GFSC Guidance Note Solvency 2: Subordinated Guarantees and the Quality of Capital for Insurers

www.gfsc.gi GFSC Guidance Note Solvency 2: Subordinated guarantees and the quality of capital for insurers 1 Month 2017 Version: 1 Publication Date: 3 October 2025

Gibraltar Financial Services Commission Guidance Note – Subordinated guarantees and the quality of 2 capital for insurers Contents

1. Introduction .......................................................................................................... 3
2. Acceptable outcomes when using subordinated guarantees in connection with capital instruments.................................................................................................................. 3
3. Situations where the quality of capital is undermined by a guarantee .......................... 4

Gibraltar Financial Services Commission Guidance Note – Subordinated guarantees and the quality of 3 capital for insurers

1. Introduction 1.1. This Guidance Note applies to all insurance firms within the scope of the Financial Services (Insurance Companies) Regulations 20201 (the ‘Insurance Companies Regulations’), including in the context of provisions relating to groups, mutuals and third-country branches. 1.2. This Guidance Note sets out the GFSC’s expectations of firms in relation to: • the use of subordinated guarantees in connection with capital instruments issued by a company, whereby the payment of coupons and repayment of principal are guaranteed by a firm (the ‘guarantor’); • how subordinated guarantees should not undermine the quality of capital held by firms to meet capital requirements (this expectation applies regardless of both the motivation for using a subordinated guarantee and the structure in which a guarantee is used); and • how the guarantor’s regulatory capital position should be reported if the liability created by the guarantee serves to undermine the guarantor’s quality of capital. 1.3. This Guidance Note relates only to structures where guarantees are being used to facilitate obtaining finance. It complements and should be read in conjunction with the Insurance Companies Regulations and the Financial Services (Solvency 2) (Technical Standards) Regulations 20252 (the ‘Solvency 2 Technical Standards’). 1.4. For guarantees outside the scope of this Guidance Note and to which firms may be party, firms should still consider whether those guarantees serve to undermine the quality of their capital and discuss these with their usual supervisory contact as appropriate.
2. Acceptable outcomes when using subordinated guarantees in connection with capital instruments 2.1. The GFSC understands that firms utilise subordinated guarantees for a variety of reasons within a variety of corporate structures (two illustrative examples are provided in Section 3 of this Guidance Note). Regardless of the reason or structure, subordinated guarantees should not serve to undermine the quality of capital held by firms to meet capital requirements. Generally, the quality of capital is undermined when firms take on additional potential liabilities that are not taken into account in, and would have to be met from, the guarantor firm’s capital resources. 2.2. Any subordinated guarantee arrangement will be assessed by the GFSC to ascertain whether it is consistent with one of the following two situations deemed acceptable by the GFSC, and whether it displays the characteristics set out in paragraph 2.3 below. 1 Financial Services (Insurance Companies) Regulations 2020 2 Financial Services (Solvency 2) (Technical Standards) Regulations 2025

Gibraltar Financial Services Commission Guidance Note – Subordinated guarantees and the quality of 4 capital for insurers Situation 1 • From the perspective of the guarantor firm, if a subordinated guarantee is called upon, the guarantee should effectively extinguish or replace an existing subordinated liability. Otherwise, the guarantee represents an additional potential liability that has not been reflected in, and would have to be met from, the guarantor’s capital resources. The subordinated guarantee should possess the same, or better, features regarding quality of capital (e.g., loss absorbency and subordination) as the subordinated liability it is replacing. Situation 2 • Where a subordinated guarantee does not extinguish or replace an existing subordinated liability, the firm should acknowledge the existence of the guarantee by disqualifying the guaranteed amount from the guarantor’s Tier 1 capital. The amount may still count towards a lower tier of capital if the terms of the subordinated guarantee meet all of the relevant criteria – in effect a relegation. Whether the relegated amount can count towards total capital resources will also depend on the provisions in the Insurance Companies Regulations and the Solvency 2 Technical Standards in relation to the eligibility and limits applicable to the classification of own funds into tiers 2.3. In either case, any capital instrument that is guaranteed should still fulfil its regulatory purpose. The subordinated guarantee should not override the loss-absorbing features of a capital instrument and investors in a capital instrument should not avoid bearing losses when it is appropriate for them to do so. 3. Situations where the quality of capital is undermined by a guarantee 3.1. Two situations where the quality of capital is undermined by a subordinated guarantee are set out below. They are designed to be illustrative of the issue which this Guidance Note addresses, but they are not the only possible examples. 3.2. The first example describes a situation where a holding company (‘HoldCo’) issues a Tier 2 capital instrument to investors. HoldCo owns an operating company (‘OpCo’) by virtue of holding 100% of its equity share capital (See Diagram A).

Gibraltar Financial Services Commission Guidance Note – Subordinated guarantees and the quality of 5 capital for insurers Diagram A: Simple structure where the quality of capital is undermined

3.3. The issuer is purely a holding company and relies on the dividends of OpCo to pay the coupons due to the holders of the Tier 2 subordinated debt instrument. Furthermore, the contract governing the debt instrument provides that OpCo will guarantee the coupon payments and principal. 3.4. The economic effect of the arrangement is that OpCo is liable for the Tier 2 debt instrument. The quality of OpCo’s capital is undermined as it has a potential liability to the investors in the capital instrument issued by HoldCo. 3.5. As such, in reporting its regulatory capital on a solo basis, OpCo should disqualify £100 million of its Tier 1 capital. The amount may still count towards a lower tier of capital if the terms of the subordinated guarantee meet all of the relevant criteria. 3.6. A more complex example is illustrated in Diagram B. The structure is broadly similar to that set out in Diagram A, but there is an additional internal Tier 2 instrument issued by OpCo to HoldCo. The coupon payments on the internal instrument could be seen to support the coupon payments on the instrument issued by HoldCo to the market.

Gibraltar Financial Services Commission Guidance Note – Subordinated guarantees and the quality of 6 capital for insurers Diagram B: Complex structure with internal instrument 3.7. In this example, it will depend on the precise contractual arrangements of the internal instrument and the subordinated guarantee as to whether two sets of liabilities can be assumed by OpCo. 3.8. Disqualification of OpCo’s Tier 1 capital is not required if, when the subordinated guarantee is called upon, the guarantee effectively extinguishes or replaces the existing subordinated liability arising from the internal Tier 2 instrument. The subordinated guarantee should possess the same, or better, features regarding quality of capital (e.g., loss absorbency and subordination) as the subordinated liability it is replacing. 3.9. The above examples are not the only ones where the situation arises. This Guidance Note applies to any arrangement where a firm has guaranteed, on a subordinated basis, a regulatory capital instrument issued by another entity.

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