Circular NBB_2016_11 on the Classification of Own Funds

NBB_2016_11 – 25 April 2016 Circular – Page 1/22 boulevard de Berlaimont 14 – BE-1000 Brussels tel. +32 2 221 38 12 – fax + 32 2 221 31 04 company number: 0203.201.340 RPM Brussels www.bnb.be

Circular
Brussels, 25 April 2016
Reference: NBB_2016_11 your correspondent:
Kaiser Patrica tel. +32 2 221 34 31 – fax +32 2 221 31 04 patricia.kaiser@nbb.be

Circular on the classification of own funds

Scope
Belgian insurance or reinsurance undertakings.
Insurance or reinsurance undertakings that are part of a Belgian group within the meaning of Article 339, 2° of the Law of 13 March 2016 on the status and supervision of insurance or reinsurance undertakings.
Belgian undertakings that are part of a Belgian financial conglomerate within the meaning of Article 340, 1° of the aforementioned Law of 13 March 2016.
Branches of undertakings from third countries carrying on insurance [or reinsurance] activities in Belgium.
This circular applies to mutual insurance companies defined in Article 15, 79° of the aforementioned Law of 13 March 2016. For these undertakings, "the Bank" should be replaced by "the Office for the Supervision of Mutual Societies and National Unions of Mutual Societies" as defined in Article 15, 84° of the same Law. This circular does not apply to insurance undertakings referred to in Articles 275, 276 or 294 of the aforementioned Law of 13 March 2016.

Summary/Objectives
This circular aims to clarify certain criteria for the classification of own funds.

Legal References
The Law: the Law of 13 March 2016 on the status and supervision of insurance or reinsurance undertakings.
Regulation 2015/35: Delegated Regulation (EU) 2015/35 of the Commission of 10 October 2014 supplementing Directive 2009/138/EC of the European Parliament and of the Council on the taking-up and pursuit of the business of Insurance and Reinsurance.

Circular – Page 2/22 NBB_2016_11 – 25 April 2016

Structure
I. Objectives
II. Definitions
III. Additional Information
IV. Entry into Force
V. Guidelines on the classification of own funds

Madam,
Sir,

I. Objective
This circular relates to Articles 146 to 148 of the Law, as well as to Articles 69 to 73, 76, 77, 79 and 82 of Regulation 2015/35.
The objective of this circular is to provide clarification on the application of the lists of own fund items and on the characteristics determining the classification for each tier.
The guidelines also describe the procedures relating to the classification of own funds, including prior approval by the Bank of items not included in the lists of own fund items.
Undertakings have different capital elements in their financial statements. Most of them correspond to the lists of basic own fund items defined in Regulation 2015/35, which do not require any approval from supervisory authorities. Some, including undistributed profits, will be taken into account in the reconciliation reserve, a unique own fund item. Other items not included in the lists must be approved as basic or ancillary own fund items. All items should be assessed against the characteristics determining the classification to determine whether they can be considered as available own funds and to define their appropriate tier. The terms of the contractual agreement governing the own fund items should be consistent with the substance and not just the form specified in the Law, while being clear and unambiguous. Paid ordinary share capital, including its related share premium account, and, for mutual insurance associations, the initial fund, members' contributions or the equivalent basic own fund item, paid, should constitute the highest quality own funds on which it is possible to rely to absorb losses on a going concern basis. The quality of these own funds should not be compromised. The interpretation of the share premium account should be based on economic substance. Therefore, the share premium account has its usual meaning in accounting law and is understood as a separate account or reserve into which premiums, namely the amount representing the difference between the amount received and the nominal value of the share at its issue or the amount received at issue and the amount recognized in share capital, are transferred in accordance with national law. The guidelines specify that, in order for undertakings to always retain total freedom in raising new own fund items, subordinated and paid mutual accounts, paid preferred shares, including the related share premium account, and paid subordinated liabilities should not, by virtue of their contractual provisions, prevent or hinder the raising of new own funds.

NBB_2016_11 – 25 April 2016 Circular – Page 3/22

Own fund items should have sufficient maturity, depending on their classification tier. According to the guidelines, this requirement should not be compromised by any call option before five years for items of all tiers referred to in Article 147 of the Law, whether or not they relate to changes outside or within the control of the undertaking. If the repurchase or buy-back of an own fund item is authorized at the choice of the undertaking at the first possible call date or at a later date, the undertaking should not give the impression that, at the time of issue, the item will be repurchased, redeemed or cancelled before the contractual maturity of the item. Since the repurchase or redemption may have a significant impact on the undertaking's solvency position in the short and medium term, the repurchase or redemption is always subject to the approval of the Bank. This is without prejudice to the treatment of transactions that are not considered as a repurchase or redemption, referred to in Article 71, paragraph 2, Article 73, paragraph 2, and Article 77, paragraph 2, of Regulation 2015/35. In order to avoid deterioration of an undertaking's solvency position, own fund items must ensure that undertakings will be able to maintain own funds in the event of non-compliance with the required solvency capital requirement (hereinafter, the "SCR") or if the repurchase or redemption is likely to lead to such non-compliance. According to the guidelines, this should be independent of any contractual commitment or notification of repurchase and redemption. Since distributions cannot be made as long as they further weaken the undertaking's solvency position, the guidelines provide that alternative coupon payment mechanisms should only be authorized to a limited extent, so as not to compromise the cancellation of distributions and not to reduce the undertaking's own funds. Agreements to stop payments or requiring payments regarding other items compromise the total freedom of distributions. The guidelines specify that the use of dividend payment suspension mechanisms in any own fund item, regardless of the tier, which would result in setting caps or limiting the level or amount of distributions to be made on the item referred to in Article 69, point a), i) of Regulation 2015/35, is prohibited, as it could discourage new providers of own funds and, consequently, represent an obstacle to recapitalization. In order for any loss-absorption mechanism on the principal to achieve its objective when a trigger event occurs, the terms of the contractual agreement should be clearly defined and legally certain, and capable of being applied without delay. According to the guidelines, if a future increase is generally authorized, this mechanism should not compromise the absorption of losses and should only be authorized based on realized profits once there is again compliance with the SCR. If called but unpaid ordinary share capital can be classified as Level 2 basic own
funds, provided that the Level 2 characteristics are present, the guidelines provide that this capital should be taken into account as own funds only for a limited period, in order to avoid that capital is called solely for the purpose of satisfying the own fund classification requirements without any intention to pay up the item in due time. These guidelines also provide clarification in the event of non-compliance with the SCR. There is non-compliance with the SCR when the value of own funds eligible to cover the SCR is less than the amount of the SCR. This non-compliance with the SCR should not be confused with significant non-compliance with the SCR, as defined in Article 71, paragraph 8, of Regulation 2015/35 for the specific purposes of loss-absorption mechanisms on the principal. There is non-compliance with the minimum capital requirement (hereinafter, the "MCR") when the value of own funds eligible to cover the MCR is less than the amount of the MCR.

Circular – Page 4/22 NBB_2016_11 – 25 April 2016

II. Definitions
For the purposes of these guidelines, the following definition has been developed: "item not included in the lists": an own fund item not included in the lists referred to in Articles 69, 72 and 76 of Regulation 2015/35.
In the absence of a definition in this circular, the terms have the meaning defined in the legislative and regulatory acts referred to therein.

III. Additional Information
This circular falls within the framework of the harmonized implementation of the principles of Directive 2009/138/EC of the European Parliament and of the Council of 25 November 2009 on the taking-up and pursuit of the business of Insurance and Reinsurance (Solvency II), as this implementation has been determined by the guidelines of the European Insurance and Occupational Pensions Authority. Undertakings may, for information purposes, consult these guidelines at the following address: https://eiopa.europa.eu/publications/eiopa-guidelines.

IV. Entry into Force
The guidelines apply from 23 March 2016.

V. Guidelines
Section 1: Level 1 items
Sub-section 1 - definition of Level 1 items
For information, pursuant to Article 69 of Regulation 2015/35, the following basic own fund items are deemed to present, in substance, the characteristics set out in Article 146 § 1st points a) and b) of the Law, taking into account the factors referred to in Article 146 § 2 of the Law, and are classified at Level 1, when they present all the characteristics set out in Article 71 of Regulation 2015/35 (cf. below):

(a) the part of the excess of assets over liabilities, valued in accordance with Article 75 and Chapter VI, Section 2, of Directive 2009/138/EC 1, which consists of the following:
i) paid ordinary share capital and the related share premium account; ii) for mutuals and mutual-type undertakings, the initial fund, members' contributions or the equivalent basic own fund item, paid; iii) subordinated and paid mutual accounts; iv) excess funds that are not considered as insurance and reinsurance liabilities in accordance with Article 91, paragraph 2, of Directive 2009/138/EC 2; v) paid preferred shares and the related share premium account; vi) a reconciliation reserve; (b) paid subordinated liabilities, valued in accordance with Article 75 of Directive 2009/138/EC 3.

1 Article 123 of the Law
2 Article 145 of the Law
3 Article 123 of the Law

NBB_2016_11 – 25 April 2016 Circular – Page 5/22

Guideline 1 – Paid ordinary share capital and Level 1 preferred shares For the purposes of Article 69, point a), i) of Regulation 2015/35, undertakings should identify paid ordinary share capital taking into account the following characteristics:
(a) the shares are issued directly by the undertaking with the prior approval of its shareholders or, of its legal administrative body; (b) the shares give their owner the right to a claim on the residual assets of the undertaking in the event of liquidation, proportional to the amount of the issued items, which is neither fixed nor subject to a cap. When an undertaking has more than one category of shares:
(a) in order to verify that ordinary capital and Level 1 preferred shares occupy a lower rank than all other claims in the event of liquidation of the insurance or reinsurance undertaking, in accordance with Article 71, paragraph 1, point a), i) of Regulation 2015/35, it should define the differences between categories that allow one category to occupy a higher rank than another category, and consider as potential Level 1 ordinary share capital only the category that occupies a lower rank than all other claims. (b) similarly, in order to verify that there is no preferential treatment regarding the order of distribution payments, and that the terms of the contractual agreement governing the own fund item do not provide for preferential rights to distribution payments, in accordance with Article 71, paragraph 3, point a) of Regulation 2015/35, it should define the differences between categories that create preferential treatment regarding distributions and consider as potential Level 1 ordinary share capital only the category that has no preferential rights. (c) it should consider all categories of shares that occupy a higher rank than the most subordinated categories or that have other preferential characteristics preventing them from being classified as Level 1 ordinary share capital in accordance with points a) and b), as potentially meeting the characteristics of preferred shares and classify these items in the relevant tier based on their characteristics.

Guideline 2 – Reconciliation reserve
For information, Article 70 of Regulation 2015/35 defines the reconciliation reserve as follows:
“1. The reconciliation reserve referred to in Article 69, point a), vi), is equal to the total amount of the excess of assets over liabilities, reduced by all of the following:
(a) the amount of its own shares held by the insurance or reinsurance undertaking; (b) dividends, distributions and foreseeable charges; (c) basic own fund items referred to in Article 69, point a), i) to v), Article 72, point a), and Article 76, point a); (d) basic own fund items not referred to in Article 69, point a), i) to v), Article 72, point a), and Article 76, point a), which have been approved by the supervisory authorities in accordance with Article 79; (e) restricted own fund items meeting one of the following conditions:
i) they exceed the notional amount of the required solvency capital in the case of portfolios with equalizer adjustment and ring-fenced funds, determined in accordance with Article 81, paragraph 1; ii) they are deducted pursuant to Article 81, paragraph 2;

Circular – Page 6/22 NBB_2016_11 – 25 April 2016

(f) the amount of holdings in credit institutions and financial institutions referred to in Article 92, paragraph 2, of Directive 2009/138/EC 4, deducted in accordance with Article 68, to the extent that this amount is not already included in points a) to e).
2. The excess of assets over liabilities referred to in paragraph 1 includes the amount corresponding to the expected profit included in future premiums provided for in Article 260, paragraph 2.”
When calculating the reconciliation reserve, when they deduct their own shares, in accordance with Article 70, paragraph 1, point a), of Regulation 2015/35, undertakings must take into account both directly held own shares and indirectly held own shares.
When calculating the reconciliation reserve, when they deduct dividends, distributions and foreseeable charges in accordance with Article 70, paragraph 1, point b), of Regulation 2015/35:
(a) undertakings should consider a dividend or distribution as foreseeable at the latest when it is announced or approved by the legal administrative body or by other persons who effectively manage the undertaking, regardless of any requirement for approval by the annual general meeting; (b) if a participating undertaking holds a stake in another undertaking with a foreseeable dividend, the participating undertaking should not reduce its reconciliation reserve to take into account this foreseeable dividend; (c) undertakings should consider the amount of foreseeable charges to be taken into account as:
i) the amount of taxes that are foreseeable and are not already recognized as liabilities in the Solvency II balance sheet; ii) the amount of all commitments or circumstances appearing during the relevant reference period, which are likely to reduce the undertaking's profits and for which the Bank is not certain that they have been duly taken into account in the valuation of assets and liabilities in accordance with Regulation 2015/35.

Sub-section 2 - characteristics of Level 1 items
Article 71 of Regulation 2015/35 determines the characteristics that own fund items must meet to be classified as Level 1 items. The following guidelines clarify some of these specific characteristics for Level 1 items.

Guideline 3 – Characteristics determining the classification of items referred to in Article 69, point a), i), ii) and iv), of Regulation 2015/35 as Level 1 items Absence of clauses likely to cause insolvency or accelerate the insolvency of the insurance undertaking. (Article 71, 1; b) of Regulation 2015/35) In the case of an item referred to in Article 69, point a), i), ii) and iv) of Regulation 2015/35, (i.e. in order: i) paid ordinary share capital and the related share premium account, ii) for mutual insurance associations, the initial fund, members' contributions or the equivalent basic own fund item, paid and iv) excess funds that are not considered as insurance and reinsurance liabilities in accordance with Article 145 of the Law), undertakings should consider that the characteristics likely to cause the insolvency of the undertaking or accelerate the process leading to insolvency include the following:
(a) the holder of the own fund item is able to request the liquidation of the issuer if distributions are not made; (b) the holder of the own fund item may, due to the cancellation or non-realization of a distribution, be granted the possibility to cause the full or partial repayment of the invested amount or to demand penalties or any other compensation that could result in a reduction of own funds.

Guideline 4 – Characteristics determining the classification of items referred to in Article 69, point a), i) and ii), of Regulation 2015/35 as Level 1 items Total freedom of distribution (Article 71, paragraph 3) of Regulation 2015/35) For an item referred to in Article 69, point a), i) and ii) of Regulation 2015/35, (i.e., i) paid ordinary share capital and the related share premium account and ii) for mutual insurance associations, the initial fund, members' contributions or the equivalent basic own fund item, paid), to be considered as presenting the characteristics referred to in Article 71, paragraph 3, of Regulation 2015/35 (total freedom), undertakings should:
(a) consider that distributable items include undistributed profits, including profits from the closed financial year before the year of distribution, and distributable reserves in accordance with the Royal Decree of 17 November 1994 on the annual accounts of insurance undertakings or the statutes of the undertaking, less, in undistributed profits, any net interim loss for the current financial year; (b) determine the amount of distributable items based on the undertaking's individual accounts and not on consolidated accounts; (c) report, in the determination of distributable items, any restriction imposed in accordance with the Royal Decree of 27 September 2009 on the consolidated accounts of insurance and reinsurance undertakings; (d) ensure that the terms of the contractual agreements governing the own fund item or any other own fund item do not impose a cap or limit on the level or amount of distributions to be made on the item referred to in Article 69, point a), i) (ordinary shares), of Regulation 2015/35, including by imposing a cap or limiting distribution to zero; (e) ensure that the terms of the contractual agreement governing the own fund item do not require that a distribution be made if a distribution is made on another own fund item issued by the undertaking. The undertaking should specify the legal basis authorizing the cancellation of distributions in accordance with Article 71, paragraph 1, point l), i), of Regulation 2015/35 in order to classify an item at Level 1.

---

4 Article 15 of the Law

Circular – Page 8/22 NBB_2016_11 – 25 April 2016

Orientation 5 – Tier 1 characteristics determining the classification of items referred to in Article 69, point a), iii) (subordinated mutual accounts and paid-up) and v) (paid-up preference shares and related share premium account), and to Article 69, point b) (paid-up subordinated liabilities, valued in accordance with Article 123 of Directive 2009/138/EC) (Article 123 of the Act), of Regulation 2015/35.

Absence of clauses likely to cause or accelerate the insolvency of the insurance undertaking (Article 71, 1; b) of Regulation 2015/35)

In the case of an item referred to in Article 69, point a), iii) (subordinated mutual accounts and paid-up) and v) (paid-up preference shares and related share premium account), and to Article 69, point b) of Regulation 2015/35 (paid-up subordinated liabilities, valued in accordance with Article 123 of the Act), undertakings should consider that characteristics likely to cause the insolvency of the undertaking or accelerate the process leading to insolvency include the following:

(a) the holder of the own funds item is able to request the liquidation of the issuer if distributions are not made; (b) the terms of the contractual agreement governing the own funds item specify the circumstances or conditions that would require, where applicable, the initiation of insolvency proceedings or any other proceedings affecting the continuity of the undertaking's activities or its going concern status; (c) the holder of the financial instrument relating to an own funds item may, due to the cancellation of a distribution, be granted the possibility to cause the full or partial repayment of the invested amount or to demand penalties or any other compensation that could result in a reduction of own funds.

Loss absorption in the event that the Solvency Capital Requirement is not met and absence of obstacles to recapitalization (Article 71, paragraph 1, point d) of Regulation 2015/35)

For an own funds item to be considered as having the characteristics referred to in Article 71, paragraph 1, point d), of Regulation 2015/35 (loss absorption in the event that the Solvency Capital Requirement is not met and absence of obstacles to recapitalization), the terms of the contractual agreement governing it or the terms of any associated provision:

(a) cannot prevent the issuance or increase of another own funds item that would rank senior to this item or have the same degree of subordination as this item; (b) do not require that new own funds items raised by the undertaking be more subordinated than this item under stress conditions or in other circumstances where additional own funds may be necessary; (c) do not include terms preventing distributions on other own funds items; (d) do not require that the item be automatically converted into an item ranking senior in terms of subordination, under stress conditions or in other circumstances where additional own funds may be necessary, or due to structural changes, including a merger or acquisition.

NBB_2016_11 – 25 April 2016 Circular – Page 9/22

Buyback or repayment before five years (Article 71, paragraph 1, point f), ii) of Regulation 2015/35)

For an own funds item to be considered as having the characteristics referred to in Article 71, paragraph 1, point f), ii), of Regulation 2015/35 (buyback or repayment before five years), the terms of the contractual agreement governing it cannot include a clause providing for a buyback option before five years from the date of issuance, including buyback options based on unforeseen changes beyond the control of the undertaking.

Buyback or repayment before five years (Article 71, paragraph 2 of Regulation 2015/35)

Nevertheless, subject to its prior approval, and the presence of all the characteristics determining classification, the Bank considers authorized, as provided for in Article 71, paragraph 2, of Regulation 2015/35, agreements based on unforeseen changes beyond the control of the undertaking that could give rise to transactions or agreements that are not considered as a buyback or repayment.

Absence of distribution in case of insufficiency of the Solvency Capital Requirement (Article 71, paragraph 1, point m) of Regulation 2015/35)

For an own funds item to be considered as having the characteristics referred to in Article 71, paragraph 1, point m) (Absence of distribution in case of insufficiency of the Solvency Capital Requirement) of Regulation 2015/35, the terms of the contractual agreement governing it cannot include an alternative coupon payment mechanism:

(a) unless this mechanism replaces cash payments of the distribution by allowing distributions to be settled by means of the issuance of ordinary share capital; (b) unless through this mechanism the same degree of loss absorption as the cancellation of the distribution is achieved, and own funds are not reduced; (c) provided that any distribution made under this mechanism takes place as soon as the Bank has exceptionally accepted that the distribution is not cancelled using unissued ordinary share capital that has already been approved or authorized under national law or the company's statutes; (d) if this mechanism does not allow the undertaking to use treasury shares held following a securities lending transaction or a REPO transaction; (e) the terms of the contractual agreement governing the own funds item:
i) provide that the implementation of any alternative coupon payment mechanism is subject to exceptional acceptance by the Bank under Article 71, paragraph 1, point m), of Regulation 2015/35 each time the non-cancellation of the distribution is necessary; ii) do not oblige the undertaking to implement an alternative coupon payment mechanism.

Circular – Page 10/22 NBB_2016_11 – 25 April 2016

Total freedom regarding distributions (Article 71, paragraph 4 of Regulation 2015/35)

For an own funds item to be considered as having the characteristics referred to in Article 71, paragraph 4, of Regulation 2015/35 (total freedom regarding distributions), the terms of the agreement governing it:

(a) do not require that distributions be made on this item if a distribution is made on another own funds item issued by the undertaking; (b) do not require that the payment of distributions on any other own funds item of the undertaking be cancelled or prevented if no distribution is made with respect to this item; (c) do not link the payment of distributions to another event or another transaction having the same economic effects as those referred to in point a) or b).

Loss absorption mechanisms on principal (Article 71, paragraph 1, point e) and Article 71, paragraphs 5, 6 and 8 of Regulation 2015/35).

This fundamental characteristic of Tier 1 own funds items deserves some additional explanation.

Regulation 2015/35 (Article 71 paragraph 1 e)) provides that when own funds items consist of subordinated mutual accounts, preference shares, or subordinated liabilities, they must integrate one of the following loss absorption mechanisms on principal, which must be triggered upon the occurrence of the trigger event:

i) a reduction of the nominal amount or principal of the underlying own funds item; ii) the automatic conversion of the underlying own funds item into ordinary shares or, in the case of mutuals, into an equivalent own funds item; iii) a loss absorption mechanism on principal allowing to achieve a result equivalent to that of the loss absorption mechanisms on principal provided for in points i) and ii).

Furthermore, Regulation 2015/35 also stipulates (Article 71 paragraph 5) that in the case of the nominal amount or principal reduction mechanism, the nominal amount or principal of the underlying own funds item is reduced by reducing the value of all the following elements:

(a) the claim of the holder of this item in the event of liquidation proceedings; (b) the amount payable in the event of repayment or buyback of this item; (c) the distributions paid on this item.

For an own funds item to be considered as having the characteristics referred to in Article 71, paragraph 1, point e), and to Article 71, paragraphs 5, 6 and 8, of Regulation 2015/35 (loss absorption mechanisms on principal), undertakings should ensure that:

(a) the loss absorption mechanism, including the trigger event, is clearly defined in the terms of the contractual agreement governing the own funds item and legally certain;

NBB_2016_11 – 25 April 2016 Circular – Page 11/22

(b) the loss absorption mechanism can be effective at the time of the trigger event, without delay and regardless of any requirement to notify holders of the item; (c) when the debt reduction mechanism does not provide for a write-up of the write-down, there can be no restoration of the debt. (d) when the debt reduction mechanism allows for a write-up of the write-down, it can only take place under the following conditions:
i) the increase is authorized only once the undertaking meets the SCR; ii) the increase is not implemented taking into account the issuance or increase of own funds items intended to restore compliance with the SCR; iii) the increase takes place only on the basis of profits that contribute to distributable items after the restoration of compliance with the SCR in a manner that does not compromise the loss absorption capacity provided for in Article 71, paragraph 5, of Regulation 2015/35; (e) any conversion mechanism provides that:
i) the basis on which the financial instrument relating to an own funds item is converted into ordinary share capital in the event of significant non-compliance with the SCR is clearly specified in the terms of the contractual agreement governing the financial instrument; ii) in the event of a drop in the share price, the conversion conditions do not fully compensate for the nominal amount of the financial instrument held. In this case, the conversion rate must be limited to a cap; iii) when a conversion range is specified for instruments, the maximum number of shares that the holder of the financial instrument can receive is certain at the time of issuance of said financial instrument, subject only to adjustments aimed at taking into account any share splits occurring after the issuance of these instruments; iv) the conversion will contribute to a going concern loss absorption and the basic own funds resulting from the conversion do not hinder recapitalization.

If undertakings possess own funds items with conversion mechanisms, they should ensure that a sufficient number of shares has already been authorized in accordance with national law or the company's statutes, so that shares are available for issuance when necessary.

Orientation 6 – Tier 1 characteristics determining the classification of items referred to in Article 69, point a), i), ii), iii) and v), and to Article 69, point b), of Regulation 2015/35 – immediate availability to absorb losses

In the case of an item referred to in Article 69, point a), i) (ordinary share capital), ii) (initial fund or members' contributions), iii) (subordinated mutual accounts) and v) (preference shares), and to Article 69, point b) (subordinated liabilities), of Regulation 2015/35, undertakings should not consider an item as immediately available to absorb losses unless this item is paid-up and there is no condition or contingency regarding its loss absorption capacity.

Circular – Page 12/22 NBB_2016_11 – 25 April 2016

Orientation 7 - Tier 1 characteristics determining the classification of items referred to in Article 69, point a), i), ii), iii) and v), and to Article 69, point b), of Regulation 2015/35 – buyback or repayment at the undertaking's option (ordinary share capital, initial fund or members' contributions, subordinated mutual accounts, preference shares and subordinated liabilities)

Absence of incentive to repay

For an item referred to in Article 69, point a), i), ii), iii) and v), and to Article 69, point b), of Regulation 2015/35, (ordinary share capital, initial fund or members' contributions, subordinated mutual accounts, preference shares and subordinated liabilities) to be considered as having the characteristics referred to in Article 71, paragraph 1, points h) (buyback or repayment at the undertaking's option) and i) (absence of incentive to repay), of Regulation 2015/35, undertakings:

(a) should ensure that the legal or contractual provisions governing the item, or any related agreement, do not include an incentive to repay it, as provided for in Orientation 19; (b) should not give hope, at the time of issuance, that the item will be repaid or cancelled, and the legal or contractual provisions governing the own funds item should not contain any term likely to generate such an expectation.

Undertakings should treat the item as bought back or repaid from the date of notification to its holders or, if no notification is necessary, from the date of the Bank's approval, and exclude the item from own funds from that date.

In the case of an item referred to in Article 69, point a), iii) and v) (subordinated mutual accounts, preference shares), and to Article 69, point b) (subordinated liabilities), of Regulation 2015/35, for an item to be considered as having the characteristics referred to in Article 71, paragraph 1, point j), of Regulation 2015/35 (suspension of repayment or buyback), the terms of the agreement governing it must include provisions that allow, if the SCR is not met or if the buyback or repayment is likely to lead to such non-compliance, the suspension of the buyback or repayment of the item, at any time, including when a buyback or repayment notification has been given, but not if an exceptional acceptance of non-suspension or of buyback or repayment has been granted under Orientation 15.

For undertakings that have suspended the buyback or repayment in accordance with Article 71, paragraph 1, point j), of Regulation 2015/35, subsequent actions of the undertakings should be part of the recovery plan referred to in Article 510 of the Act.

Orientation 8 – Contractual opportunities for repayment and appropriate margin

In the event of a request for approval by the Bank of a buyback or repayment in the period between five and ten years following the date of issuance in accordance with Article 71, paragraph 1, point g), of Regulation 2015/35, undertakings should demonstrate that the SCR will be exceeded by an appropriate margin following the buyback or repayment for the period of their medium-term capital management plan or, if longer, for the period between the date of repayment or buyback and ten years after the date of issuance.

NBB_2016_11 – 25 April 2016 Circular – Page 13/22

When assessing the appropriateness of the margin, the Bank will take into account:

(a) the current and projected solvency position of the undertaking, taking into account the proposed buyback or repayment and any other proposed buyback and repayment or any other proposed issuance; (b) the undertaking's medium-term capital management plan and its Internal Risk and Solvency Assessment (hereinafter, the "IRSA"); (c) the volatility of the undertaking's own funds and SCR, taking into account the nature, scale, and complexity of the risks inherent in the undertaking's activity; (d) the extent to which the undertaking has access to external sources of own funds and the impact of market conditions on undertakings' ability to raise own funds.

Section 2 : Tier 2 Items

Orientation 9 – List of Tier 2 own funds items

In the case of items referred to in Article 72, point a), i), ii) and iv) (ordinary share capital, initial fund and members' contributions, preference shares), of Regulation 2015/35, undertakings should ensure that:

(a) the period between the call on shareholders or members and the effective payment of the item does not exceed three months. During this time, undertakings should consider own funds as called but unpaid, and should classify them as Tier 2 basic own funds, provided that all other relevant criteria are met; (b) for called but unpaid items, the shareholder or member owning the item is still obliged to pay the balance if the undertaking becomes insolvent or is subject to liquidation proceedings, and that the amount is available to absorb losses.

Orientation 10 – Tier 2 characteristics determining classification

Absence of clauses likely to cause or accelerate the insolvency of the insurance undertaking. (Article 73, paragraph 1, point b) of Regulation 2015/35)

In the case of items referred to in Article 72, point a), i) and ii) (ordinary share capital, initial fund and members' contributions), of Regulation 2015/35, for undertakings determining classification in accordance with Article 73, paragraph 1, point b), of Regulation 2015/35, Orientation 3 applies mutatis mutandis.

Absence of clauses likely to cause or accelerate the insolvency of the insurance undertaking (Article 73, paragraph 1, point b) of Regulation 2015/35)

In the case of items referred to in Article 72, point a), iii) and iv), and to Article 72, point b), of Regulation 2015/35, for undertakings determining classification in accordance with Article 73, paragraph 1, point b), of Regulation 2015/35, Orientation 5 applies mutatis mutandis.

Buyback or repayment before five years

For an own funds item to be considered as having the characteristics referred to in Article 73, paragraph 1, point c), of Regulation 2015/35 (buyback or repayment before five years),

Circular – Page 14/22 NBB_2016_11 – 25 April 2016

the contractual agreement governing it must not include a clause providing for a buyback option before five years from the date of issuance, including buyback options based on unforeseen changes beyond the control of the undertaking.

Subject to the presence of all the relevant characteristics determining classification and its prior approval, the Bank considers authorized, as provided for in Article 73, paragraph 2, of Regulation 2015/35, agreements based on unforeseen changes beyond the control of the undertaking that could give rise to transactions or agreements that are not considered as a buyback or repayment.

Limited incentives to repay

For an own funds item to be considered as having the characteristics referred to in Article 73, paragraph 1, point e), of Regulation 2015/35 (limited incentives to repay), the terms of the contractual agreement governing it or any related agreement can only include limited incentives to repay, as provided for in Orientation 19.

Undertakings should treat Tier 2 basic own funds items as bought back or repaid from the date of notification to the holders of the item or, if no notification is necessary, from the date of approval by the supervisory authority, and exclude the item from own funds from that date.

Suspension of repayment or buyback

Undertakings should ensure that the terms of the contractual agreement governing the own funds item:

(a) include, for an item to be considered as having the characteristics referred to in Article 73, paragraph 1, point f), of Regulation 2015/35 (suspension of repayment or buyback), provisions that allow, if the SCR is not met or if the buyback or repayment is likely to lead to such non-compliance, the suspension of the buyback or repayment of the item, at any time, including when a buyback or repayment notification has been given or at the final maturity date of the instrument, but not if an exceptional acceptance of non-suspension or of buyback or repayment has been granted under Orientation 15; (b) include, for the item to be considered as having the characteristics referred to in Article 73, paragraph 1, point g), of Regulation 2015/35 (deferred distributions), provisions allowing for the deferral of distributions at any time in the event of non-compliance with the SCR or if the distribution is likely to lead to such non-compliance.

For undertakings that have suspended the buyback or repayment in accordance with Article 73, paragraph 1, point f), of Regulation 2015/35, subsequent actions of the undertakings should be part of the recovery plan referred to in Articles 510, 513 to 516 and 574 of the Act.

Section 3 : Tier 3 Items

Orientation 11 – Tier 3 characteristics determining classification

For undertakings determining classification in accordance with Article 77, paragraph 1, point b), of Regulation 2015/35 Orientation 5 applies mutatis mutandis to Tier 2 basic own funds items

NBB_2016_11 – 25 April 2016 Circular – Page 15/22

level 3.

For an own funds item to be considered as having the characteristics referred to in Article 77(1)(c) of Regulation 2015/35 (buyback or redemption before five years), the agreement governing it must not include any contractual clause providing for a buy option before the scheduled maturity date, including buy options based on unforeseen changes beyond the company's control;

Subject to the presence of all the characteristics determining classification and its prior approval, the Bank considers as authorized, as provided for in Article 77(2) of Regulation 2015/35, agreements based on unforeseen changes beyond the company's control that would result in transactions or agreements that are not considered as a buyback or redemption.

For an own funds item to be considered as having the characteristics referred to in Article 77(1)(e) of Regulation 2015/35 (limited incentives to redeem), the terms of the agreement governing it or any linked agreement may only include limited incentives to redeem, as provided for in Guideline 19.

Companies should treat Tier 3 basic own funds items as being bought back or redeemed as from the date of notification to their holders, or, if no notification is required, as from the date of approval by the Bank, and exclude the item from own funds as from that date.

In the case of an item referred to in Article 76(a)(i), (ii), and Article 76(b) of Regulation 2015/35, the terms of the contractual agreement governing the own funds item:

(a) should include, for the item to be considered as having the characteristics referred to in Article 77(1)(f) of Regulation 2015/35, provisions that allow, if the SCR is not met or if the buyback or redemption is likely to result in such non-compliance, the suspension of the buyback or redemption of the item, at any time, including when a buyback or redemption notification has been given or at the final maturity date of the instrument, but not if an exceptional acceptance of non-suspension or buyback or redemption has been granted under Guideline 15;

(b) should include, for the item to be considered as having the characteristics referred to in Article 77(1)(g) of Regulation 2015/35, provisions allowing distributions to be deferred at any time in case of non-compliance with the MCR or if the distribution is likely to result in such non-compliance.

For companies that have suspended the buyback or redemption in accordance with Article 77(1)(f) of Regulation 2015/35, subsequent actions by the companies should be part of the recovery plan referred to in Article 510 of the Act.

Section 4: All basic own funds items

Guideline 12 – Buyback or redemption

To assess whether an item has the characteristics referred to in Articles 71, 73 and 77 of Regulation 2015/35, companies should consider that buyback or redemption includes the buyback, redemption or securities lending transactions and REPO transactions of any own funds item or any other agreement having the same economic effect. This includes share buybacks, tender offers, buyback plans and the buyback of principal at maturity for fixed-maturity items, as well as buyback or redemption following the exercise of an issuer's call option. This is without prejudice to the treatment of transactions that are not considered as a buyback or redemption, referred to in Article 71(2), Article 73(2) and to

Circular – Page 16/22 NBB_2016_11 – 25 April 2016

Article 77(2) of Regulation 2015/35.

Guideline 13 – Charges

To assess whether an item has the characteristics referred to in Article 71(1)(o), Article 73(1)(i) and Article 77(1)(h), companies should:

(a) assess whether an own funds item is encumbered based on the economic effect of the charge and the nature of the item, applying the principle of substance over form;

(b) consider that charges include, among others:

i) compensation rights;

ii) restrictions;

iii) charges or guarantees;

iv) holding of the company's own funds;

v) the effect of a transaction or a group of related transactions having the same effects as those referred to in points i) to iv);

vi) the effect of a transaction or a group of related transactions otherwise compromising the ability of an item to meet the characteristics determining classification as an own funds item;

(c) consider that a charge arising from a transaction or a group of transactions equivalent to the holding of treasury shares includes the case where the company holds its own Tier 1, Tier 2 or Tier 3 own funds items.

If the charge is equivalent to the holding of treasury shares, companies should deduct the amount of the encumbered item from the reconciliation reserve.

When determining the treatment of an own funds item encumbered with a charge in accordance with Article 71(1)(o), Article 73(1)(i) or Article 77(1)(h) of Regulation 2015/35, and the item with the charge has the characteristics required for a lower tier, companies should:

(a) establish whether the encumbered item appears on the lists of own funds items for the lower tier referred to in Articles 72 and 76 of Regulation 2015/35;

(b) classify an item appearing on the lists according to the appropriate classification characteristics referred to in Articles 73 and 77 of Regulation 2015/35;

(c) request approval from the supervisory authority to classify any item not appearing on the lists in accordance with Article 79 of Regulation 2015/35.

If an item is encumbered to such an extent that it no longer has the characteristics determining classification, companies should no longer consider it as an own funds item.

Guideline 14 – Buy options based on unforeseen changes

Companies should consider that unforeseen changes beyond their control, referred to in Guideline 5, paragraphs 3 and 4, Guideline 10, paragraphs 3 and 4 and Guideline 11, paragraphs 2 and 3

NBB_2016_11 – 25 April 2016 Circular – Page 17/22

include:

(a) the amendment of legislation or regulation concerning the company's own funds item in any jurisdiction, or the interpretation of that legislation or regulation by any jurisdiction or authority empowered to do so;

(b) the modification of the applicable tax treatment, regulatory classification or rating agency treatment of the concerned own funds item.

Guideline 15 – Exceptional acceptance of non-suspension of buyback or redemption

When requesting exceptional acceptance of non-suspension of buyback or redemption, in accordance with Article 71(1)(k)(i), Article 73(1)(k)(i) and Article 77(1)(i)(i) of Regulation 2015/35, companies should:

a) describe the proposed exchange or conversion and its effects on basic own funds, including the terms according to which the exchange or conversion is provided for in the contractual agreement governing the own funds item;

b) demonstrate how the proposed exchange or conversion is or would be consistent with the recovery plan referred to in Article 510 of the Act;

c) request prior approval of the transaction from the supervisory authority in accordance with Guideline 18.

Guideline 16 – Exceptional acceptance that distributions are not cancelled or deferred

When requesting exceptional acceptance that distributions are not cancelled or deferred, in accordance with Article 71(1)(m) and Article 73(1)(h) of Regulation 2015/35, companies should demonstrate how the distribution could be made without weakening their solvency position and the MCR being respected.

A company requesting exceptional acceptance regarding a settlement obtained through an alternative coupon payment mechanism should take into account the amount of ordinary share capital that would need to be issued, the extent to which restoring compliance with the SCR would require raising new own funds, as well as the potential impact of issuing shares for the alternative coupon payment mechanism on the company's ability to raise these funds, and it should communicate this information and this analysis to the supervisory authority.

Guideline 17 – Loss absorption on principal: conversion

When applying a loss absorption mechanism on principal in the form of a conversion in accordance with Article 71(1)(e)(ii) of Regulation 2015/35, the company's supervisory body and other persons who effectively direct the company should be aware of the impact that a potential conversion of an instrument could have on the company's capital structure and ownership, and should monitor this impact as part of the company's governance system.

Circular – Page 18/22 NBB_2016_11 – 25 April 2016

Guideline 18 – Approval of buyback and redemption by the supervisory authority

If a company requests approval of a buyback or redemption from the supervisory authority in accordance with Article 71(1)(h), Article 73(1)(d) and Article 77(1)(d) of Regulation 2015/35, or of a transaction not considered as a buyback or redemption in accordance with Article 71(2), Article 73(2) and Article 77(2) of Regulation 2015/35, it should provide the supervisory authority with an assessment of the buyback or redemption taking into account:

(a) the current and short- and medium-term impact on the company's overall solvency position and the consistency of the action with the company's medium-term capital management plan and its ORSA;

(b) the company's ability to raise additional own funds, if applicable, taking into account general economic conditions and its ability to access capital markets and other sources of additional own funds.

If a company proposes a series of buybacks or redemptions over a short period, it should inform the supervisory authority, which may examine the series of transactions as a whole rather than on a case-by-case basis.

A company should submit the approval application to the supervisory authority three months before the first of the following events occurs:

(a) the contractual notification of the buyback or redemption to the holders of the item;

(b) the proposed buyback or redemption date.

After obtaining the Bank's approval regarding the buyback or redemption, the company should:

(a) consider that it is authorized, without being obliged, to exercise any call option or other optional buyback or redemption under the terms of the contractual agreement governing the own funds item;

(b) when excluding an item treated as being bought back or redeemed with effect from the date of notification to the holders of the item or, if no notification is required, from the date of approval by the supervisory authority, reduce the relevant category of own funds and make no adjustment or recalculation of the reconciliation reserve;

(c) continue to monitor its solvency position to detect any non-compliance or potential non-compliance with the SCR, which would trigger the suspension of the buyback or redemption during the period preceding the buyback or redemption date;

(d) not proceed with the buyback or redemption if it is likely to result in non-compliance with the SCR, even if the buyback or redemption has been notified to the holders of the items. If the buyback or redemption is suspended under these circumstances, the company may reinstate the item in the available own funds and the Bank's approval regarding the buyback or redemption is withdrawn.

Guideline 19 – Incentives to redeem

For the purpose of presenting the characteristics referred to in Article 71(1)(i), Article 73(1)(e) and Article 77(1)(e) of Regulation 2015/35, companies

NBB_2016_11 – 25 April 2016 Circular – Page 19/22

should consider unlimited incentives to redeem as not being authorized at any level.

Companies should consider that unlimited incentives to redeem include:

(a) a 'principal stock settlement' clause coupled with a call option, 'principal stock settlement' being a clause in the contractual agreements governing an own funds item that obliges the holder of the own funds item to receive ordinary shares if the call option is not exercised;

(b) a mandatory conversion coupled with a call option;

(c) an increase in the principal amount applicable after the call date, coupled with a call option;

(d) any other provision or any other agreement that could reasonably be considered as providing an economic basis for the potential redemption of the item.

Guideline 20 – Eligibility and limits applicable to levels 1, 2 and 3

For the purpose of calculating eligible own funds in accordance with Article 82 of Regulation 2015/35 for the SCR, companies should:

(a) consider all Tier 1 items referred to in Article 69(a)(i), (ii), (iv) and (vi) of Regulation 2015/35 as eligible to cover the SCR;

(b) consider restricted Tier 1 items exceeding the 20% limit referred to in Article 82(3) of Regulation 2015/35 as available as Tier 2 basic own funds.

For the purpose of calculating eligible own funds in accordance with Article 82 of Regulation 2015/35 for the MCR, companies should:

(a) consider all Tier 1 items referred to in Article 69(a)(i), (ii), (iv) and (vi) of Regulation 2015/35 as eligible to cover the MCR;

(b) consider restricted Tier 1 items exceeding the 20% limit referred to in Article 82(3) as available as Tier 2 basic own funds;

(c) consider that Article 82(2) of Regulation 2015/35 has the effect that Tier 2 basic own funds items are eligible provided they represent less than 20% of the MCR.

Section 5: Approval of the assessment and classification of non-listed items

Guideline 21 – General characteristics of the application

When submitting an application for approval in accordance with Article 79 of Regulation 2015/35, the company should:

(a) submit a written application for approval for each own funds item;

(b) submit the application in one of the official languages of the Member State in which the company has its seat or in a language agreed with the supervisory authority;

(c) have the application approved by the supervisory body and submit written evidence supporting this approval;

(d) provide an application in the form of a cover letter and supporting documents.

Circular – Page 20/22 NBB_2016_11 – 25 April 2016

Guideline 22 – Cover letter

The company should submit a cover letter confirming the following:

(a) the company is certain that all legal or contractual provisions governing the own funds item or any other linked agreement are unambiguous and clearly defined;

(b) taking into account possible future developments as well as circumstances existing at the date of the application, the company considers that the basic own funds item will comply, in terms of both legal form and economic substance, with the criteria set out in Articles 146 and 147 of the Act, and with the classification characteristics referred to in Articles 71, 73 and 77 of Regulation 2015/35;

(c) no fact that, if it had been brought to the attention of the supervisory authority, would have influenced its decision regarding the approval or non-approval of the assessment and classification of the own funds item has been omitted.

The company should also list, in its cover letter, the other applications it has submitted regarding the approval of items referred to in Article 308bis § 1 of the Directive, as well as their corresponding dates.

The company should ensure that the cover letter is signed by persons authorized to sign on behalf of the supervisory body.

Guideline 23 – Justification

The company should explain how the criteria set out in Articles 146 and 147 of the Act and the classification characteristics referred to in Articles 71, 73 and 77 of Regulation 2015/35 have been met, including how the item will contribute to the company's existing capital structure and enable the company to meet its existing or future capital requirements.

The company should provide a description of the basic own funds item sufficient to allow the Bank to reach a conclusion regarding the item's loss absorption capacity, including the terms of the contractual agreement governing the own funds item and the terms of any linked agreement, prove that any counterparty has, where applicable, concluded the contract and any linked agreement, and demonstrate that the contract and any linked agreement are legally binding and enforceable in all relevant jurisdictions.

Guideline 24 – Assessment of the application

The Bank will acknowledge receipt of the application.

An application will be considered complete if it covers all the issues referred to in Guidelines 21 to 23.

The Bank will confirm that the application is considered complete within 30 days from the date of its receipt.

The Bank will rule on an application within three months from the receipt of the complete application, except in exceptional circumstances communicated in good time and in writing to the companies.

NBB_2016_11 – 25 April 2016 Circular – Page 21/22

In the event of exceptional circumstances, the period within which the Bank will rule on an application shall not exceed six months from the date of receipt of the complete application.

If it proves necessary to assess the own funds item, the Bank, once it has considered the application as complete, will request additional information from the companies. It will specify the additional information required and justify its request.

The days elapsed between the date on which the Bank requests this information and the date on which it receives it will not be included in the time limits referred to in paragraphs 4 and 5 of this guideline.

The company must inform the Bank of any changes regarding the details of its application.

If a company informs the Bank of a change regarding its application, the Bank will treat this application as a new application, unless:

a) the change results from a request for additional information from the Bank; or

b) the Bank is certain that the change does not have a significant impact on the assessment of the application.

Companies should be able to withdraw an application by written notification at any time before the Bank has adopted its decision. If, subsequently, the company resubmits the application or submits an updated application, the Bank will treat this application as a new application.

Guideline 25 – Communication of the Bank's decision

When the Bank has ruled on an application, it communicates its decision in writing to the companies in good time.

If the Bank rejects the application, it provides the reasoning for this decision.

Section 6: Transitional provisions

Guideline 26 – Transitional provisions

Companies should evaluate all basic own funds items issued before 18 January 2015, to determine whether they have the classification characteristics referred to in Articles 71 and 73 of Regulation 2015/35. If these items have the classification characteristics as Tier 1 or Tier 2 items, companies should classify them in these levels, even if they cannot be used to satisfy the available solvency margin according to the legislative, regulatory and administrative provisions adopted under the Act of 9 July 1975 on the supervision of insurance companies.

If items available as basic own funds in accordance with Articles 662 and 663 of the Act are exchanged after 18 January 2015, companies should consider the item into which they are converted, or for which they are exchanged, as a new item not meeting the requirements of Article 662 or Article 663 of the Act.

Circular – Page 22/22 NBB_2016_11 – 25 April 2016

Supervisory authorities should consider that items ineligible solely due to the application of limits under the legislative, regulatory and administrative provisions adopted under the aforementioned Act of 9 July 1975 meet the requirements of Article 662 or Article 663 of the Act.

A copy of this circular is sent to the commissioner(s), approved auditor(s) of your company.

We ask you to accept, Madam, Sir, the expression of our distinguished sentiments.

Jan Smets
Governor