Question ID:
2017_3292
Legal Act:
Regulation (EU) No 575/2013 (CRR)
Topic:
Own funds
Article:
36
Paragraph:
1
Subparagraph:
h
COM Delegated or Implementing Acts/RTS/ITS/GLs/Recommendations:
Regulation (EU) No 241/2014 - RTS for Own Funds requirements for institutions
Article/Paragraph:
15a, b, c
Disclose name of institution / entity:
Yes
Name of institution / submitter:
Autorité de contrôle prudentiel et de résolution
Country of incorporation / residence:
France
Type of submitter:
Competent authority
Subject Matter:
Commitment to buy newly issued shares and synthetic holding deduction
Question:

What would be the prudential treatment applicable to a financial instrument where a bank commits itself to buy newly issued shares of an insurance company for a given amount should certain events occur?

Background on the question:

Bank A enters in a contract with Firm B (an insurance company). The contract stipulates that, if any of the three events defined below occurs at any time within the next 3 years, Bank A is committed to buying for €10 million new shares of Firm B (conducting to a capital increase for Firm B).

The new shares are generally issued with a discount (e.g. 5%) on the average market price recorded on the trading days following the event. In such a case, Bank A has to provide the cash to Firm B within a predefined timeline (e.g. 10 days).

Event 1: Firm B incurs a technical loss above a threshold (e.g. € 1m) for a specific event (e.g. natural catastrophe).

Event 2: The loss ratio of a given line of business is higher than 120% for 2 consecutive semesters.

Event 3: The share price of Firm B falls below a given value. Bank A is not allowed to sell the financial instrument resulting from this contract to other entities.

Article 36(1)(h) CRR imposes the deduction from CET1 items of direct, indirect and synthetic holdings. Synthetic holdings are defined at art. 4(1)(126) CRR : “synthetic holding” means an investment by an institution in a financial instrument the value of which is directly linked to the value of the capital instruments issued by a financial sector entity”.

Article 46(4) CRR provides that “the amount of holdings referred to in point (h) of Article 36(1) that is equal to or less than 10 % of the Common Equity Tier 1 items of the institution after applying the provisions laid down in points (a)(i) to (iii) of paragraph 1 shall not be deducted and shall be subject to the applicable risk weights in accordance with Chapter 2 or 3 of Title II of Part Three and the requirements laid down in Title IV of Part Three, as applicable”.

Commission Delegated Regulation (EU) 2015/923 of 11 March 2015 details the rules applicable to synthetic holdings:

-       “Article 15b Synthetic holdings for the purposes of Article 36(1)(f),(h) and (i) of Regulation (EU) No 575/2013 1.The following financial products shall be considered synthetic holdings of capital instruments pursuant to points (f), (h) and (i) of Article 36(1) of Regulation (EU) No 575/2013: (a) derivative instruments that have capital instruments of a financial sector entity as their underlying or have the financial sector entity as their reference entity; (b) guarantees or credit protection provided to a third party in respect of the third party's investments in a capital instrument of a financial sector entity.”

“Article 15c Calculation of synthetic holdings for the purposes of points (f),(h) and (i) of Article 36(1) of Regulation (EU) No 575/2013 1.The amount of synthetic holdings to be deducted from Common Equity Tier 1 items as required by points (f), (h) and (i) of Article 36(1) of Regulation (EU) No 575/2013 shall be as follows: (a) for holdings in the trading book: (i) for options, the delta equivalent amount of the relevant instruments calculated in accordance with Title IV of Part III of Regulation (EU) No 575/2013; (ii) for any other synthetic holdings, the nominal or notional amount, as applicable; (b) for holdings in the non-trading book: (i) for call options, the current market value; (ii) for any other synthetic holdings, the nominal or notional amount, as applicable. 2. An institution shall deduct the synthetic holdings referred to in paragraph 1 from the date of signature of the contract between the institution and the counterparty.” 

Date of submission:
12/05/2017
Published as Final Q&A:
03/11/2017
EBA Answer:

According to Article 36(1)(g), (h) and (i) CRR, an institution shall deduct from its Common Equity Tier 1 (CET1) items certain synthetic holdings of CET1 instruments of financial sector entities. According to Article 4(1)(27) CRR, an insurance company qualifies as a financial sector entity.

Article 4(1)(126) CRR defines ‘synthetic holding’ as an investment by an institution in a financial instrument the value of which is directly linked to the value of the capital instruments issued by a financial sector entity. Article 15b(1)(a) of the Commission Delegated Regulation (EU) 2015/923 of 11 March 2015 amending Delegated Regulation (EU) No 241/2014  (DR 2015/923) further provides that derivative instruments that have capital instruments of a financial sector entity as their underlying shall be considered synthetic holdings. Article 15b(2)(c) DR 2015/923 further provides that derivative instruments shall include put options sold by the institution on a capital instrument of a financial sector entity.

Accordingly, if a bank (“Bank”) commits to purchase from a financial sector entity (“FSE”) shares of the FSE (the “Shares”) upon the occurrence of certain events agreed in the contract between the Bank and the FSE, such transaction might be regarded as a put option sold by the Bank if, according to the terms of the contract between the Bank and the FSE, the FSE has an option to sell the Shares to the Bank upon the occurrence of the relevant events. Accordingly, the transaction may be regarded as a derivative instrument that has a capital instrument of a financial sector entity as its underlying and, hence, may be treated as a synthetic holding for the purposes of Article 36(1)(g),(h) and (i) CRR.
Assuming Article 36(1)(g) CRR would not be applicable, the Bank would be required to deduct the synthetic holding from its CET1:

a)     according to Article 36(1)(i) CRR if it has a significant investment (within the meaning of Article 43 CRR) in the FSE, for an amount equal to the nominal amount, as provided for by Article 15f(1)(b)(ii) DR 2015/923, unless the conditions of Article 48(1)(b) CRR are met, of which the Bank shall risk weight the holdings at 250% in accordance with Article 48(4) CRR instead; or

b)     according to Article 36(1)(h) CRR if it does not have a significant investment in the FSE, for an amount calculated in accordance with Article 46(1) CRR taking into account for this exposure the nominal amount as provided for by Article 15f(1)(b)(ii) DR 2015/923, unless the conditions of Article 46(4) CRR are met, of which the Bank shall apply the relevant risk weights in accordance with Article 46(4) and (5) CRR instead.

Moreover, Article 15f(2) DR 2015/923 provides that an institution shall deduct these synthetic holdings from the date of signature of the contract between the institution and the counterparty. 

Status:
Final Q&A
Note to Q&A:
Update 26.03.2021: This Q&A has been reviewed in the light of the changes introduced to Regulation (EU) No 575/2013 (CRR) and continues to be relevant.
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