According to Q&A 408, an agreement an institution has entered into with its 100% parent entity, pursuant to which the institution must transfer its profit for the period to the parent entity (and the parent entity must cover any losses) constitutes an obligation to distribute (mandatory distribution), which is not permitted under Article 28(1)(h)(v) of the CRR. Is the case different where the institution is free to decide to set aside reserves from profits generated, according to its own commercial judgement or discretion, hence avoiding a profit transfer?
German tax and commercial law provides institutions with such extensive powers to decide on the appropriation of profits that the requirements of Article 28(1)(h)(v) of the CRR are not violated.
EBA QA 2013_408 on the eligibility of CET 1 in case of an agreement for transfer of profit and coverage of losses indicates the following: ‘Article 28(1)(h) of Regulation (EU) No. 575/2013 (CRR) sets out the conditions that must be met with respect to distributions in order to qualify as CET1 instruments. The purpose is to ensure that the issuer has full discretion over the payment of dividends so that the institution can retain capital as necessary. Article 28(1)(h)(v) of the CRR specifically prohibits CET1 instruments from including any obligation for the institution to make distributions. The instrument in question would therefore not be eligible as a CET1 item’.
The described profit and loss agreement contradicts Article 28(1)(h)(v) of Regulation (EU) No. 575/2013 (CRR) stipulating that the conditions governing the instruments do not include any obligation for the institution to make distributions and the institution is not otherwise subject to such an obligation. This is because the institution may still be obliged to make payments of dividends to its parent entity, even if these may be reduced by allocations to retained earnings, which contradicts the necessary full discretion over payments at the institution’s level. The fact that some profit and loss transfer agreements require the parent entity’s consent for the retention of earnings at the level of the institution further reduces the discretion of the institution.
Hence, QA 2013_408 is relevant and applies for this Q&A as well. The existence of a profit and loss transfer agreement renders the concerned CET1 instrument ineligible as CET1 capital.