Joint Industry Submission on Exposure Drafts of BPR110 and BPR120

BF\63696332\1 | Page 1 31 March 2023 To Richard Downing Adviser, Financial Policy Reserve Bank of New Zealand From Nelson Building Society SBS Bank Cooperative Bank By Email capitalreview@rbnz.govt.nz Dear Richard Submission on Exposure Drafts of BPR110 and BPR120 to Incorporate Mutual Capital Instrument

1. This is a joint submission of Nelson Building Society, SBS Bank and Cooperative Bank (the Submitters) on the Exposure Drafts of BPR110 and BPR120 to incorporate a capital instrument that qualifies as CET1 capital for banks structured as mutuals (Mutual Capital Instrument). The Submitters are very pleased to be in the final stages of incorporating a Mutual Capital Instrument into the Reserve Bank of New Zealand's (Reserve Bank) capital framework. We have worked closely with the Reserve Bank on the development of its policy in relation to a Mutual Capital Instrument and understand that the intention is that the Mutual Capital Instrument should align as closely as possible to the characteristics of an ordinary share. This submission is intended to do the following: (a) provide technical feedback on the exposure drafts to align drafting with the agreed policy position; (b) based on our experience using these documents, provide suggestions to enhance clarity and usability of the new provisions from a user perspective; and (c) address minor policy issues that have come to light in reviewing the technical drafting and have not been addressed in previous consultations.
2. We attach, as an appendix to this letter, extracts of the Exposure Drafts of BPR110 and BPR120 with suggested mark-ups and comments explaining our position on outstanding issues and where we consider clarification would be beneficial for users. Below we summarise our suggested amendments to the Exposure Drafts. Structure of the BPRs
3. The criteria for qualifying as a Mutual Capital Instrument has been included in the Exposure Draft of BPR110 as a new subsection of subpart D1 which sets out the requirements for ordinary shares. While this approach works, the Submitters consider that it would be more user-friendly to have a separate subpart for Mutual Capital Instruments which clearly distinguishes the requirements for

BF\63696332\1 | Page 2 ordinary shares from the requirements for Mutual Capital Instruments and sets out all the requirements for a Mutual Capital Instrument in one place (rather than cross-referring to the requirements for ordinary shares where applicable). 4. In the appendix we provide an example of how a new subpart might be set out using the structure of the subpart setting out AT1 capital requirements. Distribution Policy 5. In accordance with the Reserve Bank's previous policy decisions, the draft Mutual Capital Instrument requirements include a requirement that the registered bank must publish an indicative distributions policy separate from the terms of the instrument. This distributions policy will be central to the marketability of the instrument. The distribution requirements also include a requirement that distributions "must not in any way be linked to the amount paid at issuance". The Submitters are seeking clarity on how this impacts their ability to communicate intended or projected investor returns in their distribution policies. We have included a suggested guidance note that will provide us some comfort on this matter. Distribution of Surplus Assets on Wind-up 6. The Exposure Draft of BPR110 sets out a formula for determining the proportion of surplus assets that will be allocated to Mutual Capital Instrument holders in a wind-up of the registered bank. We suggest the following two amendments to this formula: (a) the formula should account for any Mutual Capital Instrument cancellations (noting that the BPRs permit a registered bank to repurchase ordinary shares and Mutual Capital Instruments in certain circumstances and the formula should therefore account for this eventuality); and (b) the definition of Total CET1 capital should be amended to clarify that the formula is used at each issuance or cancellation and that this amount is the amount of CET1 capital that exists immediately prior to the new issuance or cancellation. 7. In our mark-ups in the appendix, we suggest some clarifying changes in relation to the description of how the formula must be used in order to determine the allocation of surplus assets in a wind-up, including amendments to clarify: (a) that the Mutual Capital Instrument holders' share must be recalculated at each new issuance or cancellation; and (b) that the requirement to distribute surplus assets proportionately does not apply to other members (i.e. the proportion of surplus assets allocated to other members as a class will then be distributed equally amongst those members). Cap on Distributions to Mutual Capital Instrument Holders on Wind-up 8. The Reserve Bank has determined in previous consultations that distributions to Mutual Capital Instrument holders on wind-up may be capped at the amounts paid-in at issuance in response to a request by the Submitters that this feature be permitted. We note that the Core Capital Deferred Shares (CCDSs) in the United Kingdom cap distributions on each CCDS in a wind-up at the

BF\63696332\1 | Page 3 "Average Principal Amount" rather than the exact amount paid in by each holder. While we are not yet clear whether this approach would also be appropriate in New Zealand, we expect there may be good rationale for it in some instances. We have suggested a drafting amendment to remove any doubt that this approach is allowed for Mutual Capital Instruments. We note that this remains consistent with the Reserve Bank's policy decision to limit Mutual Capital Instrument holders' participation in any upside on a wind up, while still ensuring they bear losses proportionately with other members. Deletion of Certain Requirements 9. We have suggested that a few of the requirements be deleted on the basis that they are unnecessary, or the requirement is adequately addressed by other requirements in the subpart. The Submitters would prefer to reduce the number of criteria where possible to make the document more user friendly. 10. There are three requirements that we would like to be removed on the basis that they are not requirements for ordinary shares. In particular, we consider that the requirement that Mutual Capital Instruments must be denominated in New Zealand dollars places an unnecessary limitation on mutual registered banks seeking to raise capital. The Submitters would like to retain the option of issuing these instruments overseas in local currency, particularly in the United Kingdom and Australia where markets already exist or are developing for similar instruments. While it is our preference to issue these instruments in New Zealand, it is a new instrument that is untested in the New Zealand market. Having access to offshore markets can only, in our view, be good for financial stability because it broadens access to capital, which is important for both prudential soundness and a more competitive banking system. This would require the mutual registered bank to account for foreign exchange in its accounting activities (including in relation to the formula for distribution of surplus assets). However, there are established practices for this, and we do not see it as problematic. 11. The second requirement that we would like to be removed (though less important) is the requirement that the instrument and all constituting documents be governed by New Zealand law. While we do not anticipate that this will be an issue, it is not a requirement for ordinary shares and in the absence of a clear reason for including it, we would prefer it to be removed to avoid any unintended consequences. 12. Finally, we would like the limitation on members of a registered bank's group purchasing its Mutual Capital instruments removed. This is not a limitation placed on ordinary shares and, in our view, it should be sufficient that such instruments are excluded from our capital calculations. 13. We would like to continue to work with you to finalise these standards. Please contact us if there are any matters in this submission you would like to discuss, or if any questions arise while you are finalising the amendments to the BPRs. Kind regards Nelson Building Society, SBS Bank and Cooperative Bank

BF\63696332\1 | Page 4 APPENDIX – EXTRACTS FROM BPR110 and BPR120

BPR110 1 Ref #X980754X943142v1.01.51. BPR110 Capital Definitions Exposure Draft Consultation December 2022 Purpose of document This document provides the definitions that a bank must use for calculating the value of total capital and the components of that total, for the purpose of calculating the regulatory capital ratios defined in BPR100. Banking Prudential RequirementsX 2023 [Beginning of extract]

Part A: Introduction and definitions A1 Introduction A1.1 Purpose of this document

1. The purpose of this document is to provide definitions of total capital and of the subcategories of capital to be used in calculating the capital adequacy ratios specified in section B2.7 of BPR100. It specifies minimum requirements that instruments and reserves must meet to qualify for each of the categories of capital included in the capital ratio calculations.
2. Additional terms included in the contractual terms of a capital instrument will not disqualify the instrument from being included in the applicable capital ratio calculations, provided that those terms do not affect the instrument’s compliance with the requirements contained in this document. A2 Definitions and transitionals A2.1 Meaning of terms used in this document In this document,– Additional Tier 1 capital (AT1 capital) means capital that meets the general requirements specified in section B2.1 and that falls within the definition given in section B2.2 associated, in relation to a funds management or securitisation vehicle, has the meaning given to association in Part A of BPR 160 Common Equity Tier 1 capital (CET1 capital) means capital that meets the general requirements specified in section B1.1 and that falls within the definition given in section B1.2 control or significant influence means– a. the ability to directly or indirectly appoint 20% or more of the members of the governing body of an entity; or Guidance: Members of the governing body will include, for example, a board of directors. b. the power to influence the financial and operating policy decisions of an entity; or c. holding a direct or indirect qualifying interest in 20% or more of the voting securities of an entity Guidance: Where the employees or directors of one entity (entity A) constitute a significant portion of the board of another entity (entity B), entity A will prima facie be considered to exert control or significant influence over entity B. maturity or maturity date includes a maturity date or a scheduled redemption date

mutual entity means a building society, co-operative company, credit union or other entity determined by the Reserve Bank to be a mutual entity for the purposes of this document and BPR120. mutual capital instrument means a capital instrument issued by a registered bank structured as a mutual entity that meets the criteria in subpartsection D1A5. related entity, in respect of a registered bank, means an entity– a. over which any member of the banking group (or the registered bank, in the case of solo capital) exercises control or significant influence; or b. that exercises control or significant influence over any member of the banking group (or the registered bank, in the case of solo capital); or c. over which another entity exercises control or significant influence, where that other entity also exercises control or significant influence over a member of the banking group (or the registered bank, in the case of solo capital). Guidance: This definition includes, but is not limited to, a holding company, a sister company, or subsidiary, of any member of the banking group. repay includes to repay by way of a call, acquisition, or redemption, and repayment and repaid have corresponding meanings special purpose vehicle or SPV means a single purpose non-operating entity established for the principal purpose of raising regulatory capital for the banking group third party means an entity that is not the registered bank or a member of the banking group Tier 2 capital means capital that falls within the definition given in section B3.2 total capital has the meaning given in section A2.2 written off means written off, extinguished, or discharged. A2.2 Meaning of total capital

1. Total capital is calculated as the sum of the values of the following categories of capital: a. Tier 1 capital (going-concern capital), which is the sum of– i. Common Equity Tier 1 capital (CET1 capital); and ii. Additional Tier 1 capital (AT1 capital); and b. Tier 2 capital (gone-concern capital).
2. Each of the three categories above ((a)(i), (a)(ii) and (b)) is calculated net of associated regulatory adjustments. Commented [A1]: Suggest adding this and the following definition into BPR001: Glossary. These terms have been bolded and underlined throughout to reflect this suggestion. Commented [A2]: This is one of the criteria in new subpart D1A so can be deleted.

Guidance: Requirements in this document for each of the three categories of capital include eligibility requirements that a financial instrument must meet to be included in the respective category. A2.3 Transitional recognition of capital instruments A bank may include in its regulatory capital a capital instrument that does not meet the requirements set out in this document, subject to the following conditions: a. the instrument was issued on or before 30 June 2021; and b. the instrument meets the requirements for AT1 capital or Tier 2 capital in the Reserve Bank of New Zealand document– i. Capital Adequacy Framework (Standardised Approach) (BS2A) dated November 2015 if issued by a standardised bank; or ii. Capital Adequacy Framework (Internal Models Based Approach) (BS2B) dated November 2015 if issued by an IRB bank; and c. on 30 September 2021 the bank holds a current notice of non-objection from the Reserve Bank in respect of the instrument allowing it to recognise the instrument as– i. an AT1 capital instrument (referred to in section A2.4 as a “transitional AT1 capital instrument”); or ii. a Tier 2 capital instrument (referred to in section A2.4 as a “transitional Tier 2 capital instrument”); and d. the recognition of the instrument in regulatory capital is phased out beginning on 1 January 2022, following the approach set out in section A2.4; and e. in all cases no portion of the value of the instrument can be included in regulatory capital on or after 1 July 2028. A2.4 Phasing out of transitional recognition of capital instruments

1. A bank must phase out the recognition of an instrument included in its regulatory capital under section A2.3 in accordance with this section.
2. The total value of a bank’s transitional AT1 capital instruments that it may include in total AT1 capital on any date on or after 1 October 2021 is the lesser of– a. the sum of the outstanding amounts of those instruments as at that date; and b. the cap on transitional AT1 capital instruments applying at that date, calculated by multiplying the total nominal amount of such instruments outstanding and recognised as AT1 capital on 30 September 2021 by the applicable percentage for the relevant date in accordance with Table A2.4.
3. The total value of a bank’s transitional Tier 2 capital instruments that it may include in total Tier 2 capital on any date on or after 1 October 2021 is the lesser of– a. the sum of the outstanding amounts of those instruments as at that date; and

b. the cap on transitional Tier 2 capital instruments applying at that date, calculated by multiplying the total nominal amount of such instruments outstanding and recognised as Tier 2 capital on 30 September 2021, after applying any required amortisation, by the applicable percentage for the relevant date in accordance with Table A2.4. Table A2.4 – Transitional phase-out schedule Period Percentage cap 1October 2021 to 31 December 2021 100% 1January 2022 to 31 December 2022 87.5% 1January 2023 to 31 December 2023 75% 1January 2024 to 31 December 2024 62.5% 1January 2025 to 31 December 2025 50% 1January 2026 to 31 December 2026 37.5% 1January 2027 to 31 December 2027 25% 1January 2028 to 30 June 2028 12.5% On and after 1 July 2028 0%

Part B: Categories of capital B1 Common Equity Tier 1 capital B1.1 General principles Common Equity Tier 1 capital is the highest quality of capital, and must– a. provide a permanent and unrestricted commitment of funds; and b. be freely available to absorb losses; and c. not impose any unavoidable servicing charge against earnings. B1.2 Definition of Common Equity Tier 1 capital

1. Common Equity Tier 1 capital (CET1 capital) must be calculated as the sum of the values of the components specified in subsection (2) and the regulatory adjustments specified in sections B1.3 to B1.13. Guidance: A regulatory adjustment may result in an addition to or subtraction from the total CET1 figure, as specified in each of those sections. Additional deductions from CET1 capital may be required under the corresponding deductions approach provided in Part C. Any asset that is deducted from CET1 capital should not be included in the calculation of risk-weighted assets Banks structured as mutual entities will not always be able to issue paid-up ordinary shares, such as those held by ‘ordinary’ companies (i.e. those that are not co-operative companies).
2. The components of CET1 capital are– a. paid-up ordinary shares, issued by the bank, that meet the criteria in subpart D1; and b. share premium resulting from the issue of ordinary shares included in CET1 capital; and c. retained earnings net of any appropriations such as tax payable, dividends to be paid, or transfers to other reserves; and d. accumulated other comprehensive income and other disclosed reserves– i. including, but not limited to, reserves that are created or increased by appropriations of retained earnings and unrealised gains and losses on measuring assets at fair value through other comprehensive income in accordance with NZ IFRS 9; but ii. excluding– A. reserves that are earmarked to particular assets or particular categories of banking activities; and Commented [A3]: Suggest deleting unless RBNZ is going to take a position on which types of mutual entities cannot issue 'ordinary shares'. This paragraph creates uncertainty for mutual entities that are not a co￾operative company.

B. reserves held on account of any assessed likelihood of loss; and C. revaluation reserves that may be included in Tier 2 capital under subsection B3.2(2)(d); and e. interests arising from the issue of ordinary shares to third parties (minority interests) by a fully consolidated subsidiary (calculated in accordance with subpart E1) that meet the eligibility criteria in section E1.2; and f. paid-up mutual capital instruments issued by a bank structured as a mutual entity that meet the criteria in section D1.5. B1.3 Goodwill deduction

1. Goodwill and other intangible assets, including amounts specified in subsection (2), must be deducted from CET1 capital. 2. The deduction for goodwill must include any goodwill included in the valuation of a significant investment– a. in the regulatory capital of a bank, non-bank deposit taker, or insurance entity (or overseas equivalent); and b. in the equity of another entity that is a financial institution and is outside the scope of consolidation for the capital ratio calculation.

2. The amount of goodwill to be deducted may be reduced by the value of any associated deferred tax liability that would be extinguished if the assets involved became impaired or derecognised under GAAP. 4. In subsection (2), significant investment means an investment in the ordinary shares of another entity that exceeds 10% of the issued ordinary shares of that entity. B1.4 Deferred tax asset deduction

3. Deferred tax assets must be deducted from CET1 capital, subject to netting against deferred tax liabilities, as provided for in subsections (2) and (3).

4. The value of the deferred tax asset deduction may be reduced by the value of deferred tax liabilities, but only if the deferred tax assets and liabilities to be netted meet all of the following criteria: a. the deferred tax assets and liabilities arise as a result of deductible temporary differences (as defined by NZ IAS 12); and b. the deferred tax assets and liabilities do not arise from the carry forward of unused tax losses or tax credits; and c. the deferred tax assets and liabilities relate to taxes levied by the New Zealand Inland Revenue; and d. the deferred tax assets and liabilities netted may be offset under NZ IAS 12. Commented [A4]: This is covered by the definition of mutual capital instruments, so can be deleted.

5. The value of deferred tax liabilities that is netted may not exceed the value of deferred tax assets, which, to avoid doubt, means that any excess of deferred tax liabilities over assets cannot be added to CET1 capital. B1.5 Deductions for funds management, securitisation, and insurance business The following amounts must be deducted from CET1 capital: a. a credit enhancement provided to any associated funds management or securitisation SPV in accordance with subsection A2.3(3) of BPR 160, unless the bank has chosen to consolidate the SPV or expense the amount of the credit enhancement as provided for in that section; and b. a credit enhancement provided to any member of an affiliated insurance group in accordance with subsection B2.1 of BPR 160, unless the bank has chosen to expense the amount of the credit enhancement as provided for in that section; and c. the full amount of funding provided to an affiliated insurance group in accordance with section B3.1 of BPR160 if the minimum separation requirements in that section are not met; and d. the full amount of aggregate funding provided to all affiliated insurance groups, and to all associated funds management and securitisation vehicles that are not consolidated for the purpose of the capital ratio calculation, if that amount exceeds 10% of CET1 capital, as provided for in section C1.1 of BPR160. B1.6 Connected capital lending deduction

6. Any advance of a capital nature provided to a connected person must be deducted from CET1 capital. 2. For the purpose of subsection (1), an advance of a capital nature provided to a connected person has the meaning given in the Reserve Bank document Connected Exposures Policy (BS8), in the version applying to the bank in its conditions of registration. B1.7 Fair value gains and losses to be excluded The following amounts must be excluded from CET1 capital: a. any unrealised gain or loss that has resulted from a change in the fair value of liabilities due to a change in the creditworthiness of— i. a member of the banking group, for the purpose of the group capital ratio calculation; or ii. an entity within the scope of the solo capital ratio calculation, for the purpose of that calculation; and b. any fair value gain or loss relating to a financial instrument for which a fair value cannot reliably be calculated, but, to avoid doubt, this case must not be used to add back to CET1 capital a fair value loss arising from credit impairment on a loan and recognised in retained earnings.

Guidance: Excluding such items means that gains must be deducted and losses may be added back. B1.8 Removal of cash flow hedge reserve The reserves included in CET1 capital must be adjusted to remove the amount of the cash flow hedge reserve that relates to the hedging of items that are not recorded at fair value on the balance sheet (including projected cash flows). Guidance: Any gains on hedges are to be deducted and any losses on hedges added back. B1.9 Superannuation fund assets and liabilities

1. Any asset on the balance sheet arising from a defined benefit superannuation fund must be deducted from CET1 capital in accordance with subsection (2).
2. The amount to be deducted under subsection (1) is the value of the asset net of any associated deferred tax liability that would be extinguished if the asset should become impaired or derecognised under GAAP.
3. Any liability on the balance sheet arising from a defined benefit superannuation fund must be fully recognised in the calculation of CET1 capital. Guidance: This means that CET1 capital cannot be increased through derecognising these liabilities. There is an asymmetry in the treatment of superannuation fund assets and liabilities. B1.10 Holdings of own shares
4. The value of any holding of the bank’s own ordinary shares or mutual capital instruments that meets the conditions in subsection (2) must be deducted from CET1 capital, unless the holding is eliminated through the application of GAAP.
5. The conditions referred to in subsection (1) are as follows: a. the bank owns the shares or mutual capital instruments, whether directly or indirectly, and regardless of whether they are held for trading or held for investment purposes; or b. the bank or a member of the banking group could be contractually obliged to purchase the shares or mutual capital instruments. B1.11 Unrealised loss on securities held
6. Any unrealised revaluation loss on a holding of securities that arises in the circumstances described in subsection (2) must be deducted from CET1 capital.
7. For the purpose of subsection (1), an unrealised loss arises where the book value of the securities exceeds the market value but the resulting unrealised loss has not been incorporated into the accounts, and the amount to be deducted is the full value of the difference. Commented [A5]: Inserted for clarity. Commented [A6]: Inserted for clarity.

B1.12 Deduction for under-collateralised reverse mortgages

1. A deduction from CET1 capital must be made if– a. the loan value of a reverse residential mortgage loan on the balance sheet exceeds the value of the security for the loan; and b. the security is residential property.
2. The amount of the deduction required under subsection (1) is the amount by which the loan value exceeds the security value. Guidance: This treatment is part of the standardised risk-weighting approach for residential mortgage loans set out in Subpart C3 of BPR131. B1.13 IRB bank expected losses An IRB bank must deduct from CET1 capital the amounts required by section F1.5(1) and (2) of BPR113. Guidance: These deductions arise from the amount, if any, by which expected credit losses exceed eligible credit impairment allowances on credit exposures risk-weighted using the IRB approach. [end of extract]

[Beginning of extract] Part D: Eligibility criteria for capital instruments D1 Eligibility of CET1 (ordinary shares) D1.1 Ordinary shares To be included in CET1 capital, ordinary shares must satisfy the criteria set out in sections D1.2 to D1.4 of this subpart. D1.2 General requirements An instrument classified as ordinary shares must satisfy the following criteria: a. the instrument is classified as equity under GAAP; and b. only the paid-up amount of the instrument, irrevocably received by the registered bank, is included as CET1 capital; and c. after retained earnings and other reserves, the instrument takes the first and proportionately greatest share of any losses as they occur, and individual ordinary shares must absorb losses on a going-concern basis proportionately and pari passu with each other; and Guidance: This condition is still deemed to be met if the bank has issued an instrument other than ordinary shares that has a write-off or conversion feature. d. holders of the instrument have full voting rights arising from the ownership of the shares; and Guidance: mutual entities that adopt a ‘one member, one vote’ rule and issue ordinary shares on that basis will are not, merely through the adoption of that rule, prevented from satisfying this criterionondition. e. the instrument represents the most subordinated claim in the liquidation of the bank; and f. the instrument holder is entitled to a claim on the residual assets of the bank that is proportional to its share of issued capital, after all senior claims have been repaid in liquidation; and Guidance: This means an unlimited and variable claim, not a fixed or capped claim. g. the principal amount of the instrument is perpetual, that is, the instrument has no maturity date; and Commented [A7]: Inserted to indicate that ordinary shares and mutual capital instruments are addressed in separate subparts. Commented [A8]: Deleted - a separate subpart has been inserted for the mutual capital instrument. Commented [A9]: To clarify that one vote per member qualifies as "full voting rights".

h. setting aside discretionary acquisitions permitted by section 58 of the Companies Act 1993 (if applicable), no principal is repaid outside of liquidation, that is, the shares are not redeemable; and Guidance: A building society’s right to repay funds under section 11(2) of the Building Societies Act 1965 is not considered to make building society shares “redeemable”. i. no member of the banking group does anything to create an expectation at issuance that the instrument will be repaid or cancelled, nor do the contractual terms of the instrument provide any feature that may give rise to such an expectation; and j. the paid-up amount of the instrument, or any future payments related to the instrument, is neither secured nor covered by a guarantee of any member of the banking group or a related entity, or subject to any other arrangement that legally or economically enhances the seniority of the claim. D1.3 Distribution requirements

1. For an instrument to qualify as CET1 capital, distributions on the instrument must meet the requirements in this section.

2. The amount that may be paid in distributions– a. must be paid out of distributable items, including retained earnings; and b. must not be in any way linked to the amount paid at issuance; and c. must not be subject to a contractual cap (except to the extent that the bank is unable to pay distributions that exceed the level of distributable items). A registered bank’s conditions of registration typically limit the proportion of distributable earnings that the bank may pay out if the prudential capital buffer ratio of the banking group (as defined in BPR100) is below a specified amount.

3. There must be no circumstances under which the distributions are obligatory and in all circumstances the bank is able to waive any distribution.

4. Any waived distributions must be non-cumulative, that is, they are not required to be made up by the bank at a later date.

5. Non-payment of distributions must not be an event of default of the bank or of any other member of the banking group. 6. The instrument must not have any preferential or predetermined right to distributions of capital or income, to ensure that distributions are not paid by the bank until all legal and contractual obligations have been met and payments on more senior capital instruments have been made. D1.4 Issuance requirements

6. The instrument must be issued by the bank (and not out of an SPV).

7. The instrument must not have been purchased, and the purchase must not have been funded, whether directly or indirectly, by– i. the bank; or ii. an entity over which the bank exercises control or significant influence.

8. However, nothing in subsection (2) prevents a holding company of the bank from purchasing the instrument, nor prevents the bank undertaking full recourse lending to a borrower to fund the purchase of a well-diversified portfolio that may include the capital instrument.

D1A Eligibility of CET1 (mutual capital instruments) D1A.15 Mutual capital instruments To be included in CET1 capital as a mutual capital instrument, an instrument must satisfy all the criteria set out in this subpart. D1A.2 Overview of checklist for mutual capital instruments

1. Appendix 3 sets out a checklist, which replicates the prudential requirements specified in this subpart that a mutual capital instrument must comply with to qualify as CET1 capital. 2. Section B1.3 of BPR120 requires a completed copy of the checklist to be submitted to the Reserve Bank in respect of any new mutual capital instrument that the registered bank proposes to issue and to treat as CET1 capital, in order to demonstrate compliance with all requirements of mutual capital instruments. 3. In the event of any inconsistency between the checklist in Appendix 3 and any requirement in Parts A to E of this document, the requirement in Parts A to E of this document prevails.
2. As specified in section A1.1(2), additional terms of a mutual capital instrument, not relating to the requirements listed in the checklist, will not disqualify the instrument from being treated as CET1 capital, provided that those terms do not affect the instrument’s compliance with this document. D1A.3 General requirements An instrument classified as a mutual capital instrument must satisfy the following criteria: a. the instrument must be issued by a registered bank structured as a mutual entity; b. the instrument is classified as equity under GAAP; and c. only the paid-up amount of the mutual capital instrument, irrevocably received by the registered bank, is included as CET1 capital; and d. holders of the mutual capital instrument have full voting rights arising from the ownership of the instrument; and Guidance: mutual entities that adopt a ‘one member, one vote’ rule and issue mutual capital instruments on that basis are not, merely through the adoption of that rule, prevented from satisfying this conditionwill satisfy this criterion. e. the instrument represents the most subordinated claim in the liquidation of the registered bank, but all instrument holders must have equal ranking; and Guidance: The holders’ claim must rank junior to all other liabilities, including members’ deposits, as well as any AT1 capital and Tier 2 capital instruments. The holders’ claim should rank equally with the right of members to share in surplus assets upon liquidation, according to the formulas set out in the requirements below. This is the mechanism that ensures that the mutual capital instrument has properties that are as close as possible to ordinary shares and matches subordination and proportionality requirements. Commented [A10]: New subpart for mutual capital instruments set up so that the relevant requirements can all be found in one place. Commented [A11]: Moved these provisions to their own section in line with subpart structure for AT1 and T2 instruments. Commented [A12]: The listed criteria in old D1.5 have been reordered in this section D1A.3 to align with the order of the criteria for ordinary shares. This makes it easier to compare the criteria. Provisions that have been moved are not shown in our markup unless the wording has been changed. Commented [A13]: To clarify that one vote per member qualifies as "full voting rights". Commented [A14]: Deleted for simplicity as this is dealt with by paragraph g. below.

f. in a liquidation of the registered bank, if there are surplus assets following the settlement of all senior claims, holders of the mutual capital instrument as a class and other members of the registered bank as a class are each entitled to a proportionate share of surplus assets (expressed as a percentage), following the settlement of all senior claims, where the share of surplus assets are allocated to the mutual capital instrument holders as a class, and other members as a class, is calculated according to the predetermined formula below set by the registered bank when the instrument is offered to holdersat the first issuance and then recalculated at each subsequent issuance or cancellation of mutual capital instruments (each issuance or cancellation being a determination time, represented as ; and as time period 't') and the remainder is allocated to the other members. i Surplus assets per Mutual capital instrument (MCI) ($) = Surplus assets ×MCICPt total number of MCI instruments on issue new issuance amountt + (MCICPt−1 × Total CET1 capitalt) – Cancellation Sharet MCICPt (%) = new issuance amountt + Total CET1 capitalt – Cancellation Amountt MCICPt is the proportion, expressed as a percentage, of Ttotal CET1 capital, (for clarity, without disregarding any amounts per the definition below) determined at time ‘t’ to reflect the contribution of mutual capital instrument holders to CET1 capital. MCICPt-1 is the proportion, expressed as a percentage, of Total CET1 capital (for clarity, without disregarding any amounts per the definition below) calculated at the determination time immediately preceding t. MCICP1 is the proportion, expressed as a percentage, of total CET1 capital determined at the time period ‘1’, being the time of first issuance; and Total CET1 capitalt refers to the amount of CET1 capital as at the time where surplus assets are being allocated.'t', adjusted as necessary to disregard the impact of (i) any new issuance amount as a result of any new mutual capital instruments being issued at t, (ii) any Cancellation Amount as a result of any mutual capital instruments being cancelled at 't', and (iii) any mutual capital instruments held, as a result of treasury trading, by the registered bank in its treasury function as at 't', in each case having regard to the capital requirements in the Banking Prudential Regulations and accounting standards then applicable; Cancellation Sharet is a dollar amount (which for the avoidance of doubt shall be zero if no mutual capital instruments are being cancelled at t) equal to: (N x Notionalt ) + MCICPt-1[Cancellation Amountt – (N x Notionalt)] Where: N is the number of mutual capital instruments which are being cancelled at t; and Notionalt is the deemed notional contribution of each mutual capital instrument to CET1 capital at t calculated as follows: Total CET1 capitalt x MCICPt-1 Number of mutual capital instruments outstanding immediately prior to cancellation Commented [A15]: Moved from mid paragraph for clarity. Commented [A16]: Inserted 'as a class' after each class to clarify that it is not each member that that is entitled to proportionate assets, but each class of members (ie ordinary members are still entitled to equal shares). Commented [A17]: Deleted for simplicity. This is covered in paragraph f. below. If it is included, we suggest inserting it underneath paragraph f. below. Commented [A18]: Formula updated to account for any cancellation following a discretionary acquisition by the registered bank (which is permitted below at paragraph i). Commented [A19]: Inserted. Commented [A20]: Deleted as not used. Commented [A21]: This new definition is based on the CCDS documentation and reflects that mutual capital instrument share must be recalculated at each issue or cancellation (rather than on wind-up).

Cancellation Amountt is the dollar amount by which Total CET1 capital is reduced as the result of a discretionary purchase by the registered bank of the mutual capital instruments which are cancelled at t. Surplus assets is the amount of surplus assets at the time where surplus assets are being allocated Guidance: The Cancellation Sharet, formula allocates (notionally, and for the purposes only of determining the MCICP from time to time) between mutual capital instrument holders and the other members the reduction in the registered bank's CET1 capital as a result of the purchase by the registered bank of the mutual capital instruments which are being cancelled at 't'. The Notionalt represents the deemed notional contribution of each mutual capital instrument being cancelled to the CET1 capital of the bank as at 't', and such amount will (notionally, in the context of the calculation of MCICP) be borne by the mutual capital instrument holders. If the amount of the reduction in CET1 capital per cancelled mutual capital instruments is higher or lower than such deemed notional contribution, the difference is apportioned between the mutual capital instrument holders and the other members of the registered bank proportionately by reference to the prevailing MCICP. f.g. the proportionate amountamount of surplus assets determined to be the entitlement of for the class of mutual capital instrument holders as a class (determined by multiplying surplus assets by MCICPt, ,where t is the determination time immediately prior to liquidation), in the manner described above must then be shared among the holdersmust then be shared among the holders, pro, rata, based on the number of mutual capital instruments they each hold, unless this amountthe entitlement of each mutual capital instrument holder has been limited to the amount paid in by the holders or an average principal amount per mutual capital instrument s at the time funds are paid-up and this is specified in the terms and conditions of the instrument; and Guidance: Each class of members (tThe holders of the mutual capital instruments as a class and the other members) isare allocated a share of surplus assets calculated in accordance with subsection D1A.3(f). d1.5(m). This amount is then allocated on a pro rata basis among the holders. However, the registered bank can choose to limit the amount paid to holders upon liquidation at the amount paid-up by the holders, so long as this is specified in the instrument's terms and conditions. the instrument must be structured as legal-form “equity” (as defined in section 8(2) of the Financial Markets Conduct Act 2013); and the instrument and all constituting documents must be governed by New Zealand law; and g. the instrument must be denominated in New Zealand dollars; and h. the principal amount of the instrument is perpetual, that is, like ordinary shares in a company, the instrument has no maturity date; and i. setting aside discretionary acquisitions permitted by the constitutive documents of the mutual entity and which would be permitted by section 58 of the Companies Act 1993 or the relevant incorporating legislation of the mutual entity (if applicable), no principal Commented [A22]: New definitions inserted which are required to account for any discretionary acquisition and subsequent cancellation of mutual capital instruments. These are based on definitions in the CCDS documentation. Commented [A23]: Deleted as no longer used. Commented [A24]: This is guidance that is included in the CCDS offer documents in relation to cancellation which may be a useful addition, though we do not feel strongly about including it. Commented [A25]: Included to clarify that the cap can operate to cap distributions at the exact amounts paid in by each holder or at an average principal amount per mutual capital instrument (ie can be capped at the level of individual holders' paid in capital or at the level of holders as a class then distributed proportionately). Commented [A26]: Amended to refer only to the share of mutual capital instrument holders as this is what the calculation refers to. Commented [A27]: Updated cross-reference to reflect new subpart. Commented [A28]: Deleted for simplicity - this replicates the requirement in paragraph i. If this criterion is retained, it would need to be amended otherwise it would effectively exclude credit unions and 'other mutual entities' (as they are not contemplated by the definition of equity in the FMCA). Commented [A29]: Deleted – we expect this will need to be the case, but without a reason to include it we would prefer to remove it to avoid unintended consequences. Commented [A30]: Deleted as this is not a requirement for ordinary shares and this places an unnecessary restriction on the ability of mutual registered banks – especially noting that it may be useful to raise capital in more established mutual capital markets.

is repaid outside of liquidation, that is, the mutual capital instruments are not redeemable; and Guidance: A building society’s right to repay funds under section 11(2) of the Building Societies Act 1965 is not considered to make building society shares “redeemable”. i.j. no member of the banking group does anything to create an expectation at issuance that the instrument will be repaid or cancelled, nor do the contractual terms of the instrument provide any feature that may give rise to such an expectation; and k. the paid-up amount of the instrument, or any future payments related to the instrument, is neither secured nor covered by a guarantee of any member of the banking group or a related entity, or subject to any other arrangement that legally or economically enhances the seniority of the claim; and in a liquidation of the registered bank, if there are no surplus assets, the holders of the mutual capital instrument will receive no return on their investment; and the terms and conditions of the mutual capital instrument must include the predetermined formula above; and the registered bank must not be able to alter the predetermined formula included in the terms and conditions of the instrument once the paid-up amount of the mutual capital instrument has been irrevocably received by the registered bank; and the instrument must meet all the distribution requirements set out in section D1.3; and the instrument must meet the issuance requirements set out in subsections D1.4(1) and D1.4(2); and nothing in D1.5(s) prevents the registered bank undertaking full recourse lending to a borrower to fund the purchase of a well-diversified portfolio that may include the mutual capital instrument. Guidance: The requirements in this section ensure that the mutual capital instrument is of the same quality capital as ordinary shares and therefore eligible as CET1 capital. The variations in this section, compared to the requirements for ordinary shares, are to specify the conditions that mutual capital instruments must meet in order to be recognised as CET1 capital. D1A.3 Distribution requirements

1. For an instrument to qualify as CET1 capital, distributions on the instrument must meet the requirements in this section.
2. the registered bank must have an indicative discretionary distribution policy published separately to the terms of the instrument.
3. The amount that may be paid in distributions– a. must be paid out of distributable items, including retained earnings; and Commented [A31]: Amended to be applicable to all mutual entities. Commented [A32]: Deleted as this is covered by paragraph e. above. Commented [A33]: Deleted for simplicity - this is not needed as all of these are requirements that need to be reflected in the terms and conditions. Commented [A34]: Deleted - the consequence is simply if you do it is no longer CET1. Commented [A35]: Deleted as distribution requirements set out in full below. Commented [A36]: Issuance requirements set out in full below. Commented [A37]: Delete. This is clarified by including MCI requirements in their own subpart. Commented [A38]: Distribution Requirements section copied and pasted here from ordinary share requirements rather than cross-referencing. Commented [A39]: Moved from old D1.5 to new Distribution Requirements section.

b. must not be in any way linked to the amount paid at issuance; and Guidance: This requirement does not prevent the registered bank from indicating an intended or projected return or distributions per mutual capital instrument to investors as part of the discretionary distribution policy. b.c. must not be subject to a contractual cap (except to the extent that the bank is unable to pay distributions that exceed the level of distributable items). A registered bank’s conditions of registration typically limit the proportion of distributable earnings that the bank may pay out if the prudential capital buffer ratio of the banking group (as defined in BPR100) is below a specified amount. 4. There must be no circumstances under which the distributions are obligatory and in all circumstances the bank is able to waive any distribution. 5. Any waived distributions must be non-cumulative, that is, they are not required to be made up by the bank at a later date. 6. Non-payment of distributions must not be an event of default of the bank or of any other member of the banking group. 7. The instrument must not have any preferential or predetermined right to distributions of capital or income, to ensure that distributions are not paid by the bank until all legal and contractual obligations have been met and payments on more senior capital instruments have been made. D1A.4 Issuance requirements

1. The instrument must be issued by the bank (and not out of an SPV).
2. The instrument must not have been purchased, and the purchase must not have been funded, whether directly or indirectly, by– i. the bank; or ii. an entity over which the bank exercises control or significant influence. 3. However, nothing in subsection (2) prevents the registered bank undertaking full recourse lending to a borrower to fund the purchase of a well-diversified portfolio that may include the mutual capital instrument. [end of extract] Commented [A40]: Inserted to provide clarity on what can be communicated in the distributions policy.

BPR110 1 [Beginning of extract] Appendix 3 CET1 CHECKLIST: MUTUAL CAPITAL INSTRUMENT

Purpose of this checklist The purpose of this Appendix 3, is to provide a checklist of requirements that an instrument must meet to qualify as CET1 capital. A completed copy of this checklist must be submitted to the Reserve Bank in respect of any new instrument that the bank proposes to issue and to treat as CET 1 regulatory capital (refer to [D1A.5 of BPR110]). The completed checklist must also be appended to the legal sign-off for the issue (refer to [B1.3 of BPR120]). 5 Relevant clause of BPR110 Evidence of compliance with relevant clause of BPR110, including references to the relevant clause/clauses of constituting documents Comments D1A.3.5 requirements D1A.3 (a) "the instrument must be issued by a registered bank structured as a mutual entity"

D1A.3 (b) "the instrument is classified as equity under GAAP" D1A.3 (c) "only the paid-up amount of the mutual capital instrument, irrevocably received by the registered bank, is included as CET1 capital"

D1A.3 (d) "holders of the mutual capital instrument have full voting rights arising from the ownership of the instrument" D1A.3 (e) "the instrument represents the most subordinated claim in the liquidation of the registered bank"

D1A.3 (f) "in a liquidation of the registered bank, if there are surplus assets following the settlement of all senior claims, holders of the mutual capital instrument as a class and other

BPR110 2 members of the registered bank as a class are each entitled to a proportionate share of surplus assets (expressed as a percentage), where the share of surplus assets allocated to the mutual capital instrument holders as a class, is calculated according to the predetermined formula below at the first issuance and then recalculated at each subsequent issuance or cancellation of mutual capital instruments (each issuance or cancellation being a determination time, represented as 't') and the remainder is allocated to the other members. new issuance amountt + (MCICPt−1 × Total CET1 capital t) – Cancellation Share t MCICP t (%) = new issuance amountt + Total CET1 capitalt – Cancellation Amount t MCICP t is the proportion, expressed as a percentage, of Total CET1 capital, (for clarity, without disregarding any amounts per the definition below) at time ‘t’ to reflect the contribution of mutual capital instrument holders to CET1 capital. MCICPt-1 is the proportion, expressed as a percentage, of Total CET1 capital (for clarity, without disregarding any amounts per the definition below) calculated at the determination time immediately preceding t. Total CET1 capital t refers to the amount of CET1 capital as at 't', adjusted as necessary to disregard the impact of (i) any new issuance amount as a result of any new mutual capital instruments being issued at t, (ii) any Cancellation Amount as a result of any mutual capital instruments being cancelled at 't', and (iii) any mutual capital instruments held, as a result of treasury trading, by the registered bank in its treasury function as at 't', in each case having regard to the capital requirements in the Banking Prudential Regulations and accounting standards then applicable; Cancellation Share t is a dollar amount (which for the avoidance of doubt shall be zero if no mutual capital instruments are

BPR110 3 being cancelled at t) equal to: (N x Notionalt ) + MCICPt-1[Cancellation Amountt – (N x Notional t)] Where: N is the number of mutual capital instruments which are being cancelled at t; and Notionalt is the deemed notional contribution of each mutual capital instrument to CET1 capital at t calculated as follows: Total CET1 capital t x MCICPt-1 Number of mutual capital instruments outstanding immediately prior to cancellation Cancellation Amountt is the dollar amount by which Total CET1 capital is reduced as the result of a discretionary purchase by the registered bank of the mutual capital instruments which are cancelled at t." D1A.3 (g) "the amount of surplus assets determined to be the entitlement of mutual capital instrument holders as a class (determined by multiplying surplus assets by MCICPt, ,where t is the determination time immediately prior to liquidation), must then be shared among the holders, pro rata, based on the number of mutual capital instruments they each hold, unless the entitlement of each mutual capital instrument holder has been limited to the amount paid in by the holders or an average principal amount per mutual capital instrument and this is specified in the terms and conditions of the instrument" D1A.3 (h) "the principal amount of the instrument is perpetual, that is, like ordinary shares in a company, the instrument has no maturity date"

BPR110 4 D1A.3 (i) "setting aside discretionary acquisitions permitted by the constitutive documents of the mutual entity and which would be permitted by section 58 of the Companies Act 1993 or the relevant incorporating legislation of the mutual entity, no principal is repaid outside of liquidation, that is, the mutual capital instruments are not redeemable" D1A.3 (j) "no member of the banking group does anything to create an expectation at issuance that the instrument will be repaid or cancelled, nor do the contractual terms of the instrument provide any feature that may give rise to such an expectation" D1A.3 (k) "the paid-up amount of the instrument, or any future payments related to the instrument, is neither secured nor covered by a guarantee of any member of the banking group or a related entity, or subject to any other arrangement that legally or economically enhances the seniority of the claim" D1A.4 Distribution requirements

D1A.4 (2) "the registered bank must have an indicative discretionary distribution policy published separately to the terms of the instrument" D1A.4 (3) "The amount that may be paid in distributions– (a) must be paid out of distributable items, including retained earnings; and (b) must not be in any way linked to the amount paid at issuance; and (a)(c) must not be subject to a contractual cap (except to the extent that the bank is unable to pay distributions that exceed the level of distributable items)." D1A.4 (4) "There must be no circumstances under which the

BPR110 5 distributions are obligatory and in all circumstances the bank is able to waive any distribution" D1A.4 (5) "Any waived distributions must be non-cumulative, that is, they are not required to be made up by the bank at a later date"

D1A.4 (6) "Non-payment of distributions must not be an event of default of the bank or of any other member of the banking group " D1A.4 (7) "The instrument must not have any preferential or predetermined right to distributions of capital or income, to ensure that distributions are not paid by the bank until all legal and contractual obligations have been met and payments on more senior capital instruments have been made"

D1A.5 Issuance requirements

D1A.5 (1) "The instrument must be issued by the bank (and not out of an SPV)" D1A.5 (2) "The instrument must not have been purchased, and the purchase must not have been funded, whether directly or indirectly, by– (a) the bank; or (b) an entity over which the bank exercises control or significant influence. D1A.5 (3) " However, nothing in subsection (2) prevents the registered bank undertaking full recourse lending to a borrower to fund the purchase of a well-diversified portfolio that may include the mutual capital instrument "

Additional material

BPR110 6 Confirm that there are no other features that would affect the compliance with BPR110. [end of extract]

BPR120 [Beginning of extract] BPR120 Capital Adequacy Process Requirements Exposure Draft Consultation December 2022 Purpose of document This document sets out processes that are associated with a bank’s compliance with the minimum capital adequacy requirements summarised in BPR100. These include the required legal sign-off for a bank to be able to include an instrument as eligible AT1, Tier 2 capital, or a mutual capital instrument, and the steps needed for a bank to redeem or replace an existing capital instrument. The document also sets out the Reserve Bank’s likely actions in response to a bank falling below its prudential capital buffer trigger ratio. For an IRB bank, the document sets outs requirements around accreditation and approval of changes of the bank’s IRB models. Commented [A1]: As per comments in Exposure Draft of BPR110, we suggest that this term is included in the BPR001: Glossary.

BPR120

• All of the material set out in this document forms part of the requirements of the applicable condition, except material that is expressly identified as guidance by being included in a shaded box like this. Document version history 1 July 2021 First issue date xxx 2022 Revised for the mutual capital instrument Conditions of registration The Banking (Prudential Supervision) Act 1989 (the Act) permits the Reserve Bank to impose conditions of registration (conditions) on registered banks1 . This document BPR120: Capital Definitions forms part of the requirements for the following conditions:*  A New Zealand-incorporated registered bank is normally subject to a condition prohibiting it from including the amount of an AT1, Tier 2 capital or mutual capital instrument in the calculation of its capital ratios unless it has completed the notification requirements provided in Part B of this document, and requiring it to follow the notification and process requirements in Part C of this document, in relation to existing capital instruments2 .  An IRB-accredited bank is subject to a condition requiring it to follow the process set out in Part E of this document for getting approval for a change to an existing IRB model, and requiring it to maintain a compendium of all of its IRB models. The bank’s use of an IRB model for calculating its capital ratios is dependent on it meeting these conditions3 . 1 The conditions can relate to any of the matters referred to in sections 73 to 73B, 78, and 81 of the Act. The standard conditions are contained in Appendix 1 of document BS1: Statement of Principles. 2 This condition of registration relates to the matter referred to in: section 78(1)(c) of the Act (capital in relation to the size and nature of the business). 3 This condition of registration relates to the matter referred to in: section 78(1)(c) of the Act (capital in relation to the size and nature of the business).

BPR120 BPR120: Capital Adequacy Process Requirements Part A: Introduction Part B: Issuance of AT1 and Tier 2 instruments Part C: Notifications and limitations on changes in capital Part D: Reserve Bank supervisory responses Part E: Use of internal capital models Contents Part A: Introduction A1 Capital adequacy process and information requirements A1.1 Overview of requirements Part B: Issuance of AT1 and Tier 2 instruments B1 Notification requirements for issuing AT1 and Tier 2 capital instruments B1.1 Standard condition of registration B1.2 Process and timing B1.3 Legal sign-off B1.4 Additional information: capital instrument issued in foreign currency B1.5 Additional information: intra-group issues B1.6 Additional information: capital instrument issued via SPV Part C: Notifications and limitations on changes in capital C1 Notification requirements C1.1 Notification process C1.2 Fall in CET1 capital ratio below 5.125% C1.3 Fall in CET1 capital of more than 10% over 12 months C2 Limitations on capital transactions and amendments C2.1 Application process C2.2 Capital redemptions C2.3 Purchases of own capital C2.4 Funding of own capital C2.5 Capital amendments C3 Supporting information for capital redemption C3.1 General information requirements C3.2 Additional information where instrument replaced C3.3 Additional information where instrument not replaced Part D: Reserve Bank supervisory responses D1 Capital buffer response framework D1.1 Introduction D1.2 Overview and application D1.3 Stage 1: capital restoration plan D1.4 Stage 2: review of capital restoration plan D1.5 Stage 3: recapitalisation plan D2 Loss absorbency of transitional capital instruments D2.1 Non-viability trigger events for AT1 and Tier 2 capital instruments D2.2 Circumstances warranting section 113 direction D2.3 Effect of statutory management Part E: Use of internal capital models E1 Process requirements E1.1 Application E1.2 Limitation on use of an internal model E1.3 Proposed changes to estimates and models E1.4 Content of submissions E1.5 Compendium of models

BPR120 Guidance: Non-viability trigger events are not applicable to AT1 and Tier 2 capital instruments issued on or after 1 July 2021, under the revised capital adequacy framework in force from that date. Part A: Introduction A1 Capital adequacy process and information requirements A1.1 Overview of requirements

1. This document sets out a number of process requirements around the capital adequacy of a New Zealand-incorporated registered bank, involving interactions between the bank and the Reserve Bank.
2. Part B sets out the notifications and information that the bank must provide to the Reserve Bank before it issues a new Additional Tier 1 (AT1), Tier 2 capital or mutual capital instrument for inclusion in its capital base.
3. Part C sets out the notification and approval requirements, in relation to the bank’s existing regulatory capital instruments, that the bank must meet to comply with the standard condition of registration in that respect.
4. Part D sets out– a. the actions that the Reserve Bank may take, and may require the bank to take, if the bank’s prudential capital buffer ratio falls below various levels specified in the bank’s conditions of registration; and b. the considerations governing the Reserve Bank using its powers under Section 113 of the Act to initiate a non-viability trigger event, requiring the bank to convert or write off a capital instrument.
5. Part E applies only to IRB banks, and sets out process requirements around obtaining Reserve Bank approval for revising, or introducing new, internal models for credit risk and operational risk capital requirements, and for maintaining a compendium of approved models.

BPR120 Guidance: The wording of the standard legal sign-off is designed to give the Reserve Bank assurance that an instrument complies with the AT1, Tier 2 capital or mutual capital instrument eligibility requirements, and that no additional clauses that are added to the terms and conditions of the instrument will subvert that compliance. However, the directors of a bank are responsible for ensuring that their bank’s capital instruments comply with the Reserve Bank’s capital adequacy framework for the entire period that the instrument is recognised as regulatory capital. Part B: Issuance of AT1, Tier 2 and mutual capital instruments B1 Notification requirements for issuing AT1, Tier 2 and mutual capital instruments B1.1 Standard condition of registration

1. The standard capital process conditions of registration applying to a New Zealand-incorporated bank (set out in section C1.2 of BPR 100) include a condition that the bank must not include the amount of an AT1 or Tier 2 capital instrument within its regulatory capital unless it has completed the notification requirements in this Part in respect of the instrument. There are similar requirements for banks structured as mutual entities to cover mutual capital instruments.
2. This Part sets out the notification process for issuing an AT1, Tier 2 capital or mutual capital instrument, including the documentation that the bank must submit with the notification. B1.2 Process and timing
3. A bank must notify the Reserve Bank of its intention to issue a new instrument that it intends to treat as AT1, Tier 2 capital, or a mutual capital instrument, for the purpose of calculating its capital ratios.
4. A notification under subsection (1) must be accompanied by the information in section B1.3, and by any of the additional information in sections B1.4 to B1.6 that is applicable to the instrument.
5. The notification and supporting information required under this section must be provided– a. in writing, to the bank’s Reserve Bank supervisor; and b. at least five working days before the issue date of the new instrument B1.3 Legal sign-off
6. A bank’s notification of a new AT1, Tier 2 capital or mutual capital instrument must be accompanied by legal sign-off consisting of the following documents and meeting the requirements of subsection (2): a. a signed opinion from a New Zealand law firm, using the standard wording in the template in Appendix 1; and b. a completed copy of the applicable Reserve Bank checklist provided in – i. Appendix 1 of BPR110 for an AT1 instrument; or Commented [A2]: As per comments in Exposure Draft of BPR110, we suggest including this term in BPR001: Glossary.

BPR120 ii. Appendix 2 of BPR110 for a Tier 2 capital instrument; or ii.iii. Appendix 3 of BPR110 for a mutual capital instrument; and c. a copy of the terms sheet for the instrument (if any); and d. copies of the constituting documents for the instrument that are listed in the legal sign-off; and e. if one of more of the terms of the instrument is governed by a permitted foreign law (see D3.3 in BPR110), a signed foreign law opinion, in a form acceptable to the Reserve Bank in all respects. 2.

B1.4

a. a statement of the bank’s intended accounting treatment of the instrument and any associated swaps or other associated hedging instruments; and b. forecasts of the bank’s capital ratios, on a quarterly basis over the next two years, that demonstrate the sensitivity of the value of regulatory capital to fluctuations in currency values, including– i. a reverse stress test showing how far the exchange rate has to change in value before the bank’s prudential capital buffer ratio falls below its buffer trigger ratio; and Guidance: The checklist must be completed for any new AT1, Tier 2 capital or mutual capital instrument. It is not acceptable to replace the checklist with an alternative document. Guidance: If one or more terms of the instrument are governed by a permitted foreign law, that permitted foreign law must not override (or negatively impact) the key prudential requirement terms needed to meet the criteria for inclusion in the relevant category of capital (as replicated in the checklists). As set out in (1)(e) above, the Reserve Bank will require a foreign law opinion (in a form acceptable to it in all respects) to provide this comfort. The legal opinion should cover the following matters:

• that the permitted foreign law will not override New Zealand law in relation to any terms that are governed by New Zealand law (e.g. for instruments with hybrid governing law);
• whether there are known impediments in that jurisdiction (including conflict of laws issues) that could affect the terms of the instrument operating as intended. A signed opinion required under subsection (1)(a) or (1)(e) must be provided by a law firm that, in the opinion of the Reserve Bank, has sufficient experience and expertise in the area of law to which the opinion relates. Additional information: capital instrument issued in foreign currency If a bank intends to issue a capital instrument that will be denominated in a foreign currency, the bank must provide the following additional information with the required notification:

BPR120 Guidance: A bank may issue a capital instrument (other than a mutual capital instrument) in a foreign currency, as BPR110 does not otherwise restrict the currency of issuance to NZD. Tier 2 capital instruments issued in a foreign currency must be valued for regulatory capital purposes in NZD at the spot exchange rate. Additional Tier 1 capital instruments issued in a foreign currency should be valued in NZD in line with the appropriate accounting rules for equity instruments, which generally do not require revaluation at the spot exchange rate. Note that, as set out in BPR110, mutual capital instruments must be denominated in New Zealand dollars. Guidance: For example, if the bank intends to issue a capital instrument to a holding company, it should provide information on any related funding transactions for that holding company and also funding of entities further up the ownership structure. BPR110 limits the extent to which some types of related party of a bank can purchase or fund an eligible capital issue. Guidance: Subpart E2 of BPR110 requires that the instrument issued by the SPV must be matched by an instrument with identical terms issued by the bank to the SPV. This section requires notification of that instrument, to match by the required notification of the instrument issued out of the group to third party investors. ii. a forecast of capital ratios based on expected changes in the exchange rate. B1.5 Additional information: intra-group issues If a bank intends to issue a capital instrument to a related party, it must provide information on any related transactions in respect of the ultimate source of funding for that instrument. B1.6 Additional information: capital instrument issued via SPV If a bank intends to issue a capital instrument out of an SPV to qualify as AT1 or Tier 2 capital for the banking group, the bank must, to confirm that the arrangements will meet the requirements of subpart E2 of BPR110, provide the notifications required under section B1.2 in respect of– a. the capital instrument to be issued by the SPV; and b. the required matching instrument issued by the bank to the SPV, as if that instrument was itself subject to the capital instrument notification requirements. Commented [A3]: Deleted the note in the Guidance above as this is not a requirement for ordinary shares and should be deleted (see comments on the Exposure Draft of BPR110).

BPR120 Part C: Notifications and limitations on changes in capital C1 Notification requirements C1.1 Notification process A bank that is required to give notice under this subpart must give the notice, in writing, to the bank’s Reserve Bank supervisor. C1.2 Fall in CET1 capital ratio below 5.125% A bank that has issued and still has outstanding a transitional AT1 capital instrument must notify the Reserve Bank immediately if the banking group’s Common Equity Tier 1 (CET1) capital ratio falls below 5.125%. C1.3 Fall in CET1 capital of more than 10% over 12 months

1. Subsection (2) applies where, as a result of any of the events described in that subsection (either by itself or when added to other such payments over the 12 months prior to the payment), the result is a reduction in the amount of CET1 capital to a level that is more than 10% lower than the amount of CET1 capital 12 months ago.
2. A bank must notify the Reserve Bank of any– a. dividend, except for distributions to customers of a mutual entity that the entity is contractually obliged to make; and b. purchase of ordinary shares; and c. other capital return in respect of CET1 capital.
3. A notification required under subsection (2) must be made– a. at least five working days prior to the payment taking place; or b. in the case of a series of payments, at least five working days prior to the payment that causes the 10% threshold to be exceeded. C2 Limitations on capital transactions and amendments C2.1 Application process A bank that is providing notification or seeking approval under this subpart must provide the notification to, or seek the approval from, the bank’s Reserve Bank supervisor, in writing. C2.2 Capital redemptions
4. A bank may redeem an AT1 capital instrument, or may redeem a Tier 2 capital instrument prior to maturity, only if one of the situations described in subsection (2) or (3) applies.
5. The first situation is that the bank has– a. provided the information required under subpart C3 to the Reserve Bank; and b. received the prior written approval of the Reserve Bank to make the redemption; and

BPR120 c. either– i. prior to, or concurrent with, the redemption, replaced the instrument with a paid-up capital instrument– A. of the same, or better, quality and contributing at least the same regulatory capital amount (for the purposes of the Reserve Bank capital adequacy requirements applying to the bank at the time); and B. the terms and conditions of which are sustainable for the income capacity of the banking group; or ii. if the bank does not intend to replace the instrument, demonstrated, to the Reserve Bank’s satisfaction, that, after the redemption, the banking group’s– A. capital ratios would be sufficiently above their respective minimums; and B. prudential capital buffer ratio would be sufficiently above its buffer trigger ratio. Guidance: The requirements of (2)(c)(i) mean that a replacement capital issue must have at least the same total value as the capital it replaces. An instrument will be considered to be issued concurrently with an instrument that is being repaid if it is issued on the same day that the other instrument is repaid. For subsection (2)(c)(ii) to be met, the Reserve Bank must be satisfied that the banking group will meet its minimum capital requirements and be above its buffer trigger ratio both at the point of redemption and for at least one year after that. Where a bank issues a call notice prior to redeeming the instrument, the instrument may continue to be recognised as regulatory capital until redeemed unless, on issuing the call notice, the bank becomes subject to an unconditional, unsubordinated obligation to redeem the instrument on the redemption date. The Reserve Bank will not permit the redemption of an AT1 instrument or redemption of a Tier 2 instrument prior to maturity as a result of a tax or regulatory event if it forms the view that the tax or regulatory event could reasonably have been anticipated by the bank at the time of issuance or if it forms the view that the tax or regulatory event is minor or not applicable. A tax or regulatory event will only be considered to be anticipated at the time of issuance if it relates to a potential change in law, or application or interpretation of law, for which there is a clearly defined policy intent and clear intention to implement. This would require, for example, that– (a) for legislation, the Bill has been introduced into Parliament; and (b) for any other regulatory tool, the relevant body has issued a statement of intention to implement a defined policy. 3. The second situation is that the capital instrument was issued on or before 30 June 2021 and the bank is subject to either–

BPR120 Guidance: Despite anything in this section, sections D2.8 and D3.9 of BPR110 provide that an instrument ceases to be regulatory capital from the time that the bank, or an entity over which the bank exercises control or significant influence, purchases the instrument or indirectly funds the purchase of the instrument. A bank should have systems in place to ensure any such purchases are deducted from its capital base. a. a loss absorption trigger event; or b. a non-viability trigger event. C2.3 Purchases of own capital

1. No member of a bank’s banking group may purchase an AT1 or Tier 2 capital instrument if– a. that instrument was previously issued by the banking group; and b. that purchase would result in the banking group owning a position of more than 5% of the total outstanding value of the instruments issued as AT1 and Tier 2 instruments by the banking group.
2. However, the limitation in subsection (1) does not apply if– a. the Reserve Bank has given prior approval to the transaction; or b. the transaction is– i. a redemption or payment on maturity under the terms of the contract; or ii. in relation to a capital instrument issued on or before 30 June 2021, a repurchase or redemption to give effect to a loss absorption trigger event or a non-viability trigger event.
3. Setting aside discretionary acquisitions permitted by Section 58 of the Companies Act 1993 (if applicable) no member of a bank’s banking group may purchase a mutual capital instrument if the instrument was previously issued by the banking group. C2.4 Funding of own capital
4. No member of a bank’s banking group may fund, whether directly or indirectly, the purchase of an instrument if– a. that instrument has been issued as AT1, Tier 2 capital or a mutual capital instrument for the banking group; and b. that funding would result in that banking group being the ultimate source of funds for more than 5% of the total amount of instruments issued as AT1, Tier 2 capital and mutual capital instruments by the banking group.
5. However, the limitation in subsection (1) does not apply if– a. the Reserve Bank has given prior approval to the transaction; or b. the funding is lending by the bank to a customer to fund the purchase of a diversified portfolio. Commented [A4]: Deleted – this is not a requirement for ordinary shares and is more restrictive than the requirement for AT1 or T2 capital. It should be sufficient that the registered bank cannot include mutual capital instruments held by the banking group in its capital calculations.

BPR120 C2.5 Capital amendments

1. A bank must give the Reserve Bank at least five working days prior notice of any amendment to an AT1, Tier 2 or mutual capital instrument that it treats as regulatory capital for the purpose of calculating its capital ratios.

2. The notification required by subsection (1) must be accompanied by– a. a signed opinion from a law firm, using the standard wording in the template in Appendix 2, confirming that, once the amendments are in effect, the instrument will continue to qualify as regulatory capital of the category for which it qualified before the amendments; and b. copies of the constituting documents and the amending documents for the instrument that are listed in the legal sign-off. [end of extract]

Guidance: The guidance to section C2.3 applies equally to this section.