Would a convertible bond (Senior Non Preferred, Senior Preferred or Senior HoldCo) be deemed a structured note for the purpose of MREL eligible liabilities and therefore be excluded from MREL?
Some issuers may consider issuing MREL eligible liabilities in a convertible bond format to diversify their investor base. This type of bonds would be structured in compliance with Art 72b(2) and 45b(1) of BRRD (Eligible Liabilities Criteria) but would, in addition, feature a conversion option for the holder if the share price of the institution is above a certain price (upside conversion).
This conversion option would allow the holder to convert the bonds it holds into a number of shares of the same issuer. The conversion option would be exercisable by the holder at anytime during a predefined period of time and under terms that are set at issuance (e.g. fixed conversion price). From a regulatory standpoint, this conversion option – once exercised – would create CET1 capital for the issuer.
CRR Article 72a(2) lists “(l) liabilities arising from debt instruments with embedded derivatives” as being MREL excluded liabilities.
However, we note that BRRD Article 45b(2) allows for certain types of debt instruments with embedded derivatives (“structured notes”) to remain eligible for MREL if one of the two conditions below are met:
“(a) the principal amount of the liability arising from the debt instrument is known at the time of issue, is fixed or increasing, and is not affected by an embedded derivative feature, and the total amount of the liability arising from the debt instrument, including the embedded derivative, can be valued on a daily basis by reference to an active and liquid two-way market for an equivalent instrument without credit risk, in accordance with Articles 104 and 105 of Regulation (EU) No 575/2013; or
(b) the debt instrument includes a contractual term that specifies that the value of the claim in cases of the insolvency of the issuer and of the resolution of the issuer is fixed or increasing, and does not exceed the initially paid-up amount of the liability.”
It would therefore be helpful if the EBA could clarify whether a convertible bond would be considered as “debt instrument with embedded derivatives”, and if so, whether the exceptions laid out in Article 45b(2) of BRRD applies.
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