Basel Committee Requires Non-Common Capital Instruments to Be Convertible into Common Shares

 
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Earlier today, the Basel Committee released new minimum requirements specifying that all capital instruments issued on or after January 1, 2013 must contain provisions that require them to be converted into common shares if the relevant regulator determines that the bank is no longer viable. These requirements were endorsed by the Governors and Heads of Supervision at its January 10, 2011 meeting and are in addition to the criteria detailed in the Basel III capital rules text that were published in December 2010.

All existing non-common capital instruments outstanding on January 1, 2013 will be considered instruments that no longer qualify as additional tier 1 or tier 2 capital and will be phased out in accordance with the Basel rule text released on December 16 and described in our December 2010 bulletin.

Before the end of January, Canada's Office of the Superintendent of Financial Institutions (OSFI) is expected to release additional guidance on how these minimum requirements are likely to be implemented in Canada and to provide more detail on transitional rules relating to existing non-qualifying capital instruments. As OSFI noted in its December 16 letter, this guidance is expected also to include additional clarity regarding its expectations on the right of redemption using "regulatory event" clauses (in which the instruments can be redeemed by the bank at their issue price before the expected maturity of the instrument instead of a premium, which would normally be the case for an early redemption).

Background

As noted in our May 2010 bulletin, Canadian officials have been promoting contingent capital as the best way to strengthen the banking system and mitigate the risk of taxpayer-funded bailouts in the future. In August 2010 the Basel Committee released a consultative document titled "Proposals to Ensure the Loss Absorbency of Regulatory Capital at the Point of Non-Viability" (August Proposals). That consultation document was issued for comment by October 1, 2010. The comments were almost uniformly negative and substantially similar to the concerns that Torys LLP raised in the May 28, 2010 bulletin. However, despite those concerns, the Basel Committee announced in a press release dated October 19 that it intended to finalize the draft rules by the end of the year.

The final rules are substantially similar to August Proposals. However, they contain the possibility that the new requirements will not apply if

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