EBA issues Opinion to address possible infection risk stemming from legacy instruments

The European Banking Authority (EBA) issued today an Opinion to clarify the prudential treatment of the so-called ‘legacy instruments” in view of the end of the grandfathering period on 31 December 2021. In its Opinion, the EBA proposes policy options to address the infection risk when created by such instruments. The EBA’s recommendations aim at ensuring a high quality of capital for EU institutions and a consistent application of rules and practices across the Union.

When reviewing EU institutions’ legacy instruments and examining the clauses that led to their grandfathering, the EBA identified two main issues, which could create the so-called infection risk, i.e. the risk that other layers of own funds or eligible liabilities instruments are disqualified. The first issue relates to the flexibility of distribution payments principle, while the second one regards clauses that might contradict the eligibility criterion of subordination. Legacy instruments will need to be subject to different tests to be cascaded down into a lower category of capital or as eligible liabilities instruments without creating an infection risk.

To address the infection risk and preserve the quality of regulatory capital, the EBA, in its Opinion, envisaged two main options. Institutions can either call, redeem, repurchase or buy-back the relevant instrument or, alternatively, amend its terms and conditions. In a limited number of cases, where institutions could demonstrate to their competent authorities that neither of these two options can be pursued, and taking into account all the relevant circumstances, the EBA also considered a third and last resort option. This option would allow institutions to keep the legacy instrument in their balance sheet while it would be excluded from regulatory own funds and TLAC / MREL eligible instruments.

The EBA will monitor the situation of the legacy instruments until the end of the grandfathering period, and will place particular focus on the use of the proposed options across jurisdictions with a view to ensuring a consistent application. In addition, the EBA will consider the transposition of specific provisions of Directive 2014/59/EU into national legislation and how this might alleviate concerns about the existence of infection risk linked to subordination aspects.

Legal basis and background

The EBA issued this Opinion in accordance with Article 29(1)(a) of Regulation (EU) No 1093/2010 (the EBA Founding Regulation), as part of its tasks of building a common Union supervisory culture and consistent supervisory practices, ensuring uniform procedures and consistent approaches throughout the Union, including in the area of own funds and eligible liabilities requirements, and monitoring the quality of own funds and eligible liabilities instruments issued by institutions across the Union, in accordance with Articles 29(1), first subparagraph, of that Regulation and Article 80(1) of the Regulation (EU) No 575/2013 (the Capital Requirements Regulation or CRR).

When the CRR entered into force, grandfathering provisions were introduced. In order to ensure that institutions had sufficient time to meet the requirements set out by the new definition of own funds, certain capital instruments that, at that time, did not comply with the new definition of own funds were grandfathered for a transition period with the objective of phasing them out from own funds. The beneficial treatment provided by the CRR1 grandfathering provisions will come to an end on 31 December 2021. 

On 9 September 2019, the EBA already announced its intention to clarify the end-treatment of the legacy instruments and called institutions to engage with their respective competent authorities with regard to the magnitude and intended future treatment of their outstanding ‘legacy' instruments.