Provisions on a capital conservation plan and calculation of the maximum distributable amount

Transcription

1 Memorandum Financial Supervisory Authority Provisions on a capital conservation plan and calculation of the maximum distributable amount A requirement has been inserted in section 125 of the Financial Business Act for banks, mortgage-credit institutions and certain investment firms to meet a combined capital buffer requirement. The provisions include a statement of the consequences for undertakings if they fail to meet the combined capital buffer requirement, including restrictions on distributions and requirements to prepare a capital conservation plan. This memorandum describes the content of section 125 of the Financial Business Act, and the more detailed provisions in the Executive Order on the calculation of the combined capital buffer requirement, the maximum distributable amount and the content of a capital conservation plan for certain financial undertakings (referred to hereafter as the Capital Buffer Executive Order ) regarding requirements for undertakings capital conservation plan and calculation of the maximum distributable amount. The capital conservation plan and the maximum distributable amount Undertakings which fail to meet the combined capital buffer requirement must immediately calculate their maximum distributable amount and submit this to the Danish FSA, see section 125b(2) of the Financial Business Act. Furthermore, the undertaking must prepare a capital conservation plan and submit this to the Danish FSA by no later than five business days after the undertaking should have ascertained its failure to meet the combined capital buffer requirement, see section 125c(1). Pursuant to the Capital Buffer Executive Order, the capital conservation plan must contain the information necessary to provide the Danish FSA with an adequate basis to enable it to approve the capital conservation plan, including:

2 2/6 Estimates of income and expenditure and an estimate of the development in balance-sheet items. Measures to increase the Common Equity Tier 1 capital ratio, Tier 1 capital ratio and Tier 2 capital ratio, see Article 92(1) of the CRR 1. A plan and timeframe for the increase of own funds with the objective of meeting fully the combined capital buffer requirement. A plan of the restricted actions which the undertaking wishes to undertake, see section 125b(3) of the Financial Business Act. 2 The plan must, as a minimum, run for the financial year. The plan must be approved by the Danish FSA. If the Danish FSA does not approve the capital conservation plan, the Danish FSA will order the undertaking to increase its own funds within a time limit set by the Danish FSA, see section 125c(4) of the Financial Business Act. The Danish FSA can also specify stricter restrictions for distributions than those laid down in the provisions on capital buffers in the Financial Business Act. Pursuant to the Capital Buffer Executive Order, the capital conservation plan must be updated and resubmitted to the Danish FSA for approval if: The undertaking ascertains that there is a significant risk that the undertaking will be unable to carry out the capital plan. The undertaking deems or ascertains that the distribution factor is 3 falling. The undertaking wishes to change the plan for restricted actions. The undertaking s plan, including its plan for restricted actions, has expired. Notification All undertakings which do not meet the combined capital buffer requirement must notify the Danish FSA of their action by no later than one month prior to an action subject to a restriction, see section 125d of the Financial Business Act. The undertaking must state whether the pending action is in accordance with the latest approved capital conservation plan. The notification must also contain: The amount of capital maintained by the undertaking, subdivided into Common Equity tier 1 capital, Additional Tier 1 capital and Tier 2 capital. 1 Regulation (EU) No. 575/2013 of the European Parliament and of the Council of 26 June 2013 on prudential requirements for credit institutions and investment firms. 2 The restricted actions include: 1) making distributions in connection with Common Equity Tier 1 capital, 2) creating an obligation to pay variable remuneration or discretionary pension benefits or pay variable remuneration, if the obligation to pay was created at a time when the undertaking failed to meet the combined capital buffer requirements, and 3) making payments on Additional Tier 1 instruments, see section 125b(3) of the Financial Business Act. 3 The distribution factor is described in more detail in the section on calculation of the maximum distributable amount.

3 3/6 The amount of the interim profits and year-end profits. The maximum distributable amount. The amount of distributable profits the undertaking intends to allocate between the following: o Dividend payments. o Purchases of own shares. o Payments on Additional Tier 1 instruments. o Payment of variable remuneration or discretionary pension benefits, whether by creation of a new obligation to pay, or payment pursuant to an obligation to pay created at a time when the undertaking failed to meet its combined capital buffer requirements. Calculation of the maximum distributable amount Pursuant to the Capital Buffer Executive Order, calculation of the maximum distributable amount (MDA) is composed of three elements: 1) relevant profit, calculated on the basis of the undertaking s interim profit and yearend profits, which is multiplied by 2) a factor (distribution factor), the value of which depends on the amount the undertaking exceeds the combined capital buffer requirement. The final element, 3) adjustment for the MDA applied to carry out previous restricted actions in the period, is deducted from the result. MDA = (relevant profit X distribution factor) - adjustment for MDA applied in the period. Item 1) relevant profits MDA must be calculated on the basis of the undertaking's interim profits in the current year and the profits from the previous year. Only profits not recognised in own funds may be included in MDA. Furthermore, it is a requirement that profits must have been generated since the most recent decision on restricted actions pursuant to the capital buffer provisions. The last requirement can be met by using the most recent annual general meeting or meeting of the board of representatives as a starting point, as in such cases, in principle, the annual general meeting or the board of representatives make decisions on restricted actions. This is done either directly by administering last year's profits, or indirectly by establishing mandates and frameworks for management. In practice, this involves ensuring that recognition of profits in the MDA calculation uses year-end final financial statements as a starting point. Specifically, the profits for recognition in the MDA calculation are defined as follows:

4 4/6 (verified) profits of the undertaking from the previous year not included in the Common Equity Tier 1 capital of the undertaking plus (verified) profits of the undertaking from the current year not included in the Common Equity Tier 1 capital of the undertaking 4 less the tax amount payable if the items above were transferred to the Common Equity Tier 1 capital of the undertaking. As far as possible, the information on interim profits used as the basis of calculation for MDA must meet the same verification requirements as required for recognition of interim profits in the Common Equity Tier 1 capital, cf. Article 26(2) of the CRR. Item 2) distribution factor The distribution factor is calculated on the basis of the capital used to meet the combined buffer requirement as well as the Common Equity Tier 1 capital used to meet any pillar II capital requirement, cf. example on calculation of MDA in box 1. The distribution factor is determined by comparing the combined buffer requirement with the size of the Common Equity Tier 1 capital maintained by the undertaking which is not used to comply with the own funds requirement in Article 92(1)(c) of the CRR. The distribution factor is: 0, where the Common Equity Tier 1 capital is within the combined capital buffer requirement s first quartile, i.e. the lowest quartile. 0.2, where the Common Equity Tier 1 capital is within the second quartile of the combined capital buffer requirement. 0.4, where the Common Equity Tier 1 capital is within the third quartile of the combined capital buffer requirement. 0.6, where the Common Equity Tier 1 capital is within the fourth quartile of the combined capital buffer requirement. If the size of the Common Equity Tier 1 capital for recognition by the undertaking at establishment of the distribution factor, exceeds the size of the combined capital buffer requirement, the undertaking will fall outside the four quartiles and not be covered by a maximum distributable amount. The undertaking must continue to submit a capital conservation plan for approval and notify the Danish FSA prior to completion of actions which are subject to restrictions on exceeding the combined capital buffer requirement. 4 Recognition of the profits of the undertaking from the current year depends on the frequency at which the undertaking chooses to verify its profits. For example, if the verification is made in connection with preparation of the financial statements, the calculation basis for MDA will solely be based on the results of the undertaking in the previous year.

5 5/6 Box 1: An example of calculation of MDA when Common Equity Tier 1 capital is used for compliance with the pillar II requirement. It is assumed that the total capital of an undertaking constitutes Common Equity Tier 1 capital of 11% of the total risk exposure. The undertaking must comply with: The own funds requirement of 8% of the total risk exposure. An individual solvency need of 1.5% of the total risk exposure. A combined capital buffer requirement of 2.5% of the total risk exposure. The undertaking does not comply with the combined capital buffer requirement, as after compliance with the own funds requirement and the individual solvency need, 1.5% of the Common Equity Tier 1 capital still remains to comply with the combined capital buffer requirement of 2.5%. In relation to the calculation of the MDA, Common Equity Tier 1 capital used to comply with the individual solvency need may be included, following which, the calculation may recognise a Common Equity Tier 1 capital of 3%, which is higher than the combined capital buffer requirement. This means that the MDA must be calculated, but automatic restrictions on distribution will not apply. On the basis of the submitted capital conservation plan, the Danish FSA may decide such restrictions. Item 3) adjustment for MDA applied MDA will be reduced as restricted actions are performed. The MDA reduction is calculated on the basis of the restricted actions performed since the most recent annual general meeting/meeting of the board of representatives. 5 In some cases the actions will directly influence the ongoing profits which the MDA reduction must take into account. If an action directly reduces the ongoing profits, the MDA reduction is calculated as the value of the relevant action multiplied by (1 - the distribution factor). The calculated MDA may be negative if the distribution factor is adjusted downwards during the year and if actions have been taken beforehand which must be deducted from the MDA. The specific maximum distributable amount will then be zero. 5 Under exceptional circumstances, where the undertaking carries out a restricted action in the period from the beginning of a financial year until the annual general meeting/the meeting of the board of representatives, and if such action is carried out on the basis of the MDA calculated on the basis of the ongoing profits, such action must be included in the adjustment of the MDA basis for the current financial year. This could, e.g. be the case if the undertaking wishes to make a hybrid interest payment which falls due before the annual general meeting and if the MDA is determined on the basis of the undertaking's verified profits in the first quarter.

6 6/6 Calculation of the MDA on initial breach of the buffer requirement If an undertaking breaches the combined capital buffer requirement as a consequence of a loss deducted from the capital, there will be no basis for making a distribution from profits. Any interim profits from the previous year will have been ascribed to equity and cannot form the basis for the MDA. If the combined buffer requirement is breached as a consequence of other factors than losses, the distribution factor is calculated on the basis of the capital position of the undertaking at the time of the breach, including the interim profits of the undertaking calculated in the own funds. In calculation of the MDA, verified interim profits may be included which have not been recognised in own funds. The MDA must be reduced by the restricted actions performed since the most recent closure of the financial year, cf. the above. Requirement for recalculation of the MDA The MDA is recalculated prior to every restricted action and included in the notification to the Danish FSA, cf. section 125b(3) of the Financial Business Act. The notification ensures that the Danish FSA can confirm that the action is within the MDA. If an undertaking wishes to carry out an action not included in the most recently approved capital conservation plan, a revised plan must be submitted for approval by the Danish FSA.