Are replacements of capital instruments also possible with other own funds items (e.g. retained earnings)?

Retained earnings are part of the highest quality of own fund instruments. The dotation resp. documentation of new retained earnings should be also acknowledged as replacement of own funds instruments.

Generally, having regard to the conditions set out under Article 78(1) of Regulation (EU) No 575/2013 (CRR), competent authorities may permit an institution to reduce, redeem or repurchase Common Equity Tier 1 (CET1) instruments issued by the institution in a manner that is permitted under applicable national law, as set out in Article 77(1)(a) of the CRR, to be understood as the relevant company law applicable in the jurisdiction.

Article 78(1) of the CRR sets out two alternatives conditions under which competent authorities shall grant permission for an institution to reduce, call, redeem, repay or repurchase , call or redeem own funds instruments.

Under Article 78(1)(b) of the CRR, the institution is required to demonstrate to the satisfaction of the competent authority that its own funds and eligible liabilities, following action referred to in Article 77(1) of the CRR, the reduction, repurchase, call or the redemption exceed the requirements laid down in Article 92(1) of this Regulation and in Directives and the combined buffer requirement as defined in Article 128(6) of Directive 2013/36/EU (CRD) and 2014/59/EU (BRRD) by a margin that the competent authority  may considers necessary on the basis of Article 104(3) of the CRD. In this case, no replacement of the instruments following the call or the redemption is required, but only items that are already included in own funds and eligible liabilities may be taken into account for the purpose of the demonstration by the institution envisaged under Article 78(1)(b) of the CRR.

Under Article 78(1)(a) of the CRR, the institution is required to replace the instruments or the related share premium accounts, before or at the same time as the action referred to in Article 77(1) of the CRR to be reduced, repurchased, called or redeemed with own funds instruments of equal or higher quality at terms that are sustainable for the income capacity of the institution.

The same principle applies also for the call, redemption, repayment or repurchase of AT1 or Tier 2 instruments or the related share premium accounts, including when such an action occurs during the five years following their date of issuance, where according to Article 78(4)(d) of the CRR, the competent authorities may permit such an action on the basis of the determination that it would be beneficial from a prudential point of view and justified by exceptional circumstances and provided that the institution replaces those instruments, or the related share premium accounts, before or at the same time as the action referred to in Article 77(1) of the CRR with own funds instruments of equal or higher quality at terms that are sustainable for the income capacity of the institution.

Under this condition alternative, i.e. replacing the instruments or the related share premium accounts with own funds instruments of equal or higher quality, the CRR effectively requires the institution to issue a new own funds instrument to investors before or at the same time as the action referred to in Article 77(1) CRR. Retained earnings or other CET 1, Additional Tier 1 or Tier 2 items that are documented within the own funds planning of the institution are not sufficient to meet the requirement of Article 78 (1)(a) of the CRR.

Update 26.03.2021: This Q&A has been updated in the light of the changes introduced to Regulation (EU) No 575/2013 (CRR).