CEBS publishes a consultation paper on its proposals for a common EU definition of tier1 hybrids

The Committee of European Banking Supervisors (CEBS) is publishing today a consultation paper on its proposals for a common EU definition of Tier 1 hybrids. Hybrid capital instruments may mix features of both debt and equity and can be considered as eligible as original own funds ('Tier 1') in the EEA provided that they meet certain criteria.

The objective is not to elaborate a brand new definition of eligible hybrids but to provide guidelines for a common and clear interpretation across the EU of the international standards issued by the Basel Committee for Banking Supervision in 1998 ("the Sydney Press Release"). Such standards have not yet been reflected in the EU legislation. CEBS proposals have been elaborated in response to the European Commission's letter of April 2007.

CEBS proposes that hybrid capital instruments should only be eligible as Tier 1 capital if they simultaneously meet all of the following requirements: they must be issued and fully paid up, publicly disclosed and easily understandable. They must be undated. They must also be able to absorb losses on a going concern basis, in stressed situations and in liquidation and they must allow the cancellation of payments.

CEBS believes that regulatory capital ratios should be met without undue reliance on hybrid instruments. It reaffirms that common shareholders' funds (common shares and disclosed reserves or retained earnings) are the key elements of capital.

Therefore, CEBS considers that common shareholders' funds must always cover at least and at all times 70% of the institution's required Tier 1 capital. In addition, when an institution operates above the required Tier 1 capital, CEBS proposes that common shareholders' funds must represent at least and at all times 50 % of the total Tier 1 capital after deductions.

Some CEBS members would prefer that the same 70% limit to prevail in all cases as in their view this would be more in line with the stated aim of improving the average quality of capital.

Hybrids with incentives to redeem and hybrids with Alternative Coupon Satisfaction Mechanisms cannot exceed 15% of the total Tier 1 after deductions at any time (this limit is included in the overall limit on hybrids).

With regard to Tier 1 hybrids already issued that would not comply with the above requirements, CEBS proposes that hybrids with incentives to redeem should be eligible until their first call date. All other instruments that do not meet the above requirements (including hybrids with incentives to redeem which are not callable and those which are callable but have not been redeemed) will have to be gradually reduced to zero over a period of 30 years.

CEBS has sought input from market participants and rating agencies. These proposals have already also been presented at a public hearing on 22 November 2007. A summary of the hearing is available here.

CEBS invites all interested party to examine the proposals and to send their comments to "cp17@c-ebs.org" by 22 February 2008. It would be highly appreciated if the contribution could be submitted as early as possible.

These initial proposals submitted for consultation will be subject - during the consultation period - to a focused impact assessment in order to base the final advice on solid evidence and make sure that the final proposal is such as to maintain appropriate quality of capital in the EU.