Royal Decree 771/2011 of 3 June modifying Royal Decree 216/2008 on own funds of financial entities and Royal Decree 2606/1996 on deposit guarantee funds

OFFICIAL STATE BULLETIN No. 133 Saturday, June 4, 2011 Sec. I. Page 55028 I. GENERAL PROVISIONS MINISTRY OF ECONOMY AND FINANCE 9731 Royal Decree 771/2011, of June 3, modifying Royal Decree 216/2008, of February 15, on own funds of financial entities and Royal Decree 2606/1996, of December 20, on deposit guarantee funds of credit institutions. I Prudential supervision of credit institutions and investment service companies aims to guarantee the stability of the entire Spanish financial system, avoiding the emergence of crises among the entities that make up its fabric. The recent financial crisis has highlighted the imperfections present in financial markets worldwide in the areas of financial legislation and supervision. Currently, public supervisory activity at the national level is insufficient in a context of increasingly international markets that require efficient and effective coordination among different supervisors. These arguments intensify when analyzing the situation in the European context, given the high level of integration of financial markets in the Union, where the boundaries between national markets in which financial entities carry out their activities have progressively dissipated. On the other hand, a phenomenon that was at the origin of the crisis has been the development of increasingly opaque financial instruments, such as securitization structures, the risk of which was often difficult for investors to assess. Securitization is an effective and significant instrument for the proper functioning of the financial system, given its function of risk diversification and refinancing. However, until now, there has been a serious problem of asymmetric information between the originator or sponsor, who is better informed about the characteristics of the structure intended to be securitized and the quality of the underlying assets, and the investor, who is much less informed. Furthermore, it is appropriate to strengthen the solvency of entities with requirements for higher quality capital, as well as to avoid excessive concentration of risks to limit the systemic effects of the failure of some entities on the rest of the financial system. Also in this line, new requirements regarding liquidity risk are developed, which refers to the entity's inability to meet its payment obligations at a given moment, causing the forced sale of assets and converting potential losses into realized ones. The financial crisis has shown that measures introduced so far have not sufficiently taken this risk into account. Finally, in order to prevent remuneration policies from undermining the solidity of financial entities and destabilizing the banking system through the creation of incentives for individual behaviors involving excessive risk-taking, a new regime regarding remuneration policies of financial entities is developed, with respect to categories of employees who, in the development of their functions, may have potential effects on the risk profile of the entities. For all the above, a process of reform of prudential regulations has been launched in the European Union in line with what was discussed at the G-20, in the Financial Stability Board and in consonance with the modifications to the so-called Basel Agreement that have been carried out. In this sense, Directive 2009/111/EC of the European Parliament and of the Council of September 16, 2009, amending Directives 2006/48/EC, 2006/49/EC and 2007/64/EC as regards banks affiliated to a central body, certain elements of own funds, large exposures, the supervisory regime and crisis management, which constitutes the first phase of this process, and Directive 2010/76/EU of the European Parliament and of the Council of November 24, 2010, amending Directives 2006/48/EC and 2006/49/EC as regards capital requirements for the trading book and re-securitizations and supervision of remuneration policies, were approved. With the approval of these directives, a series of fundamental reforms are addressed, including: the establishment of conditions for the admissibility of hybrid capital instruments as own funds, the improvement of cooperation between supervisors to strengthen the European Union framework on crisis management, and the determination of a series of requirements to allow exposure to securitization positions and the trading book of entities, as well as establishing regulations on remuneration policies. Through Law 2/2011, of March 4, on Sustainable Economy and, fundamentally, Law 6/2011, of April 11, modifying Law 13/1985, of May 25, on investment coefficients, own funds and information obligations of financial intermediaries, Law 24/1988, of July 28, on the Securities Market and Royal Legislative Decree 1298/1986, of June 28, on adapting current law in the matter of credit institutions to that of the European Communities, the first phase of incorporation of the two directives into our legal system has been carried out. This royal decree aims to develop that legal norm, substantially advancing the process of transposition of the two mentioned Community directives. However, it is a partial transposition insofar as the technical specification of much of the two Community norms makes it necessary to complete the transposition process in lower-ranking provisions. On the other hand, in line with the provisions being carried out in the European context regarding deposit guarantee funds, a new regime for additional contributions to these funds based on the remuneration of the deposits themselves is introduced. II The royal decree consists of a single article that modifies Royal Decree 216/2008, of February 15, on own funds of financial entities, affecting both its Title I (credit institutions) and its Title II (investment service companies), as well as some of its transitional provisions. Said article is divided into thirty-five sections, to which a repealing provision and five final provisions are added. Sections one to twenty contain provisions relating to credit institutions and aim to improve the quality of computable own funds of credit institutions; the own funds requirements for risk derived from the trading book to equate its treatment with that of the banking book; the regulatory provisions relating to the new prudential regime for securitizations introduced in Law 6/2011, of April 11; the improvements introduced in the regime of limits on large exposures; the regime of new prudential requirements for liquidity risk; the various aspects related to the supervisory activity of the Bank of Spain and its cooperation with the supervisory authorities of other Member States of the European Union and the requirements regarding the remuneration policy of credit institutions. In sections twenty-two to twenty-nine, the aforementioned provisions are collected in an equivalent manner adapted to investment service companies. The modification of Royal Decree 216/2008, of February 15, is concluded with sections thirty to thirty-five, to add an additional provision, relating to the disclosure obligations of the Bank of Spain regarding the securitization positions of entities, the modification of the second transitional provision, related to the weighting of foreign currency exposures and the addition of four new transitional provisions that introduce various transitional regimes for the new prudential requirements established in the royal decree. cve: BOE-A-2011-9731

OFFICIAL STATE BULLETIN No. 133 Saturday, June 4, 2011 Sec. I. Page 55029 Finally, the first final provision modifies Royal Decree 2606/1996, of December 20, on deposit guarantee funds of credit institutions. Its purpose is to develop, for the first time in our country and in line with the work of the European Commission on this matter, a system of contributions to the deposit guarantee funds of entities based on the risk assumed by them. Specifically, additional contributions are required from entities that excessively remunerate their deposits, both term and demand. Through this channel, a new mechanism is designed to achieve such objectives. The royal decree concludes with three other final provisions that collect, respectively, the incorporation of European Union Law, a regulatory empowerment to the Bank of Spain and the National Securities Market Commission for its development and execution, and finally, the fifth final provision sets the date of its entry into force to the day following its publication in the "Official State Bulletin". In virtue thereof, upon proposal of the Minister of Economy and Finance, in agreement with the Council of State and prior deliberation of the Council of Ministers in its meeting of June 3, 2011, I HEREBY ORDER: Single Article. Modification of Royal Decree 216/2008, of February 15, on own funds of financial entities. Royal Decree 216/2008, of February 15, on own funds of financial entities, is modified as follows: One. Paragraph a) of section 1 of Article 12 is modified, which shall read as follows: "The share capital of joint-stock companies, excluding the part thereof contemplated in the following letter f), contributions to the share capital of credit cooperatives, and the endowment fund of branches of foreign credit institutions, to the extent that they fully serve to absorb losses in normal situations and, in the event of bankruptcy or liquidation, have lower priority than all other credits; as well as the founding funds and participatory shares of savings banks, and the social fund of the Spanish Confederation of Savings Banks and the association participatory shares issued by it." Two. Paragraph i) of Article 13.1 is modified, which shall read as follows: "i) The amount of exposures in securitizations that receive a risk weighting of 1250 percent and whose amount has not been weighted in accordance with Section IV of Chapter III, and calculated in accordance with what is established therein and the amount of exposure to securitization positions of the trading book that would receive a risk weighting of 1250 percent if they were in the investment portfolio of the same credit institutions. However, these amounts shall not be deducted if they have been included in the calculation of risk-weighted exposures in accordance with what is specified in this royal decree." Three. Article 14 shall read as follows: "Article 14. Conditions for the computability of own funds.

1. For the purposes of considering them as own funds, the capital of credit cooperatives shall be composed of the contributions of partners and associates that meet the following requirements: a) Their remuneration shall be conditional upon the existence of net results or, with prior authorization from the Bank of Spain, of sufficient free reserves to satisfy it. cve: BOE-A-2011-9731

OFFICIAL STATE BULLETIN No. 133 Saturday, June 4, 2011 Sec. I. Page 55030 b) Their duration shall be indefinite. c) Their eventual reimbursement shall be subject to the conditions derived from section 4 of Article 7 of Law 13/1989, of May 26, on credit cooperatives. 2. The part of the share capital corresponding to non-voting shares and redeemable shares whose duration is not less than that provided in the following section 4 for subordinated financings, regulated in the second section of Chapter II of Title IV and in the third section of Chapter II of Title XIV of Royal Legislative Decree 1/2010, of July 2, approving the consolidated text of the Capital Companies Law, as well as any other type of shares or contributions to the capital of credit cooperatives that do not meet the conditions required in Article 12.1.a), or financial instruments that present hybrid characteristics of capital and debt, shall be distributed between the basic and complementary own funds referred to in Article 15 in accordance with the conditions and limits that the Bank of Spain shall establish taking into account their financial characteristics and, in particular, their: a) full payment; b) permanence, without prejudice to the fact that the instrument may contain an early amortization option in favor of the issuing entity, provided that such clause cannot endanger the entity's ability to continue having access to the own funds generated by the instrument in case of experiencing financial difficulties; c) capacity to absorb losses, both in the event of liquidation and without the need to proceed to it; and, d) full flexibility in the remuneration of the instrument, in cases where the entity might experience financial difficulties. In turn, preferred shares shall be subject, at all times, for the purposes of their computability as basic own funds, to the limit of 30 percent referred to in section 1.j) of the additional provision second of Law 13/1985 or to that established by the Bank of Spain in accordance with said norm. The issuance conditions of preferred shares shall not contemplate incentives for early amortization. The Bank of Spain may grant authorization at any time for the early reimbursement of instruments with or without maturity in the event that a modification occurs in the fiscal or computability regime as own funds of said instruments that was not foreseen at the date of issuance. 3. To be considered own funds, the reserves, funds and provisions referred to in Article 12.1 in paragraphs c), d) and e) must meet, to the satisfaction of the Bank of Spain, the following requirements: a) Be freely usable by the entity to cover the risks inherent to the exercise of banking activity, even before eventual losses or write-downs have been determined. b) Be reflected in the entity's accounting, having been verified their amount with a favorable report by the entity's external auditors and said verification communicated to the Bank of Spain. c) Be free of taxes or reduced by the amount of taxes that will presumably be attributed to them. 4. The subordinated financings referred to in Article 12.1.h), during the five years prior to their maturity date, will reduce their computation as own funds by 20 percent annually, until their remaining term is less than one year, at which point they will cease to be computed as such. cve: BOE-A-2011-9731

OFFICIAL STATE BULLETIN No. 133 Saturday, June 4, 2011 Sec. I. Page 55031 Subordinated financings shall not contain clauses for redemption, early reimbursement or amortization, except in the event of liquidation of the issuing entity, and without prejudice to the fact that the Bank of Spain may authorize the debtor for early reimbursement if the solvency of the entity is not affected or the cases referred to in the last paragraph of section 2 occur. The Bank of Spain may establish general conditions for this purpose, to regulate both early reimbursement and the repurchase of this type of instruments. 5. It shall be for the Bank of Spain to classify and include in the own funds of a credit institution or a group of credit institutions subject to consolidation any kind of preferred shares or preferred participations or subordinated financings, issued in accordance with the applicable regulations, issued by the entities themselves or by instrumental companies and other subsidiaries. In the exercise of the competencies mentioned in this article, the Bank of Spain will ensure in particular that the legislation of the country where the issuance of any kind of preferred shares, preferred participations or subordinated financings takes place, or the mere interposition of instrumental companies or subsidiaries, does not weaken the effectiveness of the requirements and limitations established for these instruments, nor their value as own funds of the group, and may generally limit the computability of these instruments as computable own funds of the group taking into account these circumstances, without there being any elements of discrimination. 6. In accordance with the additional provision second, section 1, paragraph c) of Law 13/1985, the payment of the remuneration of preferred shares may be replaced, if so provided in the issuance conditions, by the delivery of ordinary shares, participatory shares or contributions to the capital of credit cooperatives, of the issuing or parent entity, provided that this allows the entity to preserve its financial resources. This delivery of capital instruments shall only be admissible if: a) It results in the same economic outcome as cancellation, that is, if it does not imply a reduction in the entity's capital. It shall only be considered that it results in the same economic outcome as cancellation if the payment in kind is made with capital instruments issued for that purpose and the issuer's obligation is limited to the issuance of said instruments, but there is no commitment on its part, or on the part of any of the companies in its economic group, to find buyers for them or to assume any risks linked to the sale or value of the delivered instruments. b) The issuer has total discretion not to pay the remuneration in cash and, in addition, can cancel the delivery of the capital instruments when necessary, and especially when any of the loss absorption mechanisms referred to in paragraph i) of section 1 of the additional provision second of Law 13/1985, of May 25, are triggered. The Bank of Spain may demand the cancellation of said delivery when the financial and solvency situation of the issuing or parent credit institution, or in that of its group or consolidable sub-group or the financial markets so advise. The Bank of Spain will develop the conditions for the application of the aforementioned limitations and may specify other conditions in which such payments may be acceptable. 7. In accordance with paragraph i) of section 1 of the additional provision second of Law 13/1985, and without prejudice to what is provided in Article 70 ter of Law 24/1988, of July 28, on the Securities Market, the issuance conditions of preferred shares must establish a mechanism for the participation of their holders in the current or future losses of the issuing or dominant entity, which must be clearly stated in said conditions. cve: BOE-A-2011-9731

OFFICIAL STATE BULLETIN No. 133 Saturday, June 4, 2011 Sec. I. Page 55032 The mechanism shall take effect when any of the following circumstances occur: a) When the issuing or parent entity, or its group or consolidable sub-group, presents a basic own funds ratio, calculated in the same way as the solvency coefficient, lower than four percent. For these purposes, the Bank of Spain may establish any other solvency ratio provided it is more stringent. b) When, having a basic own funds ratio lower than six percent, the issuing or parent entity, or its group or consolidable sub-group, presents significant accounting losses. Significant losses shall be understood to exist when the accumulated losses over the last four closed quarters have reduced the entity's capital and previous reserves by one third. In the event that the mechanism is the conversion into ordinary shares, participatory shares or contributions to the capital of credit cooperatives, of the issuing or parent credit institution, it must allow for immediate conversion and have a conversion ratio that establishes a floor for the number and nominal value of shares to be delivered. When the mechanism consists of a reduction in the nominal value of the preferred shares, the losses suffered by the issuer from the moment the mechanism takes effect shall be shared between the entity's capital and reserves on the one hand and the outstanding preferred shares on the other, so that the nominal value of the latter assumes, at least, a permanent and non-recoverable reduction of 50% of that which affects, proportionally to its weight, the entire capital and reserves. The Bank of Spain may specify the conversion conditions of the preferred shares, in accordance with the criteria indicated, and the method of determining the losses and the other mentioned indicators, especially in the case of issuances guaranteed by various entities, on the basis that the aforementioned loss absorption mechanisms do not undermine eventual recapitalization processes. 8. When calculating the amount of their own funds, the Bank of Spain will require credit institutions to apply the requirements applicable to the valuation of their trading book to all their assets evaluated at fair value, and will deduct from the total of the elements of Article 12, paragraphs a), b), d) and g), less the elements of Article 13, paragraphs a) and b), the amount corresponding to any additional value adjustment that proves necessary." Four. Sections 4 and 5 of Article 15 shall read as follows: "4. In any case, the ordinary capital and reserves, individual or consolidated, net of losses, intangible assets and treasury shares, and the participations representing minority interests that are computable must exceed 50% of the basic own funds of the credit institution or the group of credit institutions subject to consolidation. 5. The Bank of Spain may authorize credit institutions and groups of credit institutions subject to consolidation to temporarily and in emergency situations compute as own funds the excess over the limits established in this article and those established by the Bank of Spain in accordance with Article 14.2." Five. A section 2 bis is added to Article 27, with the following wording cve: BOE-A-2011-9731