Mutual ADI capital

APRA has released a consultation package on Common Equity Tier 1 capital instruments for mutually owned ADIs.

The package consists of a discussion paper and revised Prudential Standard APS 111 Capital Adequacy: Measurement of Capital (APS 111) setting out proposed revisions to the capital framework to enable mutually owned ADIs to directly issue Common Equity Tier 1 (CET1) capital instruments.

Because of their structure, mutually owned ADIs have traditionally not been able to issue ordinary shares that could qualify as CET1 capital.

For example, the criterion for ordinary shareholders to have the most subordinated, and unlimited, claim in liquidation after payment of all senior claims conflicts with the rights of members of mutually owned ADIs to a subordinated claim on residual assets.

APRA has been in discussions with the mutual ADI industry on how new capital instruments issued by mutually owned ADIs could be considered equivalent to ordinary shares in terms of quality of capital and loss absorption properties without compromising the issuing ADIs’ mutual corporate status.

APRA considers that the proposed revisions in the discussion paper will deliver improved prudential outcomes and provide efficiency and competitive benefits to mutually owned ADIs.

In APRA’s recent Unquestionably Strong Information Paper it observed:

Many standardised ADIs are more constrained in their ability to raise capital organically, relative to the four major banks. However, most of the smallest ADIs, many of whom are mutually owned, already have very high capital ratios and APRA expects that little or no increase in actual capital may be required for the vast bulk of these ADIs. Some of the larger standardised ADIs currently have capital surpluses sufficient to absorb a 50 basis points increase in capital requirements; however, others may over time, need to raise or retain additional capital to cover at least part of the 50 basis points increase, in order to restore their surplus to appropriate levels.

Limits

These proposed CET1-eligible capital instruments would share many of the same characteristics as ordinary shares and would, for example, be perpetual, subject to discretionary dividends and accounted for as equity. However, because these instruments are untested, APRA is proposing some restrictions on the amount that may be included in CET1 and, to accommodate the mutual corporate structure of issuing ADIs, proposes limits on MEI holders’ share of residual assets.

APRA proposes to also allow distributions to be determined by reference to a benchmark or index. Distributions on all mutual equity instruments (MEIs), however determined, may not exceed 50 per cent of the ADI’s net profit after tax for that annual period. There must be no circumstances under which distributions are obligatory and an ADI must retain full discretion to reduce or waive distributions where necessary. An ADI must not provide any indication that payment is guaranteed.

APRA is of the view that MEIs should not form the predominant part of a mutually owned ADI’s CET1 capital or its capital base more broadly.

APRA proposes to limit the aggregate amount of MEIs that may be included in an ADI’s CET1 capital, whether these have been created through direct issuance or as a result of conversion of AT1 or T2 instruments. APRA is proposing a limit of 15 per cent of the issuing ADI’s total CET1 capital. Any MEIs in excess of this limit could be included in the ADI’s AT1 capital.

To ensure that potential investors are appropriately informed of the nature of these instruments, APRA proposes requiring issuing ADIs to make specific disclosures to potential investors about MEIs. The issue documentation and marketing material must clearly indicate the subordinated nature of the instrument and that the MEI does not represent a deposit liability of the ADI, is not covered by the Financial Claims Scheme or guaranteed by the Australian Government and is not redeemable.

APRA proposes to retain the requirement that an ADI must obtain APRA approval prior to directly issuing MEIs or issuing AT1 or T2 instruments that convert into MEIs in loss absorption or non-viability scenarios.

APRA anticipates it will release the final revised APS 111 in late 2017 for commencement as soon as practicable thereafter.

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