Nigeria: AT-1 instruments under Basel III Framework and new CBN guidelines

AT-1 instruments
New CBN circular and guidelines
Guidelines on regulatory capital and constitution of AT-1 capital
Qualification as AT-1 instrument


AT-1 instruments

Corporate organisations typically require capital on a recurring basis for the purpose of financing their business objectives and projects, and one of the ways by which such organisations raise funding is through the issuance of financial instruments. Companies may choose, subject to applicable laws and regulations, to issue equity instruments (eg, shares and stocks), debt instruments (eg, bonds and notes) and money market instruments (eg, commercial papers). This article, however, focuses on a distinct form of financial instrument known as "additional tier-1 (AT-1) instruments".

AT-1 instruments are capital-qualifying instruments that constitute part of a company's regulatory capital. They are issued as debt securities, usually with a convertible feature triggered upon the occurrence of a contingent event. AT-1 instruments are also perpetual in nature and have no fixed maturity period.

AT-1 instruments have been described as crucial gadgets in regulators' toolkits in the post­crisis bail-in regime, as principal losses are imposed on creditors outside the normal bankruptcy process. Furthermore, hybrid securities such as AT-1 instruments provide an avenue for regulated companies to ensure orderly recapitalisation or liquidation without triggering market-wide distress. Needless to say, the issuance of AT-1 instruments is a highly regulated process.

New CBN circular and guidelines

The Central Bank of Nigeria (CBN) is responsible for regulating banks and other financial institutions in Nigeria pursuant to the Banks and Other Financial Institutions Act 2020 and the Central Bank of Nigeria Act 2007. The CBN also issues regulations and guidelines from time to time to govern the affairs of its regulated entities. On 2 September 2021, the CBN issued a circular(1) notifying deposit money banks (DMBs) of its decision to begin the implementation of the Basel III guidelines. The circular also forwarded a number of guidelines released by the CBN, including the Guidelines on Regulatory Capital dated March 2020 (the guidelines or Basel III guidelines).

The CBN's implementation of the Basel III requirements and the issuance of the guidelines seek to strengthen the capacity of DMBs to absorb losses when capital falls below the prescribed minimum requirements specified in the guidelines. This ensures that capital available to a DMB is sufficient to satisfy debts that may be owed by the DMB without recourse to public bailout.

Notably, on 24 September 2021, Access Bank Plc became the first Nigerian corporate organisation and DMB to issue AT-1 instruments in line with the CBN guidelines. This article provides an overview of the provisions of the guidelines relating to AT-1 instruments and the treatment of capital raised from the issuance of such instruments.

The implementation of the Basel III guidelines, including the Guidelines on Regulatory Capital, was activated, in a parallel run, effective November 2021, for an initial period of six months. The test period may be extended by the CBN for another three months, subject to the achievement of specific milestones by DMBs. Accordingly, all banks are required to render monthly returns on compliance with the guidelines.

It is pertinent to note that the Basel III guidelines are expected to operate concurrently with the existing Basel II guidelines during the parallel run.

Guidelines on regulatory capital and constitution of AT-1 capital

The guidelines set out the supervisory requirements for banks operating in Nigeria by increasing the minimum requirement for high quality capital to absorb losses on a going-concern basis and requires banks to build up additional capital buffers to cushion against future unexpected losses.

As previously explained, capital raised from the issuance of AT-1 instruments (AT-1 capital) constitutes part of the total regulatory capital (TRC) of a company. The TRC is a stress-test used to determine the capital adequacy of a DMB to meet possible losses and withstand economic financial crisis. This capital is required by DMBs to absorb losses that may arise in their day-to-day business operations. The component for measuring the TRC of a DMB for the purpose of compliance with the guidelines is the sum of common equity tier 1 (CET1) capital, AT-1 capital and tier 2 (T2) capital, net of regulatory adjustments.

While CET1 capital and AT-1 capital are going-concern capital, which are both able to absorb losses of a DMB without constituting an event of default on the holders of the instrument, T2 capital is a gone-concern capital that absorbs losses when a DMB's tier-1 capital (made up of CET1 and AT-1) has been eroded and the DMB is facing liquidation. The guidelines set the applicable formula for calculating relevant capital adequacy ratios (CAR) and further set minimum requirements expected of DMBs. Thus, a minimum CAR of 15% will apply to all DMBs and banking groups considered as domestic systematically important banks, including DMBs with international authorisations, while a minimum CAR of 10% will be applicable to all other DMBs.

The guidelines provide that the minimum capital adequacy of a holding company group should not be less than the capital requirement of any banking subsidiary within the group.

It is important to note that the CBN may require that a DMB maintain a higher minimum level of regulatory capital other than that prescribed in the guidelines in order for the DMB's minimum capital requirement to reflect its risk profile, business strategy and risk management capacity. The minimum requirements set out do not take into consideration such additional capital buffers as the CBN may impose on DMBs from time to time based on prevailing macroeconomic conditions and the systemic importance of individual banks. The guidelines note that in the absence of AT-1 capital, the minimum tier-1 capital ratio must be satisfied from CET1 capital.

According to the guidelines, AT-1 capital consists of the sum of the following elements:

  • instruments issued by DMBs that meet the criteria for inclusion in AT-1 capital and are not included in CET1 capital;
  • stock surplus or share premium resulting from the issue of instruments included in AT-1 capital; and
  • instruments issued by consolidated subsidiaries of the bank and held by third parties that meet the criteria for inclusion in AT-1 capital and are not included in CET1 capital.

Qualification as AT-1 instrument

For an instrument issued by a DMB to qualify as an AT-1 instrument, the following criteria must be satisfied:

  • It should be issued and paid in.
  • It should neither be secured nor covered by a guarantee of the issuer or related entity or other arrangement that legally or economically enhances the seniority of the claim vis-a-vis bank general creditors.
  • It may be callable at the initiative of the issuer only after a minimum of five years.
  • The instrument cannot have a credit sensitive dividend feature (ie, a dividend or coupon that is reset periodically based in whole or in part on the bank's credit rating).
  • Neither the bank nor a related party over which the bank exercises control or significant influence can purchase the instrument, nor can the bank directly or indirectly fund the purchase of the instrument.
  • The terms and conditions must have a provision that requires, at the option of the CBN, the instrument to either be written off or converted into common equity upon the occurrence of a trigger event.
  • It must be perpetual (there is no maturity date and there are no incentives to redeem).
  • Any repayment of principal (for example, through repurchase or redemption) must be with the prior approval of the CBN and banks should not assume or create market expectations that the CBN will grant the approval.
  • It must have dividend or coupon discretion.
  • Dividends or coupons must be paid out of same distributable items.
  • The instrument cannot contribute to liabilities exceeding assets for the purpose of insolvency testing.
  • Instruments classified as liabilities for accounting purposes must have a principal loss absorption mechanism, among other things.
  • The aggregate amount to be written down or converted for all instruments classified as liabilities for accounting purposes on breaching the trigger level must be at least the amount needed to immediately return the bank's CET1 ratio to the trigger level or, if this is not possible, the full principal value of the instruments.
  • The instrument cannot have any features that hinder recapitalisation, such as provisions that require the issuer to compensate investors if a new instrument is issued at a lower price during a specified timeframe.
  • If the instrument is not issued out of an operating entity or the holding company in the consolidated group, proceeds must be immediately available without limitation to an operating entity or the holding company in the consolidated group in a form that meets or exceeds all the other criteria for inclusion in AT-1 capital.
  • The instrument must be subordinated to depositors, general creditors and subordinated debt of the bank. In the case of an issue by a holding company, the instrument must be subordinated to all general creditors.

For further information on this topic please contact Olubunmi Fayokun, Ajibola Asolo or Abisola Akinyemi at Aluko & Oyebode by telephone (+234 1 462 8360 71) or email (o[email protected], [email protected] or [email protected]). The Aluko & Oyebode website can be accessed at www.aluko-oyebode.com.

Endnotes

(1) BSD/DIR/PUB/LAB/14/063.

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