01 May 2014

APRA moves closer to levelling the regulatory capital playing field for mutual ADIs

by Louise McCoach

The mutual sector has supported the changes as a welcome first step towards providing mutual ADIs with additional flexibility for capital management, but would like more changes.

On 15 April 2014, the Australian Prudential Regulation Authority (APRA) released a revised Prudential Standard APS 111 Capital Adequacy: Measurement of Capital (APS 111) and a letter to mutual ADIs announcing the change.

The new APS 111 incorporates new loss absorption criteria which allows mutually owned authorised deposit-taking institutions, namely credit unions, building societies and mutual banks (collectively, mutual ADIs) to issue Additional Tier 1 or Tier 2 Capital instruments that provide for conversion into mutual equity interests (MEIs) in the event that the loss absorption or non-viability provisions in these instruments are triggered.

MEIs that result from such a conversion will count towards Common Equity Tier 1 (CET1) Capital provided they comply with the relevant provisions of APS 111.

Reasons for amendments

Prior to Australia's implementation of the Basel III capital reforms, mutual ADIs could issue capital instruments that counted towards their regulatory capital. This all changed following the introduction of new Basel III capital standards, which came into effect in Australia on 1 January 2013.

Under the new standards, capital instruments could only be counted towards regulatory capital if, amongst other criteria, they were capable of being written off or converted into ordinary shares. As mutual ADIs cannot issue ordinary shares because of their mutual structure, the new criteria resulted in a much reduced capacity for mutual ADIs to raise regulatory capital within the new rules.

The amended APS 111 addresses this problem by allowing mutual ADIs to issue capital instruments that will be recognised as Additional Tier 1 or Tier 2 Capital provided the instruments are convertible into MEIs if certain conversion criteria is met. Moreover, on conversion, MEIs can be counted towards CET1 Capital for capital adequacy purposes.

The criteria which must be satisfied by MEIs are set out in a new Attachment K to APS 111.

Other considerations

In making these changes, APRA has liaised closely with the Australian Securities and Investments Commission (ASIC) to ensure that the requirements for the issue of MEIs are consistent with ASIC’s guidance under Regulatory Guide 147 Mutuality ― Financial Institutions and the demutualisation provisions in Part 5 of Schedule 4 to the Corporations Act 2001. Mutual ADIs will need to take into account these provisions when issuing Additional Tier 1 or Tier 2 Capital instruments and on any subsequent conversion of those instruments into MEIs.

APRA has also liaised closely with the Customer Owned Banking Association, the peak industry body for the mutual sector, to ensure that the requirements for the issue of MEIs are practical to implement, and take into account the needs of potential investors vis-à-vis existing members of mutual ADIs.

Further refinements to the capital framework

The mutual sector has supported the changes as a welcome first step towards providing mutual ADIs with additional flexibility for capital management. At the same time, it is pressing for further refinements to the capital framework which will allow mutual ADIs to directly issue CET1 instruments in the ordinary course of business, rather than only in a conversion scenario.

 

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Clayton Utz communications are intended to provide commentary and general information. They should not be relied upon as legal advice. Formal legal advice should be sought in particular transactions or on matters of interest arising from this communication. Persons listed may not be admitted in all States and Territories.