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CMCOB 7.3 Calculation of prudential resources

Eligible prudential resources

CMCOB 7.3.1R
  1. (1)

    1A firm must calculate its prudential resources only from the items which are eligible to contribute to a firm’s prudential resources as set out in the table in CMCOB 7.3.2R.

  2. (2)

    In arriving at its calculation of its prudential resources, a firm must deduct certain items as set out in the table in CMCOB 7.3.3R.

CMCOB 7.3.2R

1Table: Items which are eligible to contribute to the prudential resources of a firm

Item

Additional explanation

1

Share capital

This must be fully paid and may include:

(1)

ordinary share capital; or

(2)

preference share capital (excluding preference shares redeemable by shareholders within two years).

2

Capital other than share capital (for example, the capital of a sole trader, partnership or limited liability partnership)

The capital of a sole trader is the net balance on the firm’s capital account and current account. The capital of a partnership is the capital made up of the partners’:

(1)

capital account, that is the account:

(a)

into which capital contributed by the partners is paid; and

(b)

from which, under the terms of the partnership agreement, an amount representing capital may be withdrawn by a partner only if:

(i)

the person ceases to be a partner and an equal amount is transferred to another such account by the person’s former partners or any person replacing that person as their partner; or

(ii)

the person ceases to be a partner and an equal amount is transferred to another such account by the person’s former partners or any person replacing that person as their partner; or

(iii)

the partnership is otherwise dissolved or wound up; and

(2)

current accounts according to the most recent financial statement.

For the purpose of the calculation of capital resources in respect of a defined benefit occupational pension scheme:

(3)

a firm must derecognise any defined benefit asset;

(4)

a firm may substitute for a defined benefit liability the firm’s deficit reduction amount, provided that the election is applied consistently in respect of any one financial year.

3

Reserves (Note 1)

These are, subject to Note 1, the audited accumulated profits retained by the firm (after deduction of tax, dividends and proprietors’ or partners’ drawings) and other reserves created by appropriations of share premiums and similar realised appropriations. Reserves also include gifts of capital, for example, from a parent undertaking.

For the purposes of calculating capital resources, a firm must make the following adjustments to its reserves, where appropriate:

(1)

a firm must deduct any realised gains or, where applicable, add back in any unrealised losses on debt instruments held, or formerly held, in the available-for-sale financial assets category;

(2)

a firm must deduct any unrealised gains or, where applicable, add back in any unrealised losses on cash flow hedges of financial instruments measured at cost or amortised cost;

(3)

in respect of a defined benefit occupational scheme:

(a)

a firm must derecognise any defined benefit asset;

(b)

a firm may substitute for a defined benefit liability the firm’s reduction amount, provided that the election is applied consistently in respect of any one financial year.

4

Interim net profits (Note 1)

If a firm seeks to include interim net profits in the calculation of its capital resources, the profits have, subject to Note 1, to be verified by the firm’s external auditor, net of tax, anticipated dividends or proprietors’ drawings and other appropriations.

5

Revaluation reserves

Revaluation reserves such as reserves arising from the revaluation of land and buildings, including any net unrealised gains for the fair valuation of equities held in the available-for-sale financial assets category.

6

Subordinated loans/debt

Subordinated loans/debt must be included in capital on the basis of the provisions in this chapter that apply to subordinated loans/debts.

Note:

1

Reserves must be audited and interim net profits, general and collective provisions must be verified by the firm’s external auditor unless the firm is exempt from the provisions of Part VII of the Companies Act 1985 (section 249A (Exemption from audit) or, where applicable, Part 16 of the Companies Act 2006 (section 477 (Small companies; Conditions for exemption from audit)) relating to the audit of accounts.

CMCOB 7.3.3R

1Table: Items which must be deducted in arriving at prudential resources

1

Investments in own shares

2

Investments in subsidiaries (Note 1)

3

Intangible assets (Note 2)

4

Interim net losses (Note 3)

5

Excess of drawings over profits for a sole trader or a partnership (Note 3)

Notes:

1

Investments in subsidiaries are valued at the full balance sheet value.

2

Intangible assets are the full balance sheet value of goodwill, capitalised development costs, brand names, trademarks and similar rights and licences.

3

The interim net losses in row 4, and the excess of drawings in row 5, are in relation to the period following the date as at which the prudential resources are being computed.

Subordinated loans/debt

CMCOB 7.3.4R

1A subordinated loan/debt must not form part of the prudential resources of the firm unless it meets the following conditions:

  1. (1)

    it has an original maturity of:

    1. (a)

      at least five years; or

    2. (b)

      it is subject to five years’ notice of repayment;

  2. (2)

    the claims of the subordinated creditors must rank behind those of all unsubordinated creditors;

  3. (3)

    the only events of default must be non-payment of any interest or principal under the debt agreement or the winding-up of the firm;

  4. (4)

    the remedies available to the subordinated creditor in the event of non-payment or other default in respect of the subordinated loan/debt must be limited to petitioning for the winding-up of the firm or proving the debt and claiming in the liquidation of the firm;

  5. (5)

    the subordinated loan/debt must not become due and payable before its stated final maturity date, except on an event of default complying with (3);

  6. (6)

    the agreement and the debt are governed by the law of England and Wales, or of Scotland or of Northern Ireland;

  7. (7)

    to the fullest extent permitted under the rules of the relevant jurisdiction, creditors must waive their right to set off amounts they owe the firm against subordinated amounts owed to them by the firm;

  8. (8)

    the terms of the subordinated loan/debt must be set out in a written agreement that contains terms which provide for the conditions set out in this rule; and

  9. (9)

    the loan/debt must be unsecured and fully paid up.

CMCOB 7.3.5R

1When calculating its prudential resources, the firm must exclude any amount by which the aggregate amount of its subordinated loans/debts exceeds the amount calculated as follows:

  1. a – b

  2. where:

  3. a = the sum of Items 1-5 in the Table of items, which are eligible to contribute to a firm’s capital resources (see CMCOB 7.3.2R)

  4. b = the sum of Items 1-5 in the Table of items, which must be deducted in arriving at a firm’s capital resources (see CMCOB 7.3.3R)

CMCOB 7.3.6G

1CMCOB 7.3.5R can be illustrated by the examples set out below:

(1)

Share capital

£20,000

Reserves

£30,000

Subordinated loans/debts

£10,000

Intangible assets

£10,000

As subordinated loans/debts (£10,000) are less than the total of share capital + reserves - intangible assets (£40,000) the firm need not exclude any of its subordinated loans/debts pursuant to CMCOB 7.3.4R when calculating its prudential resources. Therefore the firm’s total prudential resources will be £50,000.

(2)

Share capital

£20,000

Reserves

£30,000

Subordinated loans/debts

£60,000

Intangible assets

£10,000

As subordinated loans/debts (£60,000) exceed the total of share capital + reserves - intangible assets (£40,000) by £20,000, the firm should exclude £20,000 of its subordinated loans/debts pursuant to CMCOB 7.3.5R when calculating its prudential resources. Therefore the firm’s total prudential resources will be £80,000.