Public funding of failing banks in the European Union (LBF vol. 19) 2020/2.4.2.2:2.4.2.2 AT 1 capital

Public funding of failing banks in the European Union (LBF vol. 19) 2020/2.4.2.2

2.4.2.2 AT 1 capital

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AT 1 capital items consist of (a) capital instruments where the conditions laid down in Article 52(1) CRR are met; and (b) the share premium accounts related to the capital instruments referred to in point (a). Certain deductions have to be applied to all AT 1 capital items.1

Pursuant to Article 52(1) CRR a list of conditions has to be met in order for capital instruments to qualify as AT 1. Those criteria are supplemented by Delegated Regulation (EU) No 241/2014. In order for capital instruments to qualify as AT 1 instruments, they must, inter alia, be issued and paid up, rank below Tier 2 instruments in the event of insolvency of the bank and be perpetual. In addition, the provisions governing the instrument have to specify that, upon the occurrence of a trigger event, the principal amount of the capital instruments has to be written down on a permanent or temporary basis or the instruments have to be converted in CET 1 instruments.2 A trigger event occurs when the CET 1 capital ratio of the bank falls below 5.125% or a level higher than 5.125%, where determined by the bank and specified in the provisions governing the instrument. Additional trigger events may be specified in the provisions governing the instrument.3

The EBA published a third update of the report on the monitoring of AT 1 instruments of EU institutions on 20 July 2018.4 For the preparation of this report, the EBA reviewed 23 issuances, between May 2015 and December 2017, for a total amount of EUR 11.41 billion. 8 issuances were made under a conversion mechanism and 15 under a write-down mechanism. Since the publication of the first report, the EBA has reviewed in total 56 issuances of AT 1 instruments for a total amount of EUR 44.68 billion.

Preferred shares and contingent convertible securities, otherwise known as 'CoCos' may qualify as AT 1 capital instruments. CoCos are hybrid securities issued by banks as debt instruments (e.g. bonds) and automatically converted into equity shares, if a contractually pre-defined 'trigger event' occurs. Their defining characteristics are a loss-absorption mechanism (conversion or write-down) and an activation trigger, either based on a mechanical rule or on supervisors’ discretion.5 CoCos start as debt, and convert to equity only upon the occurrence of a triggering event. They can thus facilitate balance sheet repair, or the orderly resolution of a bank, without the bank having to seek to issue extra equity under stressful conditions.6 In order for a CoCo to qualify as AT 1 capital, it must, inter alia, be perpetual and include a minimum trigger level of 5.125%. If they do not meet this minimum trigger level, CoCos can qualify as Tier 2 capital.7

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