In line with the first recommendation of the Hammond Review released two weeks ago, the Australian Prudential Regulation Authority (APRA) has released the final revisions to the capital framework for mutually-owned authorised deposit-taking institutions (mutual ADIs) together with its response to submissions to its consultation, which commenced in July 2017.
From 1 January 2018, new prudential requirements will apply to mutual ADIs, permitting them to directly issue mutual equity interests (MEIs) under a revised Attachment K to APS 111. Under the current regime, MEIs may only be issued on conversion of capital instruments. Below, we outline the key changes which are being made to APS 111. Further background to these changes is outlined in our earlier alert.
1. Direct issuance of MEIs
The existing framework has been amended to allow direct issuance of MEIs as Common Equity Tier 1 (CET1) capital, in addition to the issuance of MEIs on conversion of Additional Tier 1 (AT1) and Tier 2 (T2) capital instruments. As detailed in our earlier alert, this is a significant development which should make the issuance process more flexible for mutual ADIs seeking to raise CET1 capital.
2. A 25% limit on MEIs included as CET1 Capital
The new APS 111 will limit the amount of all MEIs on issue that may be included in CET1 capital (whether directly issued, or issued on conversion of a capital instrument) to 25% of the mutual ADI's CET1 capital before applying regulatory adjustments. MEIs in excess of this limit can be included in AT1 capital. Although APRA originally proposed a 15% limit in its July consultation paper, it has increased this limit to 25% in response to industry submissions. APRA has also amended APS 111 to clarify that MEIs on issue in excess of the CET1 limit may be included as AT1 capital and Total Capital (provided they otherwise meet the criteria in the standard).
3. Limits on the level of distributions
Under the current regime, distributions on MEIs cannot exceed 50% of the issuer's net profit after tax in the financial year in which the distribution is made. In addition to retaining this test for distributions, APRA had in its July 2017 consultation proposed to expressly permit the calculation of distributions on MEIs to be made by reference to a benchmark or index. However, APRA has not included this in the new standard so as to avoid duplication of the requirements under ASIC Regulatory Guide 147 (RG 147), which allows distributions on investor shares (including MEIs) to be calculated by reference to a benchmark or index. In contrast to an AT1 capital instrument, APRA will not allow the issue documentation or marketing material to indicate that the distribution on the MEI will be a set amount (such as a specified margin above the BBSW rate applied to the face value of the MEI). This does not mean that the board of the mutual ADI could not use such a methodology in determining the quantum of distribution that it elects to pay.
ADIs must continue to retain full discretion to reduce or waive distributions, and may not give any indication that payment of distributions is guaranteed.
4. Disclosure requirements
The new standard will specifically require issuing ADIs to make additional disclosures to potential investors about MEIs when offering them. ADIs must state clearly and prominently in issue documentation and marketing materials that:
- the MEI is not a deposit liability of the ADI and is not covered by the Financial Claims Scheme or guaranteed by the Australian Government;
- an ADI cannot buy back, repurchase or redeem an MEI other than in exceptional circumstances and with APRA's approval;
- the holder of a MEI may only be entitled to a claim on the issuing ADI's residual assets after other more senior claims (including AT1 and T2 capital instruments) have been paid;
- neither the issuer nor holder of the MEI is allowed to exercise any contractual rights of set-off in relation to the MEI; and
- the ADI has full discretion over the timing and amount of any distributions paid on the MEIs, including not paying a distribution.
5. Approval requirements
The new standard will continue to require APRA's approval and an independent legal opinion prior to issuance. However, APRA has noted in its response to submissions that it may consider removing the requirement for prior approval if standardised documentation is developed in future.
6. Removal of duplicated provisions
APRA has also updated the standard to remove provisions that essentially mirror the requirements of the Corporations Act and RG 147, to avoid duplication with ASIC requirements. In addition to meeting the requirements of APS 111, issuers of MEIs will still need to meet the requirements of ASIC in RG 147.
7. Interplay with Hammond Review
The revised APS 111 relating to MEIs implements Recommendation 1 of the Hammond Review (i.e. give mutual ADIs the ability to directly issue MEIs). Part (i) of Recommendation 3 (i.e. develop standard template forms for MEIs) was hinted at being actioned - as mentioned above, APRA may consider removing the requirement that it approve MEIs ahead of issuance if standardised documentation is developed. Part (ii) of Recommendation 3, i.e. the development of minimum service standards for APRA for assessment of capital instruments, was not addressed.
Recommendations 4, 5 and 6, directed at ASIC's role in capital raisings by mutual ADIs (including ASIC's discretions in relation to demutualisations and disclosure standards) should, if effectively actioned by the government, complete the picture on making the issuance of MEIs by mutual ADIs simpler. We note that one mutual ADI, Warwick Credit Union, has with our assistance recently lodged with ASIC an offer information statement with enhanced disclosure for a small scale offering of capital instrument convertible to MEIs.
We welcome the government's further action on the Hammond Review recommendations.
The new standard will commence from 1 January 2018 (no transitional arrangements are proposed).
These changes are significant developments for mutually owned ADIs seeking to issue MEIs. The updated standard should make the issuance process more flexible for most mutual ADI issuers.
If you need further guidance on what the new prudential standard means for you, please contact us.