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.”