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PRU 2.2 Capital resources

Application

PRU 2.2.1R

PRU 2.2 applies to an insurer unless it is:

  1. (1)

    a non-directive friendly society; or

  2. (2)

    a Swiss general insurer; or

  3. (3)

    an EEA-deposit insurer; or

  4. (4)

    an incoming EEA firm; or

  5. (5)

    an incoming Treaty firm.

Purpose

PRU 2.2.2G

PRU 2.1 sets out minimum capital resources requirements for a firm. This section (PRU 2.2) sets out how, for the purpose of these requirements, capital resources are defined and measured. PRU 2.2 also implements minimum EC standards for the composition of capital resources required to be held by a firm undertaking business that falls within the scope of the Consolidated Life Directive (2002/83/EC) or the First Non-Life Directive (73/239/EEC) as amended.

Principles underlying the definition of capital resources

PRU 2.2.3G

The FSA has divided its definition of capital into categories, or tiers, reflecting differences in the extent to which the capital instruments concerned meet the purpose and conform to the characteristics of capital listed in PRU 2.2.5 G. The FSA generally prefers a firm to hold higher quality capital that meets the characteristics of permanency and loss absorbency that are features of tier one capital. Capital instruments falling into core tier one capital can be included in a firm's regulatory capital without limit. Typically, other forms of capital are either subject to limits (see PRU 2.2.16 R to PRU 2.2.26 R) or, in the case of some specialist types of capital, may only be included with the express consent of the FSA (which takes the form of a waiver under section 148 of the Act).

PRU 2.2.4G

Details of the individual components of capital are set out in PRU 2.2.14 R.

Tier one capital

PRU 2.2.5G

Tier one capital typically has the following characteristics:

  1. (1)

    it is able to absorb losses;

  2. (2)

    it is permanent;

  3. (3)

    it ranks for repayment upon winding up after all other debts and liabilities; and

  4. (4)

    it has no fixed costs, that is, there is no inescapable obligation to pay dividends or interest.

PRU 2.2.6G

The forms of capital that qualify for tier one capital are set out in PRU 2.2.14 R and include, for example, share capital, reserves, verified interim net profits and, for a mutual, the initial fund plus permanent members' accounts. Tier one capital is divided into core tier one capital, perpetual non-cumulative preference shares, and innovative tier one capital.

Upper and lower tier two capital

PRU 2.2.7G

Tier two capital includes forms of capital that do not meet the requirements for permanency and absence of fixed servicing costs that apply to tier one capital. Tier two capital includes, for example:

  1. (1)

    capital which is perpetual (that is, has no fixed term) but cumulative (that is, servicing costs cannot be waived at the issuer's option, although they may be deferred - for example cumulative preference shares); perpetual capital instruments may be included in upper tier two capital; and

  2. (2)

    capital which is not perpetual (that is, it has a fixed term) and which may also have fixed servicing costs that cannot generally be either waived or deferred, for example subordinated debt. Such capital should normally be of a medium to long-term maturity (that is, an original maturity of at least five years). Dated capital instruments are included in lower tier two capital.

Deductions from capital

PRU 2.2.8G

Deductions should be made at the relevant stage of the calculation of capital resources to reflect capital that may not be available to the firm or assets of uncertain value, for example, holdings of intangible assets and assets that are inadmissible for a firm.

PRU 2.2.9G

A full list of deductions from capital resources is shown in PRU 2.2.14 R.

Calculation of capital resources

PRU 2.2.10G

Capital resources can be calculated either as the total of eligible assets less foreseeable liabilities (which is the approach taken in the Insurance Directives) or by identifying the components of capital. Both calculations give the same result for the total amount of capital resources. The approach taken in this section has been to specify the components of capital and the relevant deductions. This is set out in PRU 2.2.14 R. This approach is the same as that used for the calculation of capital resources for banks, building societies and investment firms. A simple example, showing the reconciliation of the two methods, is given in PRU 2.2.11 G.

PRU 2.2.11G

Table: Approaches to calculating capital resources

Liabilities

Assets

Borrowings

100

Admissible assets

350

Ordinary shares

200

Intangible assets

100

Profit and loss account and other reserves

100

Other inadmissible assets

100

Perpetual subordinated debt

150

Total

550

Total

550

Calculation of capital resources: eligible assets less foreseeable liabilities

Total assets

550

less intangible assets

(100)

less inadmissible assets

(100)

less liabilities (borrowings)

(100)

Capital resources

250

Calculation of capital resources: components of capital

Ordinary shares

200

Profit and loss account and other reserves

100

Perpetual subordinated debt

150

less intangible assets

(100)

less inadmissible assets

(100)

Capital resources

250

PRU 2.2.12R

A firm must calculate its capital resources for the purpose of PRU in accordance with PRU 2.2.14 R, subject to the limits in PRU 2.2.16 R to PRU 2.2.26 R.

PRU 2.2.13G

Where PRU 2.2.14 R refers to related text, it is necessary to refer to that text in order to understand fully what is included in the descriptions of capital items and deductions set out in the table.

PRU 2.2.14R

Table: Capital resources (see PRU 2.2.12 R)

Related text

Included in the calculation of capital resources

A √ denotes that the item is included in the calculation of a firm's capital resources: a x denotes that the item is not included in the calculation of a firm's capital resources.

(A) Core tier one capital:

Permanent share capital

PRU 2.2.36 R

Profit and loss account and other reserves

PRU 2.2.76 R and PRU 2.2.77 R

Share premium account

None

Externally verified interim net profits

PRU 2.2.82 R

Positive valuation differences

PRU 2.2.78 R

Fund for future appropriations

None22

(B) Perpetual non-cumulative preference shares

Perpetual non-cumulative preference shares

PRU 2.2.50 R

(C) Innovative tier one capital

Innovative tier one instruments

PRU 2.2.52 R to PRU 2.2.75 R

(D) Total tier one capital before deductions = A + B + C

(E) Deductions from tier one capital:

Investments in own shares

None

Intangible assets

PRU 2.2.84 R

Amounts deducted from technical provisions for discounting and other negative valuation differences

PRU 2.2.78 R to PRU 2.2.81 R

(F) Total tier one capital after deductions = D - E

(G) Upper tier two capital:

Perpetual cumulative preference shares

PRU 2.2.101 R

Perpetual subordinated debt

PRU 2.2.101 R

Perpetual subordinated securities

PRU 2.2.101 R

(H) Lower tier two capital

Fixed term preference shares

PRU 2.2.108 R

Fixed term subordinated debt

PRU 2.2.108 R

Fixed term subordinated securities

PRU 2.2.108 R

(I) Total tier two capital = G + H

(J) Positive adjustments for related undertakings

Related undertakings that are regulated related undertakings (other than insurance undertakings)

PRU 2.2.90 R

(K) Total capital after positive adjustments for regulated related undertakings that are not insurance undertakings but before deductions = F + I + J

(L) Deductions from total capital

Inadmissible assets

PRU 2.2.86 R & PRU 2 Annex 1R

Assets in excess of market risk and counterparty limits

PRU 3.2.22 R

Related undertakings that are ancillary services undertakings

PRU 2.2.89 R

Negative adjustments for related undertakings that are regulated related undertakings (other than insurance undertakings)

PRU 2.2.90 R

(M) Total capital after deductions = K - L

(N) Other capital resources*:

Unpaid share capital or, in the case of a mutual, unpaid initial funds and calls for supplementary contributions

PRU 2.2.126 G to PRU 2.2.128 G

×

Implicit items

PRU 2 Annex 2 G

×

(O) Total capital resources after deductions = M + N

* Items in section (N) of the table can be included in capital resources if subject to a waiver under section 148 of the Act.

Limits on the use of different forms of capital

PRU 2.2.15G

As the various components of capital differ in the degree of protection that they offer the firm and its customers, restrictions are placed on the extent to which certain types of capital are eligible for inclusion in a firm's capital resources. These restrictions are set out in PRU 2.2.16 R to PRU 2.2.26 R.

PRU 2.2.16R

At least 50% of a firm's MCR must be accounted for by the sum of:

  1. (1)

    the amount calculated at stage A of the calculation in PRU 2.2.14 R; and

  2. (2)

    notwithstanding PRU 2.2.20 R (1), the amount calculated at stage B of the calculation in PRU 2.2.14 R;

less the amount calculated at stage E of the calculation in PRU 2.2.14 R.

PRU 2.2.17R

A firm carrying on long-term insurance business must meet the higher of:

  1. (1)

    1/3 of the long-term insurance capital requirement; and

  2. (2)

    the base capital resources requirement;

with the sum of the items listed at stages A, B, G and H less the sum of the items listed at stage E in PRU 2.2.14 R.

2
PRU 2.2.18R

A firm carrying on general insurance business must meet the higher of:

  1. (1)

    1/3 of the general insurance capital requirement; and

  2. (2)

    the base capital resources requirement;

with the sum of the items listed at stages A, B, G and H less the sum of the items listed at stage E in PRU 2.2.14 R.

2
PRU 2.2.19G

The purposes of the requirements in PRU 2.2.16 R to PRU 2.2.18 R are to comply with the Insurance Directives' requirement that firms maintain a guarantee fund of higher quality capital resources items and to ensure that at least 50% of the firm's capital resources needed to meet its MCR provide maximum loss absorbency to protect the firm from insolvency.

PRU 2.2.20R

In relation to a firm's tier one capital resources calculated at stage F of the calculation in PRU 2.2.14 R:

  1. (1)

    at least 50% must be accounted for by core tier one capital; and

  2. (2)

    no more than 15% may be accounted for by innovative tier one capital.

PRU 2.2.21G

The purpose of the requirement in PRU 2.2.20 R (1) is to ensure that at least 50% of the firm's tier one capital resources (net of tier one capital deductions) is met by core tier one capital which provides maximum loss absorbency on a going concern basis to protect the firm from insolvency. Although a perpetual non-cumulative preference share is in legal form a share, it behaves in many ways like a perpetual fixed interest debt instrument. Within the 50% limit on non-core tier one capital, PRU 2.2.20 R (2) places a further sub-limit on the amount of innovative tier one capital that a firm may include in its tier one capital resources. This limit is necessary to ensure that most of a firm's tier one capital comprises items of capital of the highest quality.

PRU 2.2.22R

The amount of any capital item excluded from a firm's tier one capital resources under PRU 2.2.20 R may form part of its tier two capital resources subject to the limits in PRU 2.2.23 R.

PRU 2.2.23R

Subject to PRU 2.2.24 R, a firm must exclude from the calculation of its capital resources the following:

  1. (1)

    the amount (if any) by which tier two capital resources exceed the amount calculated at stage F of the calculation in PRU 2.2.14 R; and

  2. (2)

    the amount (if any) by which lower tier two capital resources exceed 50% of the amount calculated at stage F of the calculation in PRU 2.2.14 R.

PRU 2.2.24R

At least 75% of a firm's MCR must be accounted for by the sum of:

  1. (1)

    the amount calculated at stage A plus stage B less stage E of the calculation in PRU 2.2.14 R; and

  2. (2)

    the amount calculated at stage G of the calculation in PRU 2.2.14 R.

PRU 2.2.25G

PRU 2.2.23 R and PRU 2.2.24 R give effect to the Insurance Directives' requirements that a firm's tier two capital resources must not exceed its tier one capital resources and that no more than 25% of a firm's "required solvency margin" should consist of lower tier two capital resources.

PRU 2.2.26R

A firm that carries on both long-term insurance business and general insurance business must apply the limits in PRU 2.2.16 R to PRU 2.2.24 R separately for each type of business.

Characteristics of tier one capital

PRU 2.2.27R

A firm may not include a share in, or another investment in, or external contribution to the capital of, that firm in its tier one capital resources unless it complies with the following conditions:

  1. (1)

    it is included in one of the categories in PRU 2.2.28 R;

  2. (2)

    it is not excluded by any of the rules in PRU 2.2; and

  3. (3)

    it complies with the conditions set out in PRU 2.2.29 R.

PRU 2.2.28R

The categories referred to in PRU 2.2.27 R (1) are:

  1. (1)

    permanent share capital;

  2. (2)

    a perpetual non-cumulative preference share; and

  3. (3)

    an innovative tier one instrument.

PRU 2.2.29R

Subject to PRU 2.2.30 R, an item of capital in a firm complies with PRU 2.2.27 R (3) if:

  1. (1)

    it is issued by the firm;

  2. (2)

    it is fully paid and the proceeds of issue are immediately and fully available to the firm;

  3. (3)

    it:

    1. (a)

      cannot be redeemed at all or can only be redeemed on a winding up of the firm; or

    2. (b)

      complies with the conditions in PRU 2.2.38 R and PRU 2.2.39 R;

  4. (4)

    any coupon is either non-cumulative or, if it is cumulative, it complies with PRU 2.2.40 R;

  5. (5)

    it is able to absorb losses to allow the firm to continue trading and in the case of an innovative tier one instrument it complies with PRU 2.2.56 R to PRU 2.2.58 R;

  6. (6)

    it ranks for repayment upon winding up no higher than a share of a company incorporated under the Companies Act 1985 or the Companies (Northern Ireland) Order 1986 (whether or not it is such a share);

  7. (7)

    the firm has the right to choose whether or not to pay a coupon on it in cash at any time;

  8. (8)

    the description of its characteristics used in its marketing is consistent with the characteristics required to satisfy PRU 2.2.29 R (1) to PRU 2.2.29 R (7).

PRU 2.2.30R

  1. (1)

    An item of capital does not comply with PRU 2.2.27 R (3) if the issue of that item of capital by the firm is connected with one or more other transactions which, when taken together with the issue of that item, could produce the effect described in (2).

  2. (2)

    The effect referred to in (1) is a reduction in the economic benefit intended to be conferred on the firm by the issue of the item of capital which means that the item of capital no longer displays all of the characteristics set out in PRU 2.2.29 R (1) to (8).

PRU 2.2.31R

An item of capital does not comply with PRU 2.2.29 R (5) if the holder of that item does not bear losses to at least the same degree as the holder of a share of a company incorporated under the Companies Act 1985 or the Companies (Northern Ireland) Order 1986 (whether or not it is such a share).

PRU 2.2.32G

PRU 2.2.29 R (2) is stricter than the Companies Act definition of fully paid, which only requires an undertaking to pay.

PRU 2.2.33G

An item of capital does not comply with PRU 2.2.29 R (8) if it is marketed as a capital instrument that would only qualify for a lower level of capital or on the basis that investing in it is like investing in a lower tier two instrument. For example, an undated capital instrument should not be marketed as a dated capital instrument if the terms of the capital instrument include an option by the issuer to redeem the capital instrument at a specified date in the future.

PRU 2.2.34G

For the purposes of PRU 2.2.30 R, examples of connected transactions might include guarantees or any other side agreement provided to the holders of the capital instrument by the firm or a connected party or a related transaction designed, for example, to enhance their security or to achieve a tax benefit, but which may compromise the loss absorption capacity or permanence of the original capital item.

PRU 2.2.35R

A firm may not include a share in its tier one capital resources unless (in addition to complying with the other relevant rules in PRU 2.2):

  1. (1)

    (in the case of a firm that is a company as defined in the Companies Act 1985 or the Companies (Northern Ireland) Order 1986) it is "called-up share capital" within the meaning given to that term in that Act or, as the case may be, that Order; or

  2. (2)

    (in the case of any other firm) it is:

    1. (a)

      in economic terms; and

    2. (b)

      in its characteristics as capital (including loss absorbency, permanency, ranking for repayment and fixed costs);

    substantially the same as called-up share capital falling into (1).

Core tier one capital: permanent share capital

PRU 2.2.36R

Permanent share capital means an item of capital which (in addition to satisfying PRU 2.2.29 R) meets the following conditions:

  1. (1)

    it is:

    1. (a)

      an ordinary share; or

    2. (b)

      a members' contribution; or

    3. (c)

      part of the initial fund of a mutual;

  2. (2)

    any coupon on it is not cumulative, and the firm has both the right to choose whether or not2 to pay a coupon and the right to choose the amount of that2 coupon; and

    22
  3. (3)

    the terms upon which it is issued do not permit redemption and it is otherwise incapable of being redeemed to at least the degree of an ordinary share issued by a company incorporated under the Companies Act 1985 or the Companies (Northern Ireland) Order 1986 (whether or not it is such a share).

PRU 2.2.37G

PRU 2.2.36 R has the effect that the firm should be under no obligation to make any payment in respect of a tier one instrument if it is to form part of its permanent share capital unless and until the firm is wound up. A tier one instrument that forms part of permanent share capital could not therefore count as a liability before the firm is wound up. The fact that relevant company law permits the firm to make earlier repayment does not mean that the tier one instruments are not eligible. However, the firm should not be required by any contractual or other obligation arising out of the terms of that capital to repay permanent share capital. Similarly a tier one instrument may still qualify if company law allows dividends to be paid on this capital, provided the firm is not contractually or otherwise obliged to pay them. There should therefore be no fixed costs.

Basic rules about redemption and cumulative coupons

PRU 2.2.38R

In relation to a perpetual non-cumulative preference share which is redeemable, a firm may not include it in its tier one capital resources unless its contractual terms are such that:

  1. (1)

    it is redeemable only at the option of the firm; and

  2. (2)

    the firm cannot exercise that redemption right:

    1. (a)

      on or 2before the fifth anniversary of its date of issue;

    2. (b)

      unless it has given notice to the FSA in accordance with PRU 2.2.72 R; and

    3. (c)

      unless at the time of exercise of that right it complies with PRU 2.1.9 R and will continue to do so after redemption.

PRU 2.2.39R

In relation to an innovative tier one instrument which is redeemable and which, either:

  1. (1)

    is or may become subject to a step-up; or

  2. (2)

    satisfies PRU 2.2.54 R (2);

a firm may not include it in its tier one capital resources unless it complies with the conditions in PRU 2.2.38 R, except that in PRU 2.2.38 R (2)(a)"fifth anniversary" is replaced by "tenth anniversary".

PRU 2.2.40R

A potential tier one instrument with a cumulative coupon complies with PRU 2.2.29 R (4) only if any such coupon must, if deferred, be paid by the firm in the form of permanent share capital.

PRU 2.2.41G

PRU 2.2.38 R does not apply to permanent share capital because no item of capital that is either redeemable or that has a cumulative coupon can be permanent share capital.

Further guidance on redemption

PRU 2.2.42G

The rules in PRU 2.2 about redemption of potential tier one instruments fall into three classes:

  1. (1)

    rules defining whether a firm's potential tier one instruments are eligible for inclusion in its tier one capital resources at all;

  2. (2)

    rules defining whether a firm's potential tier one instruments are eligible for inclusion in its permanent share capital; and

  3. (3)

    rules defining whether a firm's potential tier one instruments must be classified as innovative tier one instruments.

PRU 2.2.43G

The rules about redemption that are relevant to deciding whether a firm's potential tier one instruments are eligible for inclusion in its tier one capital resources at all are as follows.

  1. (1)

    PRU 2.2.29 R (3) and PRU 2.2.39 R have the following provisions.

    1. (a)

      Any capital instrument that is redeemable at the option of the holder cannot form part of a firm's tier one capital resources. Instead, if it is redeemable at all, a capital instrument should only be redeemable at the option of the firm.

    2. (b)

      A redemption right should be exercisable no earlier than the fifth anniversary of the date of issue. However, if an instrument is an innovative tier one instrument which is subject to a step-up or any other economic incentive to redeem, any such redemption should be exercisable no earlier than the tenth anniversary.

    3. (c)

      Any redemption proceeds should be payable only in cash or in shares.

    4. (d)

      The terms of the capital instrument should provide that any redemption right should not be exercised unless and until the firm has given the notice to the FSA required under PRU 2.2.72 R.

    5. (e)

      Any redemption right should not be exercisable unless both before and after the redemption the firm complies with PRU 2.1.9 R (which requires that a firm has sufficient capital resources to meet its capital resources requirement).

  2. (2)

    Under PRU 2.2.70 R, a firm should not include a potential tier one instrument that is redeemable in whole or in part in permanent share capital in its tier one capital resources unless the firm has:

    1. (a)

      sufficient permanent share capital or sufficient authority to issue permanent share capital (and the authority to allot it) to meet any redemption obligations that have become due; and

    2. (b)

      a prudent reserve of permanent share capital or sufficient authority to issue permanent share capital (and the authority to allot it) to meet possible future redemption obligations.

  3. (3)

    PRU 2.2.65 R contains limits on the amount of permanent share capital that may be issued on a redemption of a potential tier one instrument redeemable in permanent share capital.

PRU 2.2.44G

The rules defining whether a firm's potential tier one instruments are eligible for inclusion in its permanent share capital are to be found in PRU 2.2.36 R. As far as redemption is concerned, it says that the capital instrument should be no more capable of being redeemed than a share under the Companies Act 1985 or the Companies (Northern Ireland) Order 1986. PRU 2.2.38 R (which sets out the basic rules for redemption) does not apply to permanent share capital as a redeemable potential tier one instrument should not be included in permanent share capital.

PRU 2.2.45G

The rules about redemption that are relevant to deciding whether a firm's potential tier one instruments should be classified as innovative tier one instruments are as follows.

  1. (1)

    Under PRU 2.2.53 R, a redeemable potential tier one instrument is always treated as an innovative tier one instrument if the redemption proceeds are payable otherwise than in cash.

  2. (2)

    Under PRU 2.2.54 R, any feature of a tier one instrument that in conjunction with a call would make a firm more likely to redeem it or to have an incentive to do so will make it an innovative tier one instrument.

  3. (3)

    Under PRU 2.2.62 R a step-up coupled with a right of redemption results in a potential tier one instrument being treated as an innovative tier one instrument.

Further guidance on coupons

PRU 2.2.46G

The rules in PRU 2.2 about the coupons payable on potential tier one instruments fall into the same three classes that apply to the rules on redemption, as set out in PRU 2.2.42 G.

PRU 2.2.47G

The rules about coupons that are relevant to deciding whether a firm's potential tier one instruments are eligible for inclusion in its tier one capital resources at all are as follows.

  1. (1)

    Under PRU 2.2.29 R (4) and PRU 2.2.40 R, any deferred cumulative coupon should only be payable in permanent share capital. If a cumulative coupon is payable on a potential tier one instrument in another form, it should not be included in the firm's tier one capital resources.

  2. (2)

    Under PRU 2.2.29 R (7), the firm has the right not2 to pay a coupon in cash at any time.

  3. (3)

    PRU 2.2.63 R says that a potential tier one instrument that may be subject to a step-up that potentially exceeds defined limits should not be included in the firm's tier one capital resources. PRU 2.2.64 R says that any step-up should not arise before the tenth anniversary of the date of issue if it is to be included in the firm's tier one capital resources.

  4. (4)

    The provisions of PRU 2.2.70 R summarised in PRU 2.2.43 G (2) also apply to the payment of coupons.

PRU 2.2.48G

PRU 2.2.36 R (2) says that a capital instrument on which a cumulative coupon is payable must not be included in a firm's permanent share capital. The payment of a coupon must be purely discretionary.2

PRU 2.2.49G

The rules about coupons that are relevant to deciding whether a firm's potential tier one instruments should be classified as innovative tier one instruments are as follows:

  1. (1)

    Under PRU 2.2.60 R a potential tier one instrument with a cumulative coupon is an innovative tier one instrument.

  2. (2)

    Under PRU 2.2.40 R a potential tier one instrument with a coupon that if deferred must be paid in permanent share capital is an innovative tier one instrument.

  3. (3)

    Under PRU 2.2.62 R a step-up coupled with a right of redemption by the firm results in a potential tier one instrument being treated as an innovative tier one instrument.

Perpetual non-cumulative preference shares

PRU 2.2.50R

A perpetual non-cumulative preference share may be included at stage B of the calculation in PRU 2.2.14 R if:

  1. (1)

    it complies with PRU 2.2.29 R, PRU 2.2.35 R and PRU 2.2.38 R;

  2. (2)

    any coupon on it is not cumulative, and the firm has the right to choose whether or not to pay a coupon in all circumstances;

  3. (3)

    it is not excluded from tier one capital resources by any of the rules in PRU 2.2; and

  4. (4)

    it is not an innovative tier one instrument.

PRU 2.2.51G

Perpetual non-cumulative preference shares should be perpetual and redeemable only at the firm's option. Any feature that, in conjunction with a call, would make a firm more likely to redeem perpetual non-cumulative preference shares would normally result in classification as an innovative tier one instrument. Such features would include, but not be limited to, a step-up, bonus coupon on redemption or redemption at a premium to the original issue price of the share.

Innovative tier one instruments: general rules

PRU 2.2.52R

If an item of capital is stated to be an innovative tier one instrument by the rules in PRU 2.2, it cannot be included in stages A or B of the calculation in PRU 2.2.14 R.

PRU 2.2.53R

If a tier one instrument is redeemable at the option of the firm, it is an innovative tier one instrument unless it is redeemable solely in cash.

PRU 2.2.54R

If a tier one instrument:

  1. (1)

    is redeemable; and

  2. (2)

    is issued on terms that are (or its terms are amended and the amended terms are) such that a reasonable person would (judging at or around the time of issue or amendment) think that:

    1. (a)

      the firm is likely to redeem it; or

    2. (b)

      the firm is likely to have a substantial economic incentive to redeem it;

    that tier one instrument is an innovative tier one instrument.

PRU 2.2.55G

Any feature that in conjunction with a call would make a firm more likely to redeem a tier one instrument would normally result in classification as innovative tier one capital resources. Innovative tier one instruments include but are not limited to those incorporating a step-up or principal stock settlement.

Innovative tier one instruments: loss absorbency

PRU 2.2.56R

A capital instrument may only be included in innovative tier one capital resources if a firm's obligations under the instrument either:

  1. (1)

    do not constitute a liability (actual, contingent or prospective) under section 123(2) of the Insolvency Act 1986; or

  2. (2)

    do constitute such a liability but the terms of the instrument are such that:

    1. (a)

      any such liability is not relevant for the purposes of deciding whether:

      1. (i)

        the firm is, or is likely to become, unable to pay its debts; or

      2. (ii)

        its liabilities exceed its assets;

    2. (b)

      a creditor (including, but not limited to, a holder of the instrument) is not able to petition for the winding up or administration of the firm on the grounds that the firm is or may become unable to pay any such liability; and

    3. (c)

      the firm is not obliged to take into account such a liability for the purposes of deciding whether or not the firm is, or may become, insolvent for the purposes of section 214 of the Insolvency Act 1986 (wrongful trading).

PRU 2.2.57G

The effect of PRU 2.2.56 R is that if a potential tier one instrument does constitute a liability, this should only be the case when the firm is able to pay that liability but chooses not to do so. As tier one capital resources must be undated, this will generally only be relevant on a solvent winding up of the firm.

PRU 2.2.58R

A firm wishing to issue an innovative tier one instrument must obtain an opinion from Queen's Counsel, or where the opinion relates to the law of a jurisdiction outside the United Kingdom, from a lawyer in that jurisdiction of equivalent status, confirming that the criteria in PRU 2.2.29 R (5) and PRU 2.2.31 R are met.

PRU 2.2.59G

The holder should agree that the firm has no liability (including any contingent or prospective liability) to pay any amount to the extent to which that liability would cause the firm to become insolvent if it made the payment or to the extent that its liabilities exceed its assets or would do if the payment were made. The terms of the capital instrument should be such that the directors can continue to trade in the best interests of the senior creditors even if this prejudices the interests of the holders of the instrument.

Innovative tier one instruments: Coupons

PRU 2.2.60R

A tier one instrument with a cumulative coupon which complies with PRU 2.2.40 R is an innovative tier one instrument.

PRU 2.2.61G

An item of capital does not fall into PRU 2.2.60 R merely because a firm has come under an obligation to pay a particular coupon in permanent share capital where that obligation is the result of a voluntary election by the holder or the firm to be paid the coupon in that form. Thus, for example, if a shareholder of a firm is allowed to elect to be paid a dividend in the form of a conventional scrip dividend, that does not make the share into an innovative tier one instrument.

Innovative tier one instruments and other tier one instruments: step-ups

PRU 2.2.62R

If:

  1. (1)

    a potential tier one instrument is or may become subject to a step-up; and

  2. (2)

    that potential tier one instrument is redeemable at any time (whether before, at or after the time of the step-up);

that potential tier one instrument is an innovative tier one instrument.

PRU 2.2.63R

If a potential tier one instrument is or may become subject to a step-up, a firm must not include it in its tier one capital resources if the amount of the step-up exceeds or may exceed;

  1. (1)

    100 basis points; and

  2. (2)

    50% of the initial credit spread.

PRU 2.2.64R

A firm must not include a potential tier one instrument that is or may become subject to a step-up in its tier one capital resources if the step-up can arise earlier than the tenth anniversary of the date of issue of that item of capital.

Innovative tier one instruments: principal stock settlement

PRU 2.2.65R

A firm must not include a potential tier one instrument that is redeemable in whole or in part in permanent share capital in its tier one capital resources if:

  1. (1)

    the conversion ratio as at the date of redemption may be greater than the conversion ratio as at the time of issue by more than 200%; or

  2. (2)

    the issue or market price of the conversion instruments issued in relation to one unit of the original capital item (plus any cash element of the redemption) may be greater than the issue price (or, as the case may be, market price) of that original capital item.

PRU 2.2.66R

In PRU 2.2.65 R to PRU 2.2.69 R:

  1. (1)

    the original capital item means the capital item that is being redeemed; and

  2. (2)

    the conversion instrument means the permanent share capital issued on its redemption.

PRU 2.2.67R

In PRU 2.2.65 R to PRU 2.2.69 R, the conversion ratio means the ratio of:

  1. (1)

    the number of units of the conversion instrument that the firm must issue to satisfy its redemption obligation (so far as it is to be satisfied by the issue of conversion instruments) in respect of one unit of the original capital item; to

  2. (2)

    one unit of the original capital item.

PRU 2.2.68R

In PRU 2.2.65 R, the conversion ratio as at the date of issue of the original capital item is calculated as if the original capital item were redeemable at that time.

PRU 2.2.69R

If the conversion instruments or the original capital item are subdivided or consolidated or subject to any other occurrence that would otherwise result in like not being compared with like, the conversion ratio calculation in PRU 2.2.65 R must be adjusted accordingly.

Requirement to have sufficient unissued stock

PRU 2.2.70R

  1. (1)

    This rule applies to a potential tier one instrument of a firm where either:

    1. (a)

      the redemption proceeds; or

    2. (b)

      any coupon on that capital item;

    can be satisfied by the issue of another tier one instrument.

  2. (2)

    A firm may only include an item of capital to which this rule applies in its tier one capital resources if the firm has authorised and unissued tier one instruments of the kind in question (and the authority to issue them):

    1. (a)

      that are sufficient to satisfy all such payments then due; and

    2. (b)

      are of such amount as is prudent in respect of such payments that could become due in the future.

Notifying the FSA of the issue and redemption of tier one instruments

PRU 2.2.71R

A firm must not include any perpetual non-cumulative preference shares or innovative tier one instruments in its tier one capital resources for the purpose of PRU 2.2 unless it has notified the FSA of its intention at least one month before it first includes them.

PRU 2.2.72R

A firm must not redeem any tier one instrument that it has included in its tier one capital resources for the purpose of PRU 2.2 unless it has notified the FSA of its intention at least one month before it does so.

Non standard capital instruments

PRU 2.2.73G

There may be examples of capital instruments that, although based on a standard form, contain structural features that make the rules in PRU 2.2 difficult to apply. In such circumstances, a firm may seek individual guidance on the application of those rules to the capital instrument in question. See SUP 9 for the process to be followed when seeking individual guidance.

Step-ups

PRU 2.2.74R

In relation to a tier one instrument, a step-up means any change in the coupon rate on that instrument that results in an increase in the amount payable at any time, including a change already provided in the original terms governing those payments. A step-up:

  1. (1)

    includes (in the case of a fixed rate) an increase in that coupon rate;

  2. (2)

    includes (in the case of a floating rate calculated by adding a fixed amount to a fluctuating amount) an increase in that fixed amount;

  3. (3)

    includes (in the case of a floating rate) a change in the identity of the benchmark by reference to which the fluctuating element of the coupon is calculated that results in an increase in the absolute amount of the coupon;

  4. (4)

    does not include (in the case of a floating rate) an increase in the absolute amount of the coupon caused by fluctuations in the fluctuating figure by reference to which the absolute amount of the coupon floats.

PRU 2.2.75R

Where a rule in PRU 2.2 says that a particular treatment applies to an item of capital that is subject to a step-up of a specified amount, the question of whether that rule is satisfied must be judged by reference to the cumulative amount of all step-ups since the issue of that item of capital rather than just by reference to a particular step-up.

Profit and loss account and other reserves

PRU 2.2.76R

Negative amounts, including any interim net losses, must be deducted from tier one capital resources.

PRU 2.2.77R

Dividends must be deducted from reserves as soon as they are declared.

Valuation differences

PRU 2.2.78R

Valuation differences are all differences between the valuation of assets and liabilities as valued in PRU and the valuation that the firm uses for its external financial reporting purposes, except valuation differences which are dealt with elsewhere in PRU 2.2.14 R. The sum of these valuation differences must either be added to (if positive) or deducted from (if negative) a firm's capital resources in accordance with PRU 2.2.14 R.

PRU 2.2.79G

Additions to and deductions from capital resources will arise from the application of asset and liability valuation and admissibility rules (see PRU 1.3, PRU 2.2.86 R and PRU 2 Annex 1R). Downward adjustments include discounting of technical provisions for general insurance business (which is optional for financial reporting but not permitted for regulatory valuation - see PRU 2.2.80 R to PRU 2.2.81 R) and derecognition of any defined benefit asset in respect of a defined benefit occupational pension scheme (see PRU 1.3.5B R)1. Details of valuation differences relating to technical provisions and liability adjustments for long-term insurance business are set out in PRU 7.3. In particular, contingent loans or other arrangements which are not valued as a liability under PRU 7.3.79R (2) result in a positive valuation difference.

PRU 2.2.80R

PRU 2.2.81 R applies to a firm that carries on general insurance business, except a pure reinsurer, and which discounts or reduces its technical provisions for claims outstanding.

1
PRU 2.2.81R

A firm of a kind referred to in PRU 2.2.80 R must deduct from its capital resources the difference between the undiscounted technical provisions or technical provisions before deductions and the discounted technical provisions or technical provisions after deductions. This adjustment must be made for all general insurance business classes, except for risks listed under classes 1 and 2. For classes other than 1 and 2, no adjustment needs to be made in respect of the discounting of annuities included in technical provisions. For classes 1 and 2 (other than annuities), if the expected average interval between the settlement date of the claims being discounted and the accounting date is not at least four years, the firm must deduct:1

1
  1. (1)

    the difference between the undiscounted technical provisions and the discounted technical provisions; or

    1
  2. (2)

    where it can identify a subset of claims such that the expected average interval between the settlement date of the claims and the accounting date is at least four years, the difference between the undiscounted technical provisions and the discounted technical provisions for the other claims.1

Externally verified interim net profits

PRU 2.2.82R

Externally verified interim net profits are interim profits verified by a firm's external auditors after deduction of tax, declared dividends and other appropriations.

PRU 2.2.83G

The FSA may request a firm to provide it with a copy of the external auditor's opinion on whether the interim profits are fairly stated.

Intangible assets

PRU 2.2.84R

A firm must deduct from its tier one capital resources the value of intangible assets.

PRU 2.2.85G

Intangible assets include goodwill, capitalised development costs, brand names, trademarks and similar rights, and licences.

Inadmissible assets

PRU 2.2.86R

For the purposes of PRU 2.2.14 R, a firm must deduct from total capital resources the value of any asset which is not an admissible asset as listed in PRU 2 Annex 1 R.

PRU 2.2.87G

PRU 2.2.86 R does not apply to intangible assets which must be deducted from tier one capital resources under PRU 2.2.84 R.

PRU 2.2.88G

The list of admissible assets has been drawn with the aim of excluding assets:

  1. (1)

    for which a sufficiently objective and verifiable basis of valuation does not exist; or

  2. (2)

    whose realisability cannot be relied upon with sufficient confidence; or

  3. (3)

    whose nature presents an unacceptable custody risk; or

  4. (4)

    the holding of which may give rise to significant liabilities or onerous duties.

Adjustments for related undertakings

PRU 2.2.89R

A firm must deduct from its capital resources the value of its investments in each of its related undertakings that is an ancillary services undertaking.

PRU 2.2.90R

In relation to each of its related undertakings that is a regulated related undertaking (other than an insurance undertaking) a firm must add to (if positive), at stage J in PRU 2.2.14 R, or deduct from (if negative), at stage L in PRU 2.2.14 R, its capital resources the value of its shares in that undertaking calculated in accordance with PRU 1.3.35 R.

PRU 2.2.91G

For the purposes of PRU 2.2.89 R, investments must be valued at their accounting book value in accordance with PRU 1.3.5 R.

PRU 2.2.92G

Related undertakings which are also insurance undertakings are not included in PRU 2.2.90 R because a firm that is a participating insurance undertaking is subject to the requirements of PRU 8.3.

Additional requirements for a tier one or tier two instrument issued by a firm carrying on with-profits insurance business

PRU 2.2.93R

A firm carrying on with-profits insurance business must, in addition to the other requirements in respect of capital resources elsewhere in PRU 2.2, meet the following conditions before a capital instrument can be included in the firm's capital resources:

  1. (1)

    the firm must manage the with-profits fund so that discretionary benefits under a with-profits insurance contract are calculated and paid disregarding, insofar as is necessary for its customers to be treated fairly, any liability the firm may have to make payments under the capital instrument;

  2. (2)

    the intention to manage the with-profits fund on the basis set out in PRU 2.2.93 R (1) must be disclosed in the firm's Principles and Practices of Financial Management; and

  3. (3)

    no amounts, whether interest, principal, or other amounts, must be payable by the firm under the capital instrument if the firm's assets would then be insufficient to enable it to declare and pay under a with-profits insurance contract discretionary benefits that are consistent with the firm's obligations under Principle 6.

PRU 2.2.94G

The purpose of PRU 2.2.93 R is to achieve practical subordination of capital instruments if they are to qualify as capital resources to the liabilities a firm has to with-profits policyholders, including liabilities which arise from the regulatory duty to treat customers fairly in setting discretionary benefits. (Principle 6 (Customers' interests) requires a firm to pay due regard to the interests of its customers and treat them fairly.) It is not sufficient for a capital instrument to be subordinated to such liabilities only on winding up of the firm because such liabilities to policyholders may have been reduced by the inappropriate use of management discretion to enable funds to be applied in repaying subordinated capital instruments before winding up proceedings commence.

PRU 2.2.95G

PRU 2.2.93 R is an additional requirement to all other rules in PRU 2.2 concerning the eligibility of a capital instrument to count as a component of a firm's capital resources. Subordinated debt instruments will be the main type of capital instrument to which this rule is relevant, including both upper tier two (undated) and lower tier two (dated) subordinated debt instruments. Subordinated debt instruments which are issued by a related undertaking are not intended to be covered by this rule and may be included in group capital resources as appropriate if the other eligibility criteria are met.

PRU 2.2.96G

PRU 2.2.29 R (8) and PRU 2.2.108 R (10) contain provisions concerning the marketing of a capital instrument. In relation to a firm to which PRU 2.2.93 R applies, in order to comply with PRU 2.2.29 R (8) and PRU 2.2.108 R (10), it should draw to the attention of subscribers the risk that payments may be deferred or cancelled in order to operate the with-profits fund so as to give priority to the payment of discretionary benefits to with-profits policyholders.

PRU 2.2.97G

  1. (1)

    Upper tier two instruments must meet the requirements of PRU 2.2.101 R (3) which goes beyond the requirement in PRU 2.2.93 R (3) since it requires a firm to have the option to defer payments in all circumstances, not just if necessary to treat customers fairly. However, for lower tier two instruments, PRU 2.2.93 R (3) represents an additional requirement since a failure to pay amounts of interest or principal on a due date must not constitute an event of default under PRU 2.2.108 R (2) for firms carrying on with-profits insurance business.

  2. (2)

    For firms which are realistic basis life firms compliance with PRU 2.2.93 R (3) would usually be achieved if the capital instrument provides that no amounts will be payable under it unless the firm's capital resources exceed its capital resources requirement. However, such firms should ensure that the terms of the capital instrument refer to FSA capital resources requirements in force from time to time, including the current realistic reserving requirements and are not restricted to former minimum capital requirements based only on the Insurance Directives' required minimum margin of solvency. For firms which are not realistic basis life firms, compliance with PRU 2.2.93 R (3) will probably require specific reference to be made to treating customers fairly in the terms of the capital instrument.

Tier two capital

PRU 2.2.98G

Tier two capital resources is split into upper and lower tiers. The principal distinction between upper and lower tier two capital is that perpetual instruments may be included in upper tier two capital whereas dated instruments, such as fixed term preference shares and dated subordinated debt, are included in lower tier two capital.

PRU 2.2.99G

Tier two capital instruments are capital instruments that combine the features of debt and equity in that they are structured like debt, but exhibit some of the loss absorption and funding flexibility features of equity.

Upper tier two capital

PRU 2.2.100G

Examples of capital instruments which may be eligible to count in upper tier two capital resources include the following:

  1. (1)

    perpetual cumulative preference shares;

  2. (2)

    perpetual subordinated debt; and

  3. (3)

    other instruments that have the same economic characteristics as (1) or (2).

PRU 2.2.101R

A capital instrument must meet the following conditions before it can be included in a firm's upper tier two capital resources:

  1. (1)

    it must meet the general conditions described in PRU 2.2.108 R;

  2. (2)

    it must have no fixed maturity date;

  3. (3)

    the contractual terms of the instrument must provide for the firm to have the option to defer any interest payment in cash on the debt; and

  4. (4)

    the contractual terms of the instrument must provide for the loss-absorption capacity of the debt and unpaid interest, whilst enabling the firm to continue its business.

PRU 2.2.102R

A capital instrument does not meet PRU 2.2.101 R (4) unless it meets PRU 2.2.103 R and PRU 2.2.105 R.

PRU 2.2.103R

A capital instrument may only be included in upper tier two capital resources if a firm's obligations under the instrument either:

  1. (1)

    do not constitute a liability (actual, contingent or prospective) under section 123(2) of the Insolvency Act 1986; or

  2. (2)

    do constitute such a liability but the terms of the instrument are such that:

    1. (a)

      any such liability is not relevant for the purposes of deciding whether:

      1. (i)

        the firm is, or is likely to become, unable to pay its debts; or

      2. (ii)

        its liabilities exceed its assets;

    2. (b)

      a creditor (including but not limited to a holder of the instrument) is not able to petition for the winding up or administration of the firm on the grounds that the firm is or may become unable to pay any such liability; and

    3. (c)

      the firm is not obliged to take into account such a liability for the purposes of deciding whether or not the firm is, or may become, insolvent for the purposes of section 214 of the Insolvency Act 1986 (wrongful trading).

PRU 2.2.104G

The effect of PRU 2.2.103 R is that if an upper tier two instrument does constitute a liability, this should only be the case when the firm is able to pay that liability but chooses not to do so. As upper tier two capital resources must be undated, this will generally only be relevant on a solvent winding up of the firm.

PRU 2.2.105R

A firm wishing to issue an upper tier two instrument other than a perpetual cumulative preference share must obtain an opinion from Queen's Counsel, or where the opinion relates to the law of a jurisdiction outside the United Kingdom, from a lawyer in that jurisdiction of equivalent status, confirming that the criteria in PRU 2.2.101 R (4) are met.

PRU 2.2.106G

For the purpose of PRU 2.2.103 R (2)(b) above, the holder should agree that the firm has no liability (including any contingent or prospective liability) to pay any amount to the extent to which that liability would cause the firm to become insolvent if it made the payment or to the extent that its liabilities exceed its assets or would do if the payment were made. The terms of the capital instrument should be such that the directors can continue to trade in the best interests of the senior creditors even if this prejudices the interests of the holders of the instrument.

Lower tier two capital

PRU 2.2.107G

Capital instruments that meet the general conditions described in PRU 2.2.108 R may be included in lower tier two capital resources.

General conditions for eligibility as tier two capital

PRU 2.2.108R

A capital instrument must not form part of the tier two capital resources of a firm unless it meets the following conditions:

  1. (1)

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

  2. (2)

    the only events of default must be non-payment of any amount falling due under the terms of the capital instrument or the winding-up of the firm;

  3. (3)

    the remedies available to the subordinated creditor in the event of non-payment or other breach of the written agreement or instrument must be limited to petitioning for the winding-up of the firm or proving for the debt and claiming in the liquidation of the firm;

  4. (4)

    any events of default and any remedy described in (3) must not prejudice the matters in (1) and (2);

  5. (5)

    in addition to the requirement about repayment in (1), the debt must not become due and payable before its stated final maturity date (if any) except on an event of default complying with (2);

  6. (6)

    the debt agreement or terms of the capital instrument 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 laws of the relevant jurisdictions, creditors must waive their right to set off amounts they owe the firm against subordinated amounts included in the firm's capital resources owed to them by the firm;

  8. (8)

    the terms of the capital instrument must be set out in a written agreement that contains terms that provide for the conditions set out in (1) to (7);

  9. (9)

    the debt must be unsecured and fully paid up;

  10. (10)

    the description of its characteristics used in its marketing is consistent with the characteristics required to satisfy (1) to (9); and

  11. (11)

    the firm has obtained a properly reasoned external legal opinion stating that the requirements in (1) to (10) have been met.

PRU 2.2.109G

For the purposes of PRU 2.2.108 R (5) the debt agreement or terms of the instrument should not contain any clause which might require early repayment of the debt (e.g. cross default clauses, negative pledges and restrictive covenants). A cross default clause is a clause which says that the loan goes into default if any of the borrower's other loans go into default. It is intended to prevent one creditor being repaid before other creditors, e.g. obtaining full repayment through the courts. A negative pledge is a clause which puts the loan into default if the borrower gives any further charge over its assets. A restrictive covenant is a term of contract that directly, or indirectly, could lead to early repayment of the debt. Some covenants, e.g. relating to the provision of management information or ownership restrictions, are likely to comply with PRU 2.2.108 R (5) as long as monetary redress is ruled out, or any payments are covered by the subordination and limitation of remedies clauses (that is, if damages are unpaid, the only remedy is to petition for a winding up).

PRU 2.2.110G

The purpose of PRU 2.2.108 R (7) is to ensure that all of the firm's assets are available to customers ahead of subordinated creditors. The waiver should apply both before and during liquidation.

PRU 2.2.111R

PRU 2.2.108 R (6) does not apply if the firm has obtained a properly reasoned external legal opinion confirming that the same degree of subordination has been achieved under the law that governs the debt and the agreement as that which would have been achieved under the laws of England and Wales, Scotland, or Northern Ireland.

PRU 2.2.112G

An item of capital does not comply with PRU 2.2.108 R (10) if it is marketed as a capital instrument that would only qualify for a lower level of capital or on the basis that investing in it is like investing in a lower tier capital instrument. For example, an undated capital instrument should not be marketed as a dated capital instrument if the terms of the capital instrument include an option by the issuer to redeem the capital instrument at a specified date in the future.

PRU 2.2.113R

  1. (1)

    An item of capital does not comply with PRU 2.2.101 R or PRU 2.2.108 R if the issue of that item of capital by the firm is connected with one or more other transactions which, when taken together with the issue of that item, could produce the effect described in (2).

  2. (2)

    The effect referred to in (1) is a reduction in the economic benefit intended to be conferred on the firm by the issue of the item of capital which means that the item of capital no longer displays all of the characteristics set out in PRU 2.2.101 R or PRU 2.2.108 R.

PRU 2.2.114G

For the purposes of PRU 2.2.113 R, examples of connected transactions might include guarantees or any other side agreement provided to the holders of the capital instrument by the firm or a connected party or a related transaction designed, for example, to enhance their security or to achieve a tax benefit, but which may compromise the loss absorption capacity or permanence of the original capital item.

PRU 2.2.115G

The FSA is more concerned that the subordination provisions listed in PRU 2.2.108 R should be effective than that they should follow a particular form. The FSA does not, therefore, prescribe that the loan agreement should be drawn up in a standard form.

PRU 2.2.116R

A firm must not amend the terms of the debt and the documents referred to in PRU 2.2.108 R (8) unless:

  1. (1)

    at least one month before the amendment is due to take effect, the firm has given the FSA notice in writing of the proposed amendment and the FSA has not objected; and

  2. (2)

    that notice includes confirmation that the legal opinions referred to in PRU 2.2.108 R (11) and, if applicable, PRU 2.2.105 R and PRU 2.2.111 R, continue in full force and effect in relation to the terms of the debt and documents, notwithstanding any proposed amendment.

PRU 2.2.117R

A firm must notify the FSA of its intention to repay a tier two instrument at least six months before the date of the proposed repayment (unless the firm intends to repay an instrument on its contractual repayment date) providing details of how it will meet its capital resources requirement after such repayment.

Step-ups

PRU 2.2.118R

In relation to a tier two instrument, a step-up in a coupon rate means:

  1. (1)

    (in the case of a fixed rate) an increase in that rate;

  2. (2)

    (in any other case) any change in the way that the interest or other payment is calculated that may result in an increase in the amount payable at any time, including a change already provided in the original terms governing those payments.

PRU 2.2.119R

Where a tier two instrument is subject to one or more step-ups, the first date that a step-up can take effect must be treated, for the purposes of this section, as the instrument's final maturity date if its actual maturity date occurs after that, unless the effect of the step-up or step-ups is to increase the coupon rate at which payments are to be made by no more than:

  1. (1)

    50 basis points in the first ten years of the life of the debt; or

  2. (2)

    100 basis points over the whole life of the debt.

PRU 2.2.120R

A firm may not include in its tier two capital resources a capital instrument the terms of which provide for a step-up in the first five years after issue.

PRU 2.2.121R

Where a step-up arises through a change from paying a coupon on a debt instrument to paying a dividend on a share issued in settlement of the coupon, then any cost to the firm arising from the tax treatment of the dividend may be excluded.

PRU 2.2.122G

Debt instruments containing embedded options, e.g. issues containing options for the interest rate after the step-up to be at a margin over the higher of two (or more) reference rates, or for the interest rate in the previous period to act as a floor, may affect the funding costs of the borrower and imply a step-up. In such circumstances, a firm may wish to seek individual guidance on the application of the rules relating to step-ups to the capital instrument in question. See SUP 9 for the process to be followed when seeking individual guidance.

Other conditions for eligibility as lower tier two capital

PRU 2.2.123R

A capital instrument may be included in lower tier two capital resources only if it has an original maturity of at least five years or, where2 it has no fixed maturity date, notice of repayment of not less than five years has been given2.

PRU 2.2.124R

In its final five years to maturity, for the purposes of calculating the amount of a lower tier two instrument which may be included in a firm's capital resources,

the principal amount must be amortised on a straight line basis.

PRU 2.2.125G

PRU 2.2.124 R applies both to a tier two instrument with a fixed maturity and to a tier two instrument with no fixed maturity but where the firm has given five years' notice of repayment.

Unpaid share capital or initial funds and calls for supplementary contributions

PRU 2.2.126G

Unpaid share capital or, in the case of a mutual, unpaid initial funds and calls for supplementary contributions are excluded from the capital resources of a firm except to the extent allowed in a waiver under section 148 of the Act.

PRU 2.2.127G

Subject to a waiver, under the Insurance Directives a maximum of one half of unpaid share capital or, in the case of a mutual, one half of the unpaid initial fund may be included in a firm's capital resources, once the paid-up part amounts to 25% of that share capital or fund, up to 50% of total capital resources.

PRU 2.2.128G

In the case of a mutual carrying on general insurance business and subject to a waiver, calls for supplementary contributions within the financial year may only be included in a firm's capital resources up to a maximum of 50% of the difference between the maximum contributions and the contributions actually called in, subject to a limit of 50% of total capital resources. In the case of a mutual carrying on long-term insurance business, the Consolidated Life Directive does not permit calls for supplementary contributions to be included in a firm's capital resources.