CBFA Circular CBFA_2011_03 / Own Funds Regulation

rue du Congrès 12-14 | 1000 Bruxelles t +32 2 220 53 42| f +32 2 220 54 93 | www.cbfa.be Circular CBFA_2011_03 of 27 January 2011 Own Funds Regulation Scope:
Credit institutions, investment firms, liquidation bodies and bodies assimilated to liquidation bodies, and financial companies.
Summary/Objectives:
Amendment of Circular PPB-2007-1-CPB of 8 February 2007 following the publication of the regulation of 27 July 2010 amending the regulation on own funds to transpose the technical provisions of European Directives 2009/27/EC, 2009/83/EC and 2009/111/EC.

Madam,
Sir,

In accordance with what is specified in Circular CBFA_2010_20 of 30 September 2010, the Banking, Finance and Insurance Commission has integrated into its regulation of 17 October 2006 concerning the regulation on own funds of credit institutions and investment firms the technical provisions on own funds of European Directives 2009/27/EC, 2009/83/EC and 2009/111/EC amending certain provisions of Directives 2006/48/EC and 2006/49/EC relating to the supervision of credit institutions and investment firms.

These directives substantially modify the provisions relating to the definition of own funds and large exposures.

Following this amendment to the regulation of 17 October 2006, the Banking, Finance and Insurance Commission has adapted Circular PPB-2007-1-CPB of 8 February 2007, notably to take into account the guidelines (hereinafter guidelines) published by the European Banking Supervisors Committee (hereinafter CEBS) relating to the provisions of the directives concerned.

The most significant adaptations and the reference to the guidelines published by CEBS are summarized below.

Modification under Title II: definition of own funds

1. CEBS guidelines on instruments referred to in article 57 (a) of 14 June 2010

The own funds regulation, in accordance with European Directive 2009/111/EC, provides that the following instruments are eligible without limit in own funds sensu stricto (= Core Tier 1): "Capital, in the sense of company law, provided that it has been paid up, increased by the related share premium account, that it absorbs losses fully in going concern and that it ranks below all other claims in the event of bankruptcy or liquidation".

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The CEBS guidelines of 14 June 2010 define the eligibility criteria to assess whether an instrument meets the requirements of the aforementioned directive. The guidelines use as a reference the characteristics of ordinary shares issued by public limited companies.

For companies that issue capital-representative securities with particular characteristics such as cooperative shares, the CEBS document specifies to what extent these specificities are compatible with the eligibility criteria in question.

The circular transposes the eligibility criteria defined by CEBS as a commentary on article II.1°, a). The main criteria are:

¾ The amount must be effectively paid by the shareholder. This implies, in particular, that equity financed by the establishment by means of credits granted to shareholders cannot be recognized as own funds or, in other words, that the credits in question must be deducted from own funds.

¾ Perpetuity of the instrument and total absence of possibility of repayment. In this regard, an exception is introduced for cooperative shares which may be repaid at the holder's request under certain conditions.

¾ Total flexibility of the dividend amount and absence of contractual indication regarding the dividend to be paid. In this regard, it is provided that the maximum dividend amounts (cap) to be paid on cooperative shares do not constitute an indication of the amount to be paid if this amount is defined by regulation or in the statutes.

¾ Participation in losses immediately when they arise and this proportionally among holders of Core Tier 1 instruments.

¾ The instrument must be the most subordinated in the event of liquidation. The amount that could be claimed by the holder of the instrument must not be a predetermined fixed amount but correspond to the residual net asset value.

2. CEBS guidelines on hybrid capital instruments of 10 December 2009

These guidelines clarify the eligibility criteria of the directive for so-called hybrid tier 1 instruments which may be included in own funds sensu stricto.

One of the essential elements of these guidelines concerns the notion of loss absorption which is one of the characteristics that hybrid tier 1 instruments must present in accordance with Directive 2009/111.

The guidelines specify that to meet this criterion, the instrument must present the following characteristics:

¾ There must be no firm obligation to pay a coupon or repay the principal.

¾ The instrument must provide a mechanism that allows the principal to be used to strengthen the solvency of the establishment when necessary. The mechanism should be either a conversion into ordinary shares or a definitive or temporary reduction of the outstanding amount.

When this mechanism is triggered, in substance, the instrument must begin to cover losses in the same way as ordinary shares and therefore, the investor must abandon part of its privileges (fixed coupon, priority of payment on coupons and principal,...).

¾ This mechanism must not be triggered as soon as the establishment makes a loss (the first losses being borne by shareholders with voting rights) but when the losses are such that the viability of the establishment is in peril and it cannot restore its solvency sufficiently quickly. The following events justify the use of the loss absorption mechanism:

x the amount of regulatory own funds is less than 8% of the risk-weighted volume;

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x the amount of own funds sensu stricto, excluding hybrid instruments, becomes less than 5% of the risk-weighted volume;

x the net asset value of the establishment becomes less than the threshold set by article 633 of the Companies Code;

x own funds become less than the legal minimum set by article 23 of the law of 2 March 1993 and article 66 of the law of 6 April 1995;

x the CBFA, in the context of measures taken under article 57, § 1 of the law of 22 March 1993, requests the implementation of the loss absorption mechanism to safeguard the financial situation of the establishment;

x the establishment benefits from emergency aid from public authorities without which it would no longer be viable as determined by the CBFA.

Modifications under Title VIII: operational risk

The modifications to the comments included in the circular concern essentially:

x the introduction of a new activity line (article VIII.29; Corporate items) to allocate historical loss data;

x the introduction of the CEBS guidelines on operational risk mitigation techniques of December 2009 (taking into account insurance contracts on the one hand, other risk mitigation techniques on the other hand, as elements allowing to reduce the own funds requirements relating to operational risk) (articles VIII.33-37); the CEBS guidelines in this matter have confirmed the very strict position that the CBFA had already taken in this regard in the current text;

x the introduction of references to the CEBS guidelines on the scope of operational risk and operational risk loss of September 2009 and to the CEBS guidelines on the use test for AMA institutions of September 2009, supporting certain expectations of the CBFA regarding the quality of operational risk management and risk measurement models (AMA) (articles VIII.1 and VIII.26);

x the introduction of an additional paragraph to the CBFA comments on the internal allocation of own funds for operational risk, based on the CEBS guidelines on the allocation of the AMA capital of September 2009 (article VIII.40);

x the introduction of references to the CBFA communication of 12 November 2008 regarding prudential expectations regarding the monitoring of the application of the own funds regulation for establishments that have adopted an advanced approach (in casu AMA) (article VIII.24-26).

Modification under Title X: concentration of risks

The modification to the circular aims essentially to transpose the CEBS guidelines on the revised large exposures regime of 11 December 2009.

These guidelines clarify the notion of "same counterparty" used by Directive 2009/111/EC, as well as the methods for taking into account exposures in structured products such as collective investment schemes, or securitizations, for the purpose of complying with risk concentration standards.

CEBS continues to produce guidelines, particularly on risk concentration and securitization, which will lead to subsequent modifications of Circular PPB-2007-1-CPB.

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You will find the texts of the regulation and circular for titles II, VIII and X which have been modified as well as an unofficial coordination of Circular PPB-2007-1-CPB concerning the regulation on own funds on the CBFA website (www.cbfa.be) for:

credit institutions and financial companies: Control Areas > Credit Institutions > Circulars & communications > Overview of circulars and communications > Circulars > Regulatory coefficients;

investment firms: Control Areas > Investment Firms > Circulars & communications > Stockbrokerages/Portfolio management and investment advice companies > Circulars > Regulatory coefficients;

liquidation bodies: Control Areas > Liquidation Bodies > Circulars & communications > Overview of circulars and communications > Circulars.

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

The annexes mentioned in this circular are available on the CBFA website.

Please accept, Madam, Sir, the expression of our distinguished salutations.

The President,
Jean-Paul SERVAIS

Annexes: - CBFA_2011_03-1 / TITLE II: DEFINITION OF OWN FUNDS

• CBFA_2011_03-2 / TITLE VIII: OWN FUNDS REQUIREMENT FOR OPERATIONAL RISK
• CBFA_2011_03-3 / TITLE X: CONCENTRATION OF RISKS: RISK CONCENTRATION ON A COUNTERPARTY