GFSC Guidance Note on Solvency 2: The quality of capital instruments

www.gfsc.gi GFSC Guidance Note Solvency 2: The quality of capital instruments 1 Month 2017 Version: 1 Publication Date: 13 June 2025

Gibraltar Financial Services Commission Guidance Note - Solvency 2: The quality of capital instruments 2 Contents

1. Introduction .......................................................................................................... 3
2. Liability management and capital reduction .............................................................. 3
3. Principal loss-absorbency mechanism for restricted Tier 1 instruments ........................ 3
4. Instruments intended to count towards group own funds........................................... 4

Gibraltar Financial Services Commission Guidance Note - Solvency 2: The quality of capital instruments 3

1. Introduction 1.1. This Guidance Note is relevant to insurance and reinsurance undertakings as defined in the Insurance Companies Regulations1 and insurance and reinsurance undertakings which are part of a group that will determine and classify capital instruments under the Own Funds Chapters of the Insurance Companies Regulations and the Solvency 2 Technical Standards2 . 1.2. This Guidance Note should be read alongside the Insurance Companies Regulations, the Solvency 2 Technical Standards, relevant GFSC policy materials, and relevant EU guidelines. 1.3. This Guidance Note covers the following topics: • liability management and capital reduction; • principal loss-absorbency mechanism for Tier 1 instruments subject to limitation (“restricted Tier 1”); • external restricted Tier 1 instruments which write down on trigger; and • additional considerations for instruments intended to contribute to group own funds.
2. Liability management and capital reduction 2.1. In accordance with Articles 71(1)(h), 73(1)(d), 77(1)(d) of the Solvency 2 Technical Standards, the GFSC expects that any means by which capital instruments are reduced, repaid or bought back (including share repurchases), will be subject to prior supervisory approval. The GFSC also expects firms to ensure that any relevant terms and conditions in their capital instruments include the requirement for such prior supervisory approval. 2.2. Since the economic substance of a substitution of issuer is equivalent to a redemption by the original issuer and issuance by the substituted firm, the GFSC regards issuer substitution as falling within the scope of redemption and thus subject to prior supervisory approval.
3. Principal loss-absorbency mechanism for restricted Tier 1 instruments 3.1. The GFSC recognises that firms issuing restricted Tier 1 instruments (“rT1”) will need to achieve clarity as to the manner in which a principal loss-absorbency mechanism (“PLAM”) would operate3 and expects the instrument’s terms and conditions to be sufficiently clear, for the GFSC to be confident that the mechanism works as expected and meets the requirements set out in the Solvency 2 Technical Standards. The Solvency 2 Technical Standards contain a number of high-level requirements which instruments with a PLAM will have to meet and the European Insurance and Occupational Pensions Authority (“EIOPA”) guidelines also clarified some aspects of how these requirements might apply in practice. 1 Financial Services (Insurance Companies) Regulations 2020 (Insurance Companies Regulations 2020) 2 Financial Services (Solvency 2) (Technical Standards) Regulations 2025 (Solvency 2 Technical Standards 2025) 3 Solvency 2 Technical Standards 2025, art 71(1)(e)

Gibraltar Financial Services Commission Guidance Note - Solvency 2: The quality of capital instruments 4 3.2. The GFSC considers that the minimum trigger point for an instrument with a PLAM will be that specified in Article 71(8) of the Solvency 2 Technical Standards and recognises that firms may choose a higher point or points for the mechanism to operate should they so wish. 3.3. If a trigger higher than the minimum is specified, the GFSC expects this to be sufficiently clearly defined so that the firm could identify at any point in time whether or not that trigger is met. 3.4. Once the trigger point is reached, the GFSC expects the instrument with a PLAM to achieve the write-down or conversion required by the relevant requirements set out in Article 71 of the Solvency 2 Technical Standards so that the nominal or principal amount absorbs loss. 3.5. Similarly, if firms issue several instruments with a PLAM with differing trigger points, the GFSC expects them to be mindful of the need for clarity and transparency regarding how they interact with each other, and the firm’s overall capital arrangements. 3.6. The GFSC considers that any temporary write-down mechanism needs to be considered carefully in order to ensure that the potential for any subsequent write-up does not act to hinder future recapitalisation through the raising of new ordinary share capital. The GFSC considers that the potential for eligible future profits to be used to restore the position of holders of the written-down instrument could be viewed by future potential shareholders as limiting the extent to which they might receive dividends and thus could act as a disincentive to their providing investment to recapitalise. 3.7. In addition, firms are required to demonstrate that any write-up mechanism has a basis for apportioning eligible future profits that does not undermine the loss absorbency of the instrument,4 e.g., if appropriate, by adopting a similar basis as between all Tier 1 instruments, including ordinary share capital and the reconciliation reserve. 4. Instruments intended to count towards group own funds 4.1. The GFSC recognises that many of the solvency 2-derived provisions at solo level apply with the necessary modifications for the purposes of group solvency calculations. In respect of own funds requirements, the Insurance Companies Regulations and the Solvency 2 Technical Standards requires specific additional features that will be necessary if a capital instrument is to count towards group own funds. The detail of the additional features required by the Insurance Companies Regulations and the Solvency 2 Technical Standards differs depending on which type of company in the group has issued the instrument. The GFSC will consider the inclusion, or not, of these specific features as well as assessing the availability of own group funds. 4 EIOPA Guidelines on classification of own funds, Guideline 5 para 1.33(d)

Gibraltar Financial Services Commission Guidance Note - Solvency 2: The quality of capital instruments 5 4.2. Where an insurance or reinsurance undertaking has issued the instrument, the GFSC expects that instrument to meet the features determining classification for the relevant tier at a solo level. If that same item is to count towards group own funds, then the GFSC expects that actions required in relation to the firm’s solvency capital requirement (“SCR”) and minimum capital requirement (“MCR”) at solo level will also need to be triggered by reference to the group SCR, and the minimum group SCR as proxy (since there is no group MCR) where method 1 5 applies in whole or part to the group solvency calculation. 6 The GFSC considers that compliance with relevant group features for such an instrument does not obviate the need for the item’s availability to be assessed.7 In the absence of evidence regarding availability, the GFSC expects to apply the rebuttable assumption that the item is not effectively available to cover the group SCR.8 4.3. In the case of an instrument issued by a related third-country insurance or reinsurance undertaking, the GFSC expects groups to classify the item by reference to the solo features determining classification as set out in Articles 69 to 79 of the Solvency 2 Technical Standards. Where method 1 applies in whole or part to the group solvency calculation, the GFSC also expects appropriate references to the group SCR, the local capital requirement laid down by the third-country supervisory authority and the minimum group SCR9 . 4.4. The GFSC recognises that many groups choose to issue capital instruments from the ultimate holding company, or sometimes from a subsidiary set up for the purpose of issuing capital. In such circumstances, the GFSC expects firms to consider the extent to which the instruments satisfy the solo requirements as if the issuer were an insurance undertaking subject to Article 333 of the Solvency 2 Technical Standards, with suitable adjustments to the references to SCR to group SCR, and for MCR to the minimum group SCR in relation to method 1, and to the insolvency of the issuer. 4.5. The GFSC expects all instruments classified at the group level to be free from any encumbrances and any connected arrangements which would undermine the quality of the instrument at group level. The GFSC draws firms’ attention to the fact that an instrument issued by an insurance holding company or a mixed financial holding company should be deemed to be encumbered, unless the claims relating to the instrument rank after the claims of policyholders and beneficiaries of all group companies.10 This is consistent with the detailed requirements for group capital. For example, pursuant to regulation 85(1)(b) of the Insurance Companies Regulations the GFSC expects groups to consider the development of terms 5 Solvency 2 Technical Standards 2025, art 311 6 There are two methods by which group solvency can be calculated. These are ‘Method 1’ and ‘Method 2’. Method 1 (the default method) is an accounting consolidation-based method. The alternative Method 2 is a deduction and aggregation method. See Insurance Companies Regulations 2020, regs 209, 210(1) and (2), 210A, 212(1) to (5) and 212A; Solvency 2 Technical Standards 2025, arts 335 to 337 7 Solvency 2 Technical Standards 2025, art 331(2)(b)(ii) 8 Insurance Companies Regulations 2020, reg 201(5); Solvency 2 Technical Standards 2025, art 330(3); GFSC’s Guidance Note ‘GFSC’s Approach to Insurance Group Supervision’, paras 3.12 to 3.14 9 Solvency 2 Technical Standards 2025, art 332 10 Solvency 2 Technical Standards 2025, art 333A

Gibraltar Financial Services Commission Guidance Note - Solvency 2: The quality of capital instruments 6 providing that, in the case of winding up proceedings of any firm in the group, repayment of amounts due under that instrument are refused until all obligations by that member of the group to its policyholders and beneficiaries have been met. 4.6. Holding company issues must therefore satisfactorily address the position of all group policyholders and beneficiaries. Instruments will not qualify for classification as own funds at the group level if this consideration is omitted. 4.7. In assessing the availability of own funds at group level where group solvency has been calculated on the basis of method 2, the GFSC will apply similar consideration as to whether own-fund items of related undertakings meet the solo requirements and have suitable references to the undertaking’s SCR and the group’s SCR.

www.gfsc.gi Published by: Gibraltar Financial Services Commission PO Box 940 Suite 3, Ground Floor Atlantic Suites Europort Avenue Gibraltar www.gfsc.gi © 2025 Gibraltar Financial Services Commission