Framework prescribes a range for the countercyclical capital buffer of 0% to 2.5% of risk weighted assets, depending on national circumstances. Consequently, the maximum add-on to the capital conservation buffer to contain excessive credit growth will be 2.5%, resulting in a potential total capital buffer of 5% of risk weighted assets. Unlike the capital conservation buffer, this additional buffer may be satisfied with either Common Equity Tier 1 Capital or “other fully loss absorbing capital.” While no clarification is provided in the Basel III Framework for what types of instruments will be treated as fully loss absorbing, a footnote to the text states that the Basel Committee is still reviewing the question of permitting other fully loss absorbing capital beyond Common Equity Tier 1 Capital and until the Basel Committee issues further guidance on this topic the countercyclical capital buffer can only be met with Common Equity Tier 1 Capital.

The countercyclical buffer will be phased in along with the capital conservation buffer between January 1, 2016 and January 1, 2019. Starting January 1, 2016, the maximum countercyclical buffer requirement will be 0.625% of risk-weighted assets and will increase each subsequent year by 0.625% until January 1, 2019, when the final maximum possible countercyclical buffer will be 2.5% of risk-weighted assets.

(F) SYSTEMICALLY IMPORTANT FINANCIAL INSTITUTIONS

The Basel III Framework states that "[s]ystemically important banks should have loss absorbing capacity beyond the minimum standards" set out above. While not a great amount of detail is provided in the Basel III Framework about what types of additional measures may be imposed upon systemically important financial institutions ("SIFIs") in the future, it does make clear that the Basel Committee and the Financial Stability Board (the "FSB") are in the process of developing an integrated approach. A key part of this integrated approach includes the development of a methodology (which takes into account both quantitative and qualitative indicators) that can be used to assess the systemic global importance of financial institutions, thereby enabling regulators to determine the group of global SIFIs to which the completed additional measures should apply.23 The Basel Committee is also conducting a study of how much additional loss absorbency capacity beyond the minimums set out in the Basel III Framework global SIFIs should be required to have. While to date there has been no official statement of what additional quantitative requirement may be imposed, an October 2010 report by the FSB entitled "Reducing the Moral Hazard Posed by Systemically Important Financial Institutions"24 suggests that, depending on national circumstances, the required additional capacity could be drawn from a wide variety of sources, including a combination of capital surcharges, contingent capital and "bail-in" debt. The FSB report also notes that in certain circumstances, further measures, such as liquidity surcharges, tighter large exposure restrictions, levies and structural measures, could further reduce the risks posed by global SIFIs. While this integrated approach will be phased in through multiple deadlines, the FSB report does say that the FSB, in consultation with the Basel Committee, will finalize what additional degree of loss absorbency global SIFI’s must have, along with what instruments may be used to meet this requirement, by December 2011.

5. CONCLUSION

With the design of the new Basel III regime now entering its final phase following the release of the Basel III Framework, the focus of the Basel Committee, the global banking sector and national governments will shift to the critical process of implementation. Given that the Basel Committee has no regulatory authority itself, the effectiveness of the new capital standards will depend on how quickly and consistently national regulators and legislators transform the Basel III Framework into national rules and regulations. Despite the recent G-20 endorsement, there can be no guarantee that all jurisdictions will implement the proposed capital standards within the agreed timelines and/or codify the capital standards in a form that matches the Basel III Framework. Inevitably, there will be differences in implementation across jurisdictions, but with a deadline of January 1, 2013 for national regulators to translate the new proposals into national law, any remaining open items and concerns will need to be resolved efficiently and quickly if the deadline is to be met. Accordingly, the next couple of years in this space will not be lacking in excitement. We can only hope that as a result of these reforms, the next time the tide goes out the global banking sector will be better equipped than it was this last time around.

Appendix A

Phase-in Arrangements
(bolding indicates transition periods – all dates are as of January 1st)

 

   2011  

   2012  

   2013  

   2014   

   2015  

2016

   2017  

    2018  

   2019 

Minimum Common
Equity Capital Ratio

 

 

 3.5%

 4.0%

4.5%

4.5%

 4.5%

 4.5%

 4.5%

Capital Conservation
Buffer

       

 

0.625%

1.25% 

1.875% 

  2.50% 

Minimum common
equity plus capital
conservation buffer

 

 

 3.5%

 4.0%

4.5% 

5.125% 

5.75% 

6.375% 

  7.0% 

Phase-in of deductions
from CET1 (including
amounts exceeding the
limit for DTAs, MSRs
and financials)

     

 20%

40%

60%

 80% 

100%

  100% 

Minimum Tier 1
Capital

   

 4.5%

 5.5%

6.0%

6.0%

6.0% 

6.0% 

6.0% 

Minimum Total
Capital

 

 

8.0%

8.0%

8.0%

8.0%

 8.0%

 8.0%

 8.0%

Minimum Total
Capital plus
conservation buffer

 

 

8.0%

8.0% 

8.0% 

8.625% 

 9.25% 

  9.875% 

 10.5% 

Capital instruments
that no longer qualify
as non-core Tier 1
capital or Tier 2 capital

       

 

Phased out over
10 year horizon
beginning 2013

   

* This chart largely reflects the chart provided in Basel III: A Global Regulatory Framework for More Resilient Banks and Banking Systems.

Calibration of the Capital Framework

Capital requirements and buffers (all numbers in percent)

 

 Common Quity Tier 1

Tier 1 Capital 

Total Capital 

 Minimum

4.5

6.0 

8.0 

 Conservation buffer

2.5 

   

 Minimum plus conservation buffer

7.0

8.5 

10.5 

 Countercyclical buffer range

 0 – 2.5 (see Section
4(E) above)

 

 

* This chart reflects the chart provided in Basel III: A Global Regulatory Framework for More Resilient Banks and Banking Systems.

If you have any questions regarding this update, please contact any of the following Sidley lawyers or the Sidley lawyer with whom you usually work. 

London

JOHN M. CASANOVA
+44.20.7360.3739
jcasanova@sidley.com

DAVID HOWE
+44.20.7360.3674
dhowe@sidley.com

LEONARD W. NG
+44.20.7360.3667
lng@sidley.com

STEPHEN J. ROITH
+44.20.7360.2037
sroith@sidley.com

MARK WALSH
+44.20.7360.2068

New York 

CRAIG E. CHAPMAN
212.839.5564
cchapman@sidley.com

CONNIE M. FRIESEN
212.839.5507
cfriesen@sidley.com

SAMIR A. GANDHI
212.839.5684
sgandhi@sidley.com

DANIEL M. ROSSNER
212.839.5533
drossner@sidley.com

BEN A. STACKE
212.839.5904
bstacke@sidley.com

Washington, D.C. 

WILLIAM S. ECKLAND
202.736.8267
weckland@sidley.com


1 Please note, other matters covered by Basel III, including, among others, the leverage ratio, the liquidity coverage ratio and the net stable funding ratio, are beyond the scope of, and are not covered in, this particular Update.

2 The full text of Strengthening the Resilience of the Banking Sector can be accessed at http://www.bis.org/publ/bcbs164.pdf.

3 The full text of the International Framework for Liquidity Risk Management, Standards and Monitoring can be accessed at http://www.bis.org/publ/bcbs165.pdf.

4 The full text of Basel III: A Global Regulatory Framework for More Resilient Banks and Banking Systems can be accessed at http://www.bis.org/publ/bcbs189.pdf.

5 The full text of Basel III: International Framework for Liquidity Risk Measurement, Standards and Monitoring can be accessed at http://www.bis.org/publ/bcbs188.pdf.

6 Although beyond the scope of this Update, in the United States such implementation will be complicated by the Collins Amendment of the Dodd-Frank Wall Street Reform and Consumer Protection Act (the "Dodd-Frank Act"), which requires that U.S. regulators establish a floor of uniform minimum risk-based capital and leverage capital requirements for FDIC-insured depository institutions and their holding companies. These requirements must not be quantitatively lower than the generally applicable requirements that were in effect for FDIC-insured depository institutions as of the date of the enactment of the Dodd-Frank Act (i.e., July 21, 2010). Risk-based capital and leverage capital requirements for regulated holding companies must also be identical to the strictest ratios applied to FDIC-insured depository institutions.

7 The existing Basel II text is available at http://www.bis.org/publ/bcbs128.htm.

8 While outside the scope of this Update, the Basel III Framework makes clear that for an instrument to constitute Common Equity Tier 1 Capital it must satisfy 14 requirements. To see these requirements, see p. 14 of Basel III: A Global Regulatory Framework for More Resilient Banks and Banking Systems.

9 See pages 16 and 17 of Basel III: A Global Regulatory Framework for More Resilient Banks and Banking Systems for the precise text of the Basel III Framework requirements.

10 The Basel III text does not set forth a specific conversion formula or trigger point.

11 The Sydney press release is available at http://www.bis.org/press/p981027.htm.

12 CoCos are a kind of convertible bond that automatically (and permanently) switches into equity once certain capital or bailout triggers are breached. Because of this feature, which most often would take place at a time of great disruption to the issuer, CoCos have been described as having all the potential downside of equities with all the potential upside of bonds. While still being discussed for Tier 1 purposes under the Basel III Framework, the switching point for CoCos could be when a regulatory capital ratio is reached or falls below a certain level or, as in the case of the instruments discussed in Section 4(D) below, a decision by a regulator that a bank would become a non-viable entity without certain measures (such as capital injections) being taken.

13 See pages 18 and 19 of Basel III: A Global Regulatory Framework for More Resilient Banks and Banking Systems for the precise text of the Basel III Framework requirements.

14 Under the Collins Amendment to the Dodd-Frank Act, the phase-out of hybrid debt or equity instruments (such as trust preferred securities and cumulative perpetual preferred stock) from Tier 1 capital of U.S. bank holding companies with assets of $15 billion or more is required to occur in a shorter period of time (that is, between January 1, 2013 and January 1, 2016).

15 For further discussion on this topic, see pages 28 and 29 of Basel III: A Global Regulatory Framework for More Resilient Banks and Banking Systems.

16 The full text of The Proposal to Ensure the Loss Absorbency of Regulatory Capital at the Point of Non-Viability can be accessed at http://www.bis.org/publ/bcbs174.pdf.

17 See footnote 9 of Basel III: A Global Regulatory Framework for More Resilient Banks and Banking for the Basel Committee’s comments on this point.

18 The full text of the press release can be accessed at http://www.bis.org/press/p100912.pdf.

19 For example, under Basel III, the total amount of mortgage servicing rights, deferred tax assets that arise from timing differences and significant investments in the common shares of unconsolidated financial institutions will be limited, in the aggregate, to 15% of Common Equity Tier 1 Capital, with each item separately limited to 10% of Common Equity Tier 1 Capital. Any amounts above these limits are required to be deducted from Common Equity Tier 1 Capital.

20 Additional Tier 1 Going-Concern Capital will be allowed in excess of these figures and can possibly count towards certain of the other capital requirements under the Basel III Framework, such as the countercyclical capital buffer discussed in Section 4(E).

21 The full text of the Countercyclical Capital Buffer Proposal can be accessed at http://www.bis.org/publ/bcbs172.pdf.

22 The full text of Guidance for National Authorities Operating the Countercyclical Capital Buffer can be accessed at http://www.bis.org/publ/bcbs187.pdf.

23 According to the FSB, global SIFIs are institutions of such size, market importance and global interconnectedness that their distress or failure would cause significant dislocation in the global financial system and adverse economic consequences across a range of countries.

24 The full text of Reducing the Moral Hazard Posed by Systemically Important Financial Institutions can be accessed at http://www.financialstabilityboard.org/publications/r_101111a.pdf?frames=0


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