Circular 16/2018 — Modifications to Circular 3/2012 (Subordinated Obligations)

(First Section) OFFICIAL GAZETTE Wednesday, November 14, 2018 BANCO DE MÉXICO CIRCULAR 16/2018 addressed to Credit Institutions and the National Financial Institution for Agricultural, Rural, Forestry and Fisheries Development, regarding Modifications to Circular 3/2012 (Subordinated Obligations). At the margin a logo that says: Bank of Mexico. CIRCULAR 16/2018 TO CREDIT INSTITUTIONS AND THE NATIONAL FINANCIAL INSTITUTION FOR AGRICULTURAL, RURAL, FORESTRY AND FISHERIES DEVELOPMENT: SUBJECT: MODIFICATIONS TO CIRCULAR 3/2012 (SUBORDINATED OBLIGATIONS) The Bank of Mexico, with the purpose of continuing to promote the sound development of the financial system, as well as the protection of the public's interests, considers it necessary to modify the general provisions that it is empowered to issue regarding the subordinated obligations issued by credit institutions, to maintain consistency with the treatment applicable to such instruments in accordance with the legal provisions and other corresponding regulatory norms, in line with the standards in this matter currently recognized by the group of banking authorities from various countries, known as the Basel Committee on Banking Supervision. For the above reason, based on Articles 28, paragraphs sixth and seventh, of the Political Constitution of the United Mexican States, 24 and 26, of the Bank of Mexico Law, 48 and 64, of the Credit Institutions Law, 22 of the Law for Transparency and Ordering of Financial Services, 4, first paragraph, 8, paragraphs fourth and seventh, 10, first paragraph, 12, first paragraph, in relation to 19 Bis, fraction V, 14 Bis, first paragraph, in relation to 17, fraction I, and 14 Bis 1, first paragraph, in relation to 25 Bis 1, fraction IV, of the Internal Regulations of the Bank of Mexico, which grant it the authority to issue provisions through the General Directorate of Operations and Payment Systems, the General Legal Directorate and the General Directorate of Affairs of the Financial System, respectively, as well as Second, fractions I, VI and X, of the Agreement on the Attachment of Administrative Units of the Bank of Mexico, has resolved to modify the index, the second paragraph of article 27, articles 28, 29, 30 and 31, and the first paragraph of article 54, as well as adding the definition of “Business Group” to article 2º, a third and fourth paragraphs to article 27, an article 31 Bis, Section IV to Chapter I of Title Two with its corresponding article 61 Bis and the Section V to Chapter I of Title Two with its corresponding article 61 Bis 1, to the “Provisions applicable to the operations of credit institutions and of the National Financial Institution for Agricultural, Rural, Forestry and Fisheries Development”, contained in Circular 3/2012, to remain in the terms following: PROVISIONS APPLICABLE TO THE OPERATIONS OF CREDIT INSTITUTIONS AND OF THE NATIONAL FINANCIAL INSTITUTION FOR AGRICULTURAL, RURAL, FORESTRY AND FISHERIES DEVELOPMENT “INDEX … TITLE TWO OPERATIONS WITH THE PUBLIC CHAPTER I PASSIVE OPERATIONS Section I Passive operations in national currency … Section E Subordinated Obligations … Article 28.- Documentation of issuance and placement …

Wednesday, November 14, 2018 OFFICIAL GAZETTE (First Section) Article 31 Bis.- Acquisition of subordinated obligations by the Issuing Institution … Section IV Passive operations in international markets Article 61 Bis.- Issuance of securities documenting unconditional payment promises Section V General Prohibitions Article 61 Bis 1.- Prohibitions on subordinated obligations and securities referred to in article 61 Bis …” Definitions Article 2º.- … … “Business Group: the set of legal entities, distinct from the financial group, that falls within the scope of article 2, fraction X, of the Securities Market Law.” … Issuance “Article 27.- … Institutions wishing to issue subordinated obligations must submit their request for authorization to the Bank of Mexico accompanied by the draft minutes of issuance, multiple title and prospectus for placement or, if applicable, information memorandum. In said request they must indicate the terms and conditions under which they intend to issue and place such securities. Additionally, regarding those subordinated obligations that the respective Institution intends to place through any mechanism other than a public offering, the Institution, for purposes of what is contemplated in article 29, fraction V, subsection b), next, must include in the aforementioned request: i) a document in which it explains the convenience of carrying out the placement through the referred mechanism, and ii) a study of transfer prices that meets the characteristics indicated in the fourth of the “Rules on operations carried out by multiple banking institutions with persons with relevant links”, issued by the Bank of Mexico through Circular 15/2012, published in the Official Gazette of the Federation on October 10 of 2012. Additionally, the issuing Institution must publish on its website accessible to the general public the referred study of transfer prices, which excludes, if applicable, that information protected by industrial or commercial secrecy or any other confidential information. The Institution will not be obligated to present and publish the study of transfer prices referred to in subsection ii) of the immediate preceding paragraph when, in the documents referred to in the first paragraph of article 28 of these Provisions, it is expressly provided that the subordinated obligations cannot be acquired by the related persons indicated in article 73 of the Credit Institutions Law.” “Documentation of issuance and placement Article 28.- The Institution intending to issue and place subordinated obligations must explicitly state in the minutes of issuance and the respective titles, as well as in the placement prospectus or, if applicable, the information memorandum, the following: I. The prohibitions and limits foreseen in articles 29 and 30 of these Provisions; II. The Issuing Institution may pay in advance or acquire on its own behalf, directly or indirectly, the subordinated obligations it has issued and placed, in the terms and subject to the conditions established for this effect in articles 31 and 31 Bis below, and

(First Section) OFFICIAL GAZETTE Wednesday, November 14, 2018 III. In terms of what is provided by the fifth paragraph of article 64 of the Credit Institutions Law, the following information: a) The subordinated obligations and their coupons will be credit titles with the same requirements and characteristics as bank bonds, except those provided in the cited article 64; b) If the subordinated obligations are not susceptible to being converted into shares or if they are of voluntary conversion or mandatory conversion into shares. In case the subordinated obligations are susceptible to being converted into shares according to this subsection or the following subsection d), the information referred to in this article must include that, in said conversion, bondholders will be subject to what is provided in articles 14, 17 and others applicable of the Credit Institutions Law and, while they do not prove before the Issuing Institution itself compliance with said articles, they cannot exercise the corporate rights corresponding to them under such shares. Likewise, if said issuer corresponds to a Development Banking Institution, the respective bondholders will additionally be subject to what is provided in the respective organic law, in relation to the form, proportions and other conditions applicable to the subscription, holding and circulation of securities representing capital; c) If the subordinated obligations, according to their order of priority, are preferential or not preferential; d) If the subordinated obligations will have no maturity or, otherwise, the term of maturity corresponding to them; e) If the returns that the subordinated obligations will grant will be documented in coupons; f) Regarding preferential subordinated obligations, in case of liquidation or judicial liquidation of the Issuing Institution, their payment will be made pro rata, without distinction of issuance dates, after covering all other debts of the Institution, but before distributing to the holders of shares or contribution certificates, if applicable, the social equity. Non-preferential subordinated obligations will be paid under the same terms indicated in this subsection, but after having paid the preferential subordinated obligations, and g) The Issuing Institution may, in the terms indicated in article 31, first paragraph, of the present Provisions, defer or cancel, totally or partially, the payment of interest or principal or convert in advance, totally or partially, the subordinated obligations, without that, in any case, these situations can be considered as an event of payment default by the respective Institution. In addition to the above, the Multiple Banking Institution intending to issue subordinated obligations must explicitly establish, in the documents indicated in the first paragraph of this article, the following: i) What is indicated in articles 121 and 122 of the Credit Institutions Law; ii) The payment of the returns that, if applicable, those subordinated obligations that integrate the non-fundamental basic capital of the Issuing Multiple Banking Institution will be subject to the condition that it can only be carried out with resources corresponding to the accumulated net profits of the institution itself, and iii) In case that: a) the amount of the subordinated obligations, in national currency or its equivalent, added to that corresponding to other subordinated obligations that, if applicable, have been issued previously and continue to be valid on the date of presentation to the Bank of Mexico of the request referred to in article 27 above, exceeds fifty percent of the fundamental capital of the Issuing Multiple Banking Institution, calculated in accordance with the “Provisions of general character applicable to credit institutions” issued by the National Banking and Securities Commission based on article 50 of the Credit Institutions Law, and b) the fundamental capital coefficient corresponding to the Issuing Multiple Banking Institution, calculated in accordance with said provisions, is less than ten percent on the same date indicated,or, on the date on which the Bank of Mexico grants the requested authorization, despite the fact that said coefficient had been equal to or higher than said percentage prior to that last date, the referred documents must include the commitment of said institution not to decrease its fundamental capital in absolute terms with respect to what it holds on the indicated date, by virtue of the payment of dividends or any other act that implies a transfer of patrimonial benefits to the related persons indicated in article 73 of the Credit Institutions Law, until such time as the subordinated obligations referred to in the mentioned documents are amortized in their entirety, or while it maintains a fundamental capital coefficient lower than ten percent. For purposes of what is provided in this subsection, patrimonial benefits shall be understood as those monetary benefits or of any other nature that, for their granting, the Issuing Multiple Banking Institution disposes of resources or assets of its capital. In the case referred to in this subsection iii), the corresponding Multiple Banking Institution must accompany its request for authorization with the financial projections that allow to determine solvency levels and its profit distribution plans for at least three fiscal years subsequent to the one in which it presents said request. For these purposes, the Indicated Multiple Banking Institution may present, instead of the referred projections, the exercise of capital sufficiency that it elaborates in accordance with the provisions applicable to the credit institutions issued by the National Banking and Securities Commission based on article 50 Bis of the Credit Institutions Law, provided that the referred exercise contains the detail of the institution's profit distribution plans.” Prohibition of acquisition “Article 29.- In no case shall the obligations issued by Institutions be acquired by: I. Financial entities of any of the types foreseen in the corresponding legal regulations when acting on their own behalf. This prohibition is exempted for the following financial entities: a) Investment funds authorized to operate with subordinated obligations as part of their investment object assets; b) Brokerage houses that acquire the obligations for their subsequent placement to the public investor; c) Insurance mutual societies and institutions and guarantee institutions, when acquiring the obligations as an investment object of their technical reserves and for fluctuations of values; d) The controlling society of the financial group to which the Issuing Institution belongs as a financial entity member, in terms of the Law to Regulate Financial Groups, and e) The respective Issuing Institutions, in the situation indicated in fraction II of the first paragraph of article 28 of these Provisions. In case of subordinated obligations issued by Multiple Banking Institutions, the exceptions indicated in subsections a), b) and c) above will not be applicable regarding investment funds in which the Institution issuing the obligations or any entity belonging to the financial group or Business Group to which it belongs has, directly or indirectly, the majority of the fixed social capital, as well as regarding financial entities of the same financial group or Business Group of which the Issuing Multiple Banking Institution forms part. Regarding subordinated obligations issued by Development Banking Institutions, the exceptions indicated in the referred subsections a), b) and c) will not be applicable regarding investment funds in which the Institution issuing the obligations has directly or indirectly the majority of the fixed social capital and of financial entities in whose capital the Issuing Development Banking Institution participates. II. Any national or foreign legal entity with respect to which the issuer is owner of securities representing its social capital with voting rights that represent more than fifty percent of the paid capital of that person, has control of the general meetings of partners or is in a position to name the majority of the members of the board of directors or equivalent body. For purposes of this fraction, control shall be understood as thus defined in the Securities Market Law. III. Pension or retirement funds for personnel, when the entity administering them is the Issuing Institution of the obligations and, regarding obligations issued by Multiple Banking Institutions, when the entity administering said funds is a member of the financial group or Business Group to which the Issuing Institution belongs. IV. Entities acting in their capacity as trustees, agents or commissionaires, regarding trusts, mandates or commissions they celebrate, when the investment is made at the discretion of the referred entity, regarding trusts, mandates or commissions in which said entity is the own Issuing Institution or some entity of the financial group or Business Group to which such Institution belongs. V. Related persons with the Issuing Institution, as defined in article 73 of the Credit Institutions Law, except in the case that the respective subordinated obligations have been placed through: a) Public offering, or b) Some mechanism other than a public offering, subject to prior authorization by the Bank of Mexico, upon request of the Issuing Institution in which it explains the convenience to carry out the referred mechanism instead of the public offering, observing what is provided in the third paragraph of article 27 above.” Limit to acquisition “Article 30.- Institutions must verify that financial entities and pension and retirement funds that can invest in subordinated obligations do not acquire, in primary placement, more than ten percent of the amount of the issuance of obligations in question. This limit will be applicable collectively to the financial entities belonging to the same financial group or Business Group, as well as to subsidiaries of financial entities, including the entities themselves that do not form part of a financial group or Business Group.” Payment of interest and principal “Article 31.- The Issuing Institution may, subject to the terms and conditions and under the situations that the National Banking and Securities Commission expressly establishes in the provisions referred to in article 50 of the Credit Institutions Law, defer or cancel, totally or partially, the payment of interest, defer or cancel, totally or partially, the payment of principal or convert in advance, totally or partially, the subordinated obligations, without that, in any case, these situations can be considered as an event of payment default by the respective Institution. Likewise, the Issuing Institution may pay in advance, for a total or partial amount of the pending payments to be made, the obligations it has issued, provided that in the minutes of issuance, the respective titles, the placement prospectus or, if applicable, the information memorandum, as well as in any other propaganda or advertising directed to the public relative to the characteristics of the issuance in question, clearly describes the terms, dates and conditions of early payment. In obligations susceptible to being converted into shares or contribution certificates, as applicable, the right of the Issuing Institution to make early payment must include the conversion of the respective titles. The Institution that complies with what is provided in the preceding paragraphs may convert in advance the obligations of mandatory conversion into shares or contribution certificates, as applicable, as well as those of voluntary conversion into such shares or contribution certificates, whose payment is made through their conversion into securities representing the capital of the Institution in question. The Institution may pay in advance the subordinated obligations provided that, in addition to complying with what is provided in the second paragraph of this article, said Institution: I. Has prior authorization from the Bank of Mexico, upon request of the Issuing Institution; II. Makes the early payment after five years have elapsed since the issuance of the subordinated obligations and applies it to all of them equally; III. Has not previously granted, recognized or generated an expectation of right of early payment, or offered its possible exercise, and IV. Complies with either subsection a) or b) below: a) Demonstrates that, once the payment is made, it will have: i) A capitalization index equal to or greater than 8 percent, plus the supplement of capital conservation that corresponds to it;

Wednesday, November 14, 2018 OFFICIAL GAZETTE (First Section)

ii) A basic capital coefficient equal to or greater than 6 percent, plus the applicable capital conservation supplement, and iii) A fundamental capital coefficient equal to or greater than 4.5 percent, plus the applicable capital conservation supplement. b) Replace the titles of the subordinated obligations with others that, at least, meet the conditions provided in this Section, without causing detriment to the financial situation of the issuing Institution.

Without prejudice to the foregoing, Issuing Institutions may provide in the documents indicated in the second paragraph of this article, the option for early payment, at any time, due to changes in fiscal treatment, or regulatory, as regards the computation of these in their net capital, provided that the Issuing Institution, at the time of issuance of said obligations, does not have knowledge that the cited change will take place. In this case, the Institution shall be subject, where appropriate, to what is established in the preceding fractions of this article.

For the purposes of what is provided in this article, the net capital, as well as the capitalization index, capital conservation supplement and capital coefficients of the aforementioned Institutions shall correspond to those calculated in terms of what is established to that effect by the National Banking and Securities Commission in the provisions referred to in article 50 of the Credit Institutions Law.”

“Acquisition of subordinated obligations by the Issuing Institution Article 31 Bis.- The Issuing Institution may only acquire on its own account, directly or indirectly, totally or partially, the subordinated obligations it has issued, subject to compliance with the following conditions:

I. The Bank of Mexico authorizes the acquisition, upon request of the Issuing Institution; II. The acquisition is offered and carried out on the same terms and conditions for all obligors and aims to definitively extinguish the respective subordinated obligations, at the same moment of acquisition; III. The Issuing Institution has not previously granted, recognized or generated an expectation of right of acquisition, or offered its possible exercise; IV. In the event that the acquisition of the subordinated obligations is carried out during the first five years from their issuance, these shall be substituted by others issued with similar characteristics or of better loss absorption capacity of the Issuing Institution; V. In the event that the acquisition of the subordinated obligations is carried out after five years have elapsed from their issuance, the Issuing Institution shall comply with what is stated in fraction IV of the previous article 31, and VI. In the event that the Issuing Institution intends to acquire the subordinated obligations that have been offered or placed through any mechanism other than a public offering, it must first acquire at least two-thirds of the amount of the subordinated obligations that have been acquired by persons other than those established in article 73 of the Credit Institutions Law. In the event that the Issuing Institution acquires the subordinated obligations that were issued through a public offering, the Issuing Institution will not be obliged to comply with the mentioned acquisition percentage.

For the purposes of this Section E, of Section I, the term acquisition shall cover the exchange that the issuer carries out on its own account, whether directly or indirectly, of the subordinated obligations it has issued.”

Issuance “Article 54.- Institutions may issue subordinated obligations in Foreign Currencies with prior authorization from the Bank of Mexico in terms of what is provided in the previous article 27. To these titles, the indications in Section E, of Section I, of this Chapter I, as well as the second paragraph of fraction II of article 23 and articles 37, 38, penultimate and last paragraphs, 39, 41, first paragraph, and 42 of these Provisions shall apply. …”

“Section IV Passive operations in international markets

(First Section) OFFICIAL GAZETTE Wednesday, November 14, 2018 Issuance of titles documenting unconditional payment promises Article 61 Bis.- Institutions may only issue, under a specific foreign legislation, titles that document unconditional payment promises, denominated in national currency or Foreign Currencies, regarding which they expressly establish a payment priority on the same terms as the third paragraph of article 64 of the Credit Institutions Law, provided that they comply with the requirements established in Section E, of Section I, of this Chapter I. For the purposes of these Provisions, the titles referred to in this article shall be given the treatment of subordinated obligations.

Regarding the titles referred to in this article, Institutions must expressly establish in the issuance act, respective title and prospectus or informative brochure corresponding, that the following aspects shall be subject to Mexican legislation:

I. Payment priority in case of liquidation or judicial liquidation; II. Remission or forgiveness of principal, interest and other accessories; III. Corrective measures to which the Issuing Institution shall be subject; IV. Liquidation or judicial liquidation of the Issuing Institution; V. Dissolution of the Issuing Institution, and VI. Conditions and terms of payment.

Likewise, Institutions must include in the documents indicated in this article any other requirement that the Bank of Mexico determines in the letters or authorizations issued or granted to that effect to carry out the issuance in question.

In addition to the above, Institutions must present the legal opinion of an independent expert of recognized prestige in the jurisdiction of the legislation under which they intend to issue and place through public offering or through some mechanism other than a public offering, the titles referred to in this article, indicating that under the foreign legislation where the issuance and placement of said titles are intended, it is valid that the corresponding issuance be subject to Mexican legislation in the aspects referred to in this article.”

“Section V General prohibitions Prohibitions on subordinated obligations and titles referred to in article 61 Bis Article 61 Bis 1.- Institutions are prohibited from:

I. Issuing subordinated obligations or titles referred to in the previous article 61 Bis that increase their respective yield rates in a predetermined manner, as well as subjecting said obligations and titles to incentives for them to be paid early by the corresponding Issuing Institutions, and II. Receiving, as guarantee for obligations in their favor, those subordinated obligations or titles referred to in article 61 Bis above issued by other Institutions or controlling societies of financial groups.”

TRANSITORY PROVISIONS FIRST.- What is provided in this Circular shall enter into force the day following its publication in the Official Gazette of the Federation. SECOND.- Authorization requests that, prior to the entry into force of the provisions contained in this Circular, Institutions have presented to the Bank of Mexico to issue subordinated obligations or titles that document unconditional payment promises, denominated in national currency or Foreign Currencies, regarding which they expressly establish a payment priority on the same terms as the third paragraph of article 64 of the Credit Institutions Law, which are pending resolution, shall be evaluated by the Bank of Mexico in accordance with the provisions contained in this Circular.

Mexico City, November 9, 2018.- General Director of Operations and Payment Systems, Jaime José Cortina Morfín.- Initials.- General Legal Director, Luis Urrutia Corral.- Initials.- General Director of Financial System Affairs, Jesús Alan Elizondo Flores.- Initials. For any consultation regarding the content of this Circular, please contact the Department of Authorizations, Consultations and Legal Control, at phones (55) 5237-2308, (55) 5237-2317 or (55) 5237-2000 Ext. 3200.