Regulatory capital instruments: update to PIN requirements for CRR firms

On 9 September 2019, the Prudential Regulation Authority (PRA) published a consultation paper (CP) in relation to proposed changes to the pre-issuance notification (PIN) regime applicable to banks, building societies and PRA UK designated investment firms, which are subject to the Capital Requirements Regulation (CRR) (CRR firms).

What is the purpose of the PIN regime?

The PIN regime seeks to enhance and maintain the quality of firms' capital resources. This is achieved by allowing the PRA to comment on the terms and conditions of proposed capital instruments prior to their issuance.

The PIN regime complements the CRR by stipulating that CRR firms must notify the PRA before issuing any capital instruments that they intend to include in capital resources or own funds. A firm must notify the PRA regardless of whether the instrument would be issued by itself, or by another member of its consolidated or sub-consolidated group.

The PIN regime ensures that:

• the PRA receives consistent information on the quality and quantity of capital resources or own funds issued and has advance notice of any proposed change in a firm's capital position
• firms conduct an appropriate assessment of capital items to satisfy themselves that they meet PRA rules and expectations regarding capital quality.

Why are changes to the PIN regime being proposed?

On 27 June 2019, the CRR II entered into force and made significant amendments to the CRR. This was to bring the CRR up to date with international prudential standards and to address evidential findings within the EU regulatory framework for financial services.

While CRR II will not apply in its entirety until 28 June 2021, amendments to Article 26(3) of the CRR took effect from 27 June 2019. As a result, the PRA proposes to update the PIN regime to address any overlaps and make improvements the PRA believe are necessary based on its experience of assessing the quality of capital instruments.

The PRA also proposes to update its Supervisory Statement (SS) 7/13 to emphasise the PRA's preference for simpler CET1 capital structures, clarify two terms introduced by CRR II, and set out its expectations of firms' senior management in relation to the quality of capital resources. Changes to AT1 and T2 instruments have also been proposed.¹

How does the PRA intend to improve the quality and governance of CET1 issuances?

The PRA has proposed the following three measures:

• Legal opinion requirement for new CET1 issuances: All applications made under Article 26(3) of the CRR should be supported by an independent legal opinion on the CET1 eligibility of the new instrument. Currently, only AT1 and T2 issuances require support from an independent legal opinion, while CET1 issuances only require a self-assessment form known as the "CET1 compliance template". Although the PRA proposes to simplify the CET1 compliance template, an independent legal opinion would now be required in addition to this. This requirement does not apply to subsequent issuances of an already approved instrument.
• Expectations on complex capital structures: SS7/13 shall be amended to clarify that firms should refrain from employing complex capital structures that complicate prudential assessment. The PRA proposes a preference for simple, vanilla share structures consisting of only one class of share that is fully subordinated to all other capital and debt, and that has full voting rights and equal rights across all shares in respect to dividends and rights in liquidation. The PRA makes clear that in the event that firms deem it necessary to employ complex capital structures, the PRA is likely to require more time to make an assessment. In this case, complex features should be highlighted at the point of notification, and firms must set out a clear rationale for their inclusion.
• Expectations on management accountability: The PRA proposes to clarify the meaning of "member of the senior management" under SS7/13. Currently, the PRA expects senior managers to confirm that capital instruments meet the relevant eligibility criteria. However, the PRA has not defined which "member of the senior management" it views as suitable. In light of the Senior Managers and Certification Regime (SMCR), the PRA proposes that 'member of the senior management' is to mean an individual approved to hold a Senior Management Function under SMCR. Such individuals must also be allocated either of the following Prescribed Responsibilities:
• responsibility for managing the allocation and maintenance of the firm's capital, funding and liquidity
• responsibility for managing the firm's financial resources (small firms only).

The PRA also proposes that:

• The relevant individual should approve and sign all PIN submissions.
• The relevant individual should inform the firm's board when the firm proposes to utilise a complex capital structure or feature, and evidencing why a simpler structure cannot be used, and that the complexity does not impact on CRR eligibility.
• The proposed capital structure should be subject to appropriate board-level review and discussion, including consideration of how to minimise complexity.
• Where the firm adopts a complex share structure, the firm's board should discuss whether it is necessary at least annually as part of its Internal Capital Adequacy Assessment Process.

What are the new notification requirements for subsequent issuances of CET1 and AT1?

The PRA has proposed the following changes:

• Subsequent issuances of CET1: CRR II amends Article 26(3) of the CRR to allow a firm to classify an instrument as CET1 where that instrument has been previously approved under the Article. This is provided that the subsequent issuance is "substantially the same as" the initial issuance, and² is notified to the PRA "sufficiently in advance" of its classification as CET1. This overlaps with the current PRA rules which permit this provided that the terms of the subsequent issuance are 'identical' to an approved CET1 instrument in the previous 12 months, and the PRA is notified no later than the day of issuance. From 10 June 2019, the PRA has offered firms a "modification by consent" as an interim solution to address this overlap. The PRA now proposes to formally amend its rules to reflect the above changes made by CRR II.
• Aligning CET1 and AT1 requirements: The PRA proposes that the updated requirements for subsequent issuances of CET1 above should also apply to subsequent issuances of AT1 instruments. This will prevent the notification regime for AT1 subsequent issuances becoming more restrictive than CET1 issuances (which present more prudential risk).
• Interpretation of CRR II terms: The terms "substantially the same" and "sufficiently in advance" introduced to Article 26(3) CRR above will be clarified to mean:

How will T2 instruments be affected?

The PRA proposes to remove the requirement for firms to notify the PRA one month in advance of issuing T2 instruments, since the prudential risk associated with T2 instruments is lower than CET1 and AT1 instruments. However, the PRA proposes to retain a post-notification requirement for T2 instruments, albeit with less required documentation, by:

• removing the requirement to submit draft versions of the terms and conditions, or a draft independent legal opinion in advance of the new issuance
• similar to CET1 and AT1 instruments above, removing the requirement for a new independent legal opinion for subsequent issuances of T2 instruments where the terms are "substantially the same", except for: issue date, maturity date, amount, currency and rate of interest.

What information does a firm need to submit when it intends to amend the terms of an existing instrument?

Currently, PIN rules do not specify the information that a firm should submit when it notifies the PRA of its intention to amend the terms of an existing instrument. The PRA now proposes to clarify the set of documentation firms must submit alongside their pre- and post-issuance notifications. This is set out in Table 2 of the CP and reflected in the proposed amendments to the PRA rules in Annex 1 of the CP.

What changes will be made to the PIN form?

The PRA proposes to amend the current CRR PIN form to improve the PRA's assessment process by requesting:

• Information on the type and quantity of instrument, the nominal value per instrument and total amount raised.
• A copy of any side agreements and group structure chart.

For subsequent issuances, the following information would also be requested:

• details of the issuance previously seen by the PRA
• confirmation as to whether the provisions of the instrument are 'substantially the same' as previous issuance(s)
• a summary of any changes made to the instruments' provisions.

When will the proposals be implemented?

The proposed implementation date for the changes is Wednesday 1 April 2020.

When are responses to the consultation required by?

The PRA invites feedback on the proposals set out in the CP. For firms wishing to comment, they must do so by Monday 9 December 2019.

Help is at hand

If you would like to discuss any of the above points, please do get in touch.

[1] Common Equity Tier 1 (CET1) capital and Additional Tier 1 (AT1) capital together constitute Tier 1 capital, the highest quality capital; Tier 2 (T2) capital comprises lower quality capital.

[2] This removes a distinction which previously existed between notification and approval and the eligibility of CET1 capital. Prior to the CRR2 amendments, pre-notification of a subsequent issuance of CET1 capital instruments (where the original instruments had been approved) was not a requirement for including the instruments as eligible capital ie a firm was able to include such instruments as eligible capital even if had not notified the PRA prior to the issuance (although a failure to notify the PRA was a rule breach, which would need to be remedied).

[3] Subsequent issuances of CET1 and AT1 instruments would therefore no longer require at least one month's advance notice.