No. 2 Date of Paper : 25th September 1992 Amended on 1st August 1996 Version Number : V1.01 File Location : document3
Table of Contents Annex 1: Definition Of Capital... 4 Tier 1: Core Capital... 4 Tier 2: Supplementary Capital... 4 Deductions From Total Capital (Total Of Tier 1 And Tier 2)... 5 Limits And Restrictions... 5 Conditions Applying To Perpetual Subordinated Debt Necessary For Qualification As Supplementary Capital... 6 Conditions Applying To Subordinated Term Loan Capital (With A Minimum Original Term To Maturity Of Over Five Years) Necessary For Qualification As Supplementary Capital... 7 Annex 2: Explanatory Notes... 8 Tier 1 Capital... 8 Tier 2 Capital... 8 Deductions From Total Capital... 8 Miscellaneous... 8 Published by: Financial Services Commission PO Box 940, Suite 943, Europort, Gibraltar Tel (+350) 40283 Fax (+350) 40282 E-Mail: info@fsc.gi www.fsc.gi 2
1 Gibraltar, in common with the United Kingdom and the other EC member States, is required to implement the provisions of the Directive on (89/299/EEC of 17 April 1989). The Directive applies to credit institutions as defined in Article 1 of the First Banking Co-ordination Directive (77/780/EEC, dated 12 December 1977) and complements in particular the Second Banking Coordination Directive (89/646/EEC) and the Solvency Ratio Directive (89/647/EEC). It establishes standard EC definitions of capital for prudential supervision purposes and closely follows the Basle Convergence Agreement of July 1988 on capital standards. 2 This notice reflects the provisions of the Directive for the purpose of supervision of institutions under the Banking Ordinance and, where application of national discretion is permitted, follows to a large extent current practice in the United Kingdom. Annex 1 details the components of own funds which sould be read in conjunction with Number 2A. Annex 2 contains explanatory notes relating to certain aspects of implementation of the Directive in respect of certain specific items. 3 This notice, which applies to all Gibraltar-incorporated institutions licensed under the Banking Ordinance, establishes two tiers of capital. Although the Directive (unlike the Basle Agreement) does not refer to Tier 1 and 2 capital as such, limits are imposed in Article 6 on certain items that may be included in total capital which effectively creates a tiering of capital. The Commissioner of Banking will therefore differentiate for prudential supervision purposes between Tier 1 and 2 capital and apply the various limits, restrictions and conditions on Tier 2 capital set out in items II-VI of Annex 1. 4 In any case of dispute as to how a relevant item in any licensee's balance sheet should be treated, the Commissioner of Banking shall determine the appropriate treatment in accordance with the terms of the Directive and of this notice. 3
Annex 1: Definition Of Capital Tier 1: Core Capital Permanent shareholders equity: (i) Allotted, called up and fully paid share capital/common stock (net of any own shares held, at book value); (ii) Perpetual non-cumulative preferred shares, 1 including such shares redeemable at the option of the issuer and with the prior consent of the Commissioner of Banking, and such shares convertible into ordinary shares. Disclosed reserves in the form of general and other reserves created by appropriations of retained earnings, share premiums and other surplus. 2 Published and unpublished interim retained profits. 3 (d) Minority interests arising on consolidation from interests in permanent shareholders' equity less (e) Goodwill and other intangible assets 4 and (f) Current year's unpublished losses. Tier 2: Supplementary Capital (d) Deleted Reserves arising from the revaluation of tangible fixed assets and of fixed asset investments. General provisions: Provisions held against possible or latent loss but where these losses have not as yet been identified will be included, subject to a limit [see IV]. Provisions earmarked or held specifically against lower valuations of particular claims or classes of claims will not be included in capital. Hybrid capital instruments: (i) Perpetual cumulative preferred shares, including such shares redeemable at the option of the issuer and with the prior consent of the Commissioner of Banking, and such shares convertible into ordinary shares; (ii) Perpetual subordinated debt which meets the conditions set out in V (including such debt which is convertible into equity at the option of either the issuer or lender). 1 Sometimes referred to as preferred stock. 2 Including capital gifts and capital redemption reserves. 3 These must be verified by external auditors - see explanatory notes. 4 Mortgage servicing rights will be regarded as intangible assets, unless it can be demonstrated there is an active and liquid market in which they can be reliably traded. At present this condition is only met in respect of mortgage servicing rights traded in the US market. 4
(e) (f) Subordinated term debt: (i) Dated preferred shares (irrespective of original maturity); (ii) Convertible subordinated bonds not included in (d) (ii); (iii) Subordinated term loan capital with a minimum original term to maturity of over five years and meeting the conditions set out in VI, subject to a straight-line amortisation during the last five years leaving no more than 20% of the original amount issued outstanding in the final year before redemption. Minority interests arising on consolidation from interests in Tier 2 capital items. Deductions From Total Capital (Total Of Tier 1 And Tier 2) Investments in unconsolidated subsidiaries and associates; Connected lending of a capital nature; All holdings of other banks' and building societies' capital instruments except to the extent that the Commissioner of Banking has agreed that these are held in a market-making capacity and the provisions of Article 2(12) and (13) of the Directive are complied with. Limits And Restrictions The total Tier 2 supplementary elements (a-f) should not exceed a maximum of 100% of Tier 1 elements; Subordinated term debt [item II (e)] should not exceed a maximum of 50% of Tier 1 elements; General provisions [item II] should not exceed 1.25% of weighted risk assets. 5
Conditions Applying To Perpetual Subordinated Debt Necessary For Qualification As Supplementary Capital (d) (e) (f) (g) The claims of the lender on the borrowing institution must be fully subordinated to those of all unsubordinated creditors. The documents governing the issue of the debt (hereafter referred to as the debt agreement) must not include any Clauses which might trigger repayment of the debt. This will not, however, prejudice any right to petition for the winding-up of the borrower, for example, in the event of non-payment of interest on the debt [other than that which is deferred in accordance with Condition (4) below]. No repayment of the debt may be made on the bearer's initiative or without the prior consent of the Commissioner of Banking. The debt agreement must provide for the borrowing institution to have the option to defer an interest payment on the debt (eg if the institution has not paid or declared a dividend payment in a preceding period). The debt agreement must provide for the debt and unpaid interest to be able to absorb losses, whilst leaving an institution able to continue trading. This can be achieved by providing for automatic conversion of the perpetual debt, and unpaid interest, into share capital should reserves become negative and where a capital reconstruction has not been undertaken. In such a case the institution will be required to maintain a sufficient margin of authorised but unissued share capital in order to allow a conversion of the debt into equity to be made at any time. Alternatively, instead of providing for automatic conversion, the debt agreement can expressly provide for the principal and interest on the debt to absorb losses, where the institution would not otherwise be solvent, and for the noteholders to be treated as if they were holders of a specified class of share capital in any liquidation of the institution. In this case the debt agreement will provide for the debt to be treated as if it had been converted into share capital either on the day immediately preceding the presentation of a petition for the commencement of a winding-up of the borrowing institution or on the date of the creditors' or shareholders' meeting at which the relevant resolution for a winding-up was passed. the debt agreement must contain an explicit warning to noteholders that the debt can be treated in this way. Where it is proposed to make an issue of such capital for inclusion as supplementary capital, the Commissioner of Banking must be given reasonable prior notice of the issue to give him sufficient opportunity to consider and approve the debt agreement in advance. Only fully paid-up amounts are to be taken into account. 6
Conditions Applying To Subordinated Term Loan Capital (With A Minimum Original Term To Maturity Of Over Five Years) Necessary For Qualification As Supplementary Capital (d) (e) The documents governing the issue of the debt (hereafter referred to as the debt agreement) shall not contain any clause which provides that in specified circumstances, other than the winding-up of the credit institution, the debt will become repayable before the agreed repayment date. The debt agreement must normally be subject to Gibraltar law and the Commissioner of Banking must give his prior consent where foreign law is to apply. The loan capital must reflect fully paid-up funds. No early repayment of the debt may be made without the prior consent of the Commissioner of Banking, in response to a written request. (Such repayment will only be permitted where the Commissioner of Banking is satisfied that the institution's capital is adequate after repayment.) Where it is proposed to make an issue of such capital for inclusion as supplementary capital, the Commissioner of Banking must be given reasonable prior notice of the issue to give him sufficient opportunity to consider and approve the debt agreement in advance. 7
Annex 2: Explanatory Notes Tier 1 Capital 1 Published & Unpublished Profits The Commissioner of Banking's current policy is to allow the inclusion in Tier 1 capital of the current year's retained earnings (net of foreseeable charges and distributions) where they have been "verified by persons responsible for the auditing of the accounts and if it is proved to the satisfaction of the relevant competent authorities that the amount thereof has been evaluated in accordance with the principles set out in Directive 86/635/EEC (Bank Accounts Directive) and is net of any foreseeable charge or dividend" [Article 2(1)(2)]. Tier 2 Capital 1 Hybrid capital instruments, including perpetual subordinated debt and perpetual cumulative preferred shares, are included in Tier 2, as allowed in Article 3 (2). 2 Dated preferred shares and subordinated term loan capital are included in Tier 2, as allowed in Article 4 (3). 3 Deleted 4 General provisions are eligible for inclusion in Tier 2 [Article 3(1)] subject to the Basle Agreement limit of 1.25% of weighted risk assets. Deductions From Total Capital 1 Holdings of capital issued by other credit institutions. The Commissioner of Banking will deduct from capital all holdings of another credit institution's capital except to the extent that the Commissioner of Banking has agreed that these are held in a market - making capacity and the provisions of Article 2(12) and (13) of the Directive are complied with. In accordance with Article 2(12), banks may hold the capital instruments of another credit or financial institution without their deduction where they are held temporarily as part of a financial rescue of that institution and where the Commissioner of Banking has given his prior consent to this concession. Miscellaneous 1 The non-deduction from a parent company's own funds of its holdings in other credit institutions or financial institutions which are included in the consolidation in calculating the parents' unconsolidated own funds [Article 2(1)] will not be adopted. 2 The following components of capital set out in Article 2(1) are not relevant to Gibraltar: Funds for general banking risks [Article 2(1) (4)]; Value adjustments permitted in Article 37(2) of Directive 86/635/EEC [Article 2(1) (5)] Commitments of the members of credit institution set up as co-operative societies [Article 2(1) (7)]. 8