May an institution that intends to reclassify part of its share capital as related share premium apply for the prior permission pursuant to letter (a) of Article 78(1) CRR or should letter (b) be used?

According to Article 78(1)(a) CRR as amended by Reg. (EU) 2019/876, the competent authority shall grant permission for an institution to reduce, call, redeem, repay or repurchase Common Equity Tier 1, Additional Tier 1 or Tier 2 instruments or to reduce, distribute or reclassify related share premium accounts, where before or at the same time as any of the actions referred to in Article 77(1), the institution replaces the instruments or the related share premium accounts referred to Article 77(1) CRR (the ‘’replaced instrument’’) ‘’with own funds instruments of equal or higher quality at terms that are sustainable for the income capacity of the institution’’ (the ‘’replacing instrument’’).

Before the entering into force of Reg. (EU) 2019/876, with regard to:

• the replaced instrument: Q&A 2016_2808 had clarified that prior permission of the competent authority is needed not only if the institution reduces own funds instruments together with the related share premium, but also in case of ‘’a reduction, redemption or distribution of share premium without a simultaneous reduction, redemption, call or repurchase of the instrument to which the share premium relates’’ as ‘’the CRR establishes a very close link between the capital instruments and the share premium related to these instruments’’.

• the replacing instrument: Q&A 2013_467 had clarified that an institution applying according to Article 78(1)(a) CRR is required to replace the own funds instrument [or the related share premium accounts] with own funds instruments of equal or higher quality, by issuing a new own funds instrument to investors before or at the same time as the action referred to in Article 77(1) CRR.

After the changes introduced by Reg. (EU) 2019/876, Q&A 2016_2808 has been archived and Q&A 2013_467 has been reviewed without amending the part in which it is specified that only a newly issued own funds instrument may be used as replacing instrument.

Therefore, it is not clear whether share premium accounts may be used as replacing instrument in case of reduction of own funds instruments and thus Article 78(1)(a) CRR can be applied when an institution intends to reclassify part of share capital to a related share premium by reducing the nominal value of the own funds instrument and concurrently increasing the related share premium account.

In line with Q&A 467, Article 78(1) first subparagraph of Regulation (EU) No 575/2013 (CRR), sets out two conditions under which competent authorities shall grant permission for an institution to reduce, call, redeem, repay or repurchase own funds instruments.

Under Article 78(1)(a) oCRR, 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 with own funds instruments of equal or higher quality at terms that are sustainable for the income capacity of the institution.

Under Article 78(1)(b) 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) CRR, exceed the requirements laid down in this Regulation and in Directives 2013/36/EU (CRD) and 2014/59/EU (BRRD) by a margin that the competent authority considers necessary. In this case, no replacement of the instruments is required, but only items that are included in own funds and eligible liabilities following the reduction may be taken into account for the purpose of the demonstration by the institution envisaged under Article 78(1)(b) CRR.

Given that share premium accounts do not qualify as own funds instruments, the condition of Article 78(1)(a) CRR is not fulfilled. The described reclassification is limited to the procedure in accordance with Article 78(1)(b) CRR.