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24 February 2009
Trying to rely on governmental support to increase a bank's Tier I ratio while keeping state influence to a minimum? Austrian credit institutions recently rediscovered the benefits of participation capital when it comes to increasing their Core Tier I ratio and enhancing their risk-bearing capacity. Inspired by the Austrian financial market stability scheme, which is intended to assist credit institutions and insurance undertakings in the looming financial crisis, institutions appear to have rediscovered this Austrian-specific instrument. Several banks have announced that they might draw on the state's assistance by issuing participation capital in order to enhance their financial status.
Originally implemented in the Austrian legal system in 1986 to help savings banks and mutual insurance undertakings to raise funds on the capital markets, participation capital takes an intermediate position between share capital and debt. In the early 1990s participation capital began to lose its appeal, subsequent to an alleged lack of international compatibility. Furthermore, other own funds instruments, particularly hybrid capital, increasingly appeared on the scene.
The renewed popularity of participation capital is mainly due to its unlimited recognition as Core Tier I capital, combined with the absence of voting rights of the participants.
Main Statutory Criteria
Pursuant to Section 23 of the Banking Act, Austrian credit institutions may include the proceeds of any such issuance in their Core Tier I capital. In order to allow recognition as Core Tier I capital and ensure loss absorbency on a going concern, dividends must be profit-related and non-cumulative.
The most important other statutory minimum criteria include perpetuality and participation in losses alongside share capital. A decrease in participation capital can be achieved only by applying capital decrease standards applicable to joint stock corporations.
Following recent amendments, the Banking Act states that the right of participation in liquidation proceeds must at least amount to the nominal amount. However, this floor should not be understood as affecting the loss absorbency of participation capital.
In addition to these regulatory requirements, the issue of participation capital under the new financial stability framework must meet the state-aid driven terms agreed at EU level.
EU State Aid Regime v Banking Supervisory Considerations
In its Communication C (2008) 8259 final of December 5 2008, the European Commission illustrated its particular views on certain recapitalization measures proposed by lawmakers under the various national financial market stability schemes. In relation to participation capital issued by Austrian banks, two main considerations appear of interest. Firstly, in a regulatory own funds environment (basically linking the quality of own funds to their maturity and degree of loss absorbency), the catalogue of incentives to redeem must run up against predominant prudential concepts at the outset. It is surprising that step-up features proposed to be applied to participation capital would significantly exceeed what is allowed for (Austrian) hybrid Tier I (which is of lesser regulatory quality),(1) thereby creating synthetic maturities (which are usually of unfavourable reputation among supervisors).
Secondly, the proposed increased nominal redemption of principal hardly seems to achieve the desired goal (taking into account the perpetual nature of participation capital). Rather, it could be expected to have the opposite effect (which would be favourable from a supervisory perspective) of encouraging institutions never to redeem.
Senior Bonds Vested with Governmental Guarantee
As it proves to be quite challenging to bring the EU state aid regime, regulatory requirements and rating and pricing considerations in the context of participation capital into line, senior bonds backed by a governmental guarantee appear to be a viable funding alternative (if the own funds situation allows it) and Austrian banks have started making use of these instruments. The Federal Ministry of Finance has published on its website a model guarantee for standalone issues and for issues under a debt issuance programme. These guarantees are intended to allow investors to apply the rating of Austria to guaranteed exposures, subject to national solvency regulation and internal models.
For further information on this topic please contact Walter Gapp or Bernhard Marschall at Schönherr Rechtsanwälte GmbH by telephone (+43 1 53 43 70) or by fax (+43 1 53 43 76100) or by email (firstname.lastname@example.org or email@example.com).
(1) See also draft Article 63a of the proposed amendment to the Capital Requirements Directive and the step-up limits presented under Item 38 of the Committee of European Banking Supervisors Proposal for a Common EU Definition of Tier I Hybrids, dated March 26 2008.
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