Assessment and authorisation of eligible capital instruments

The Capital Adequacy Ordinance (CAO) requires banks and account-keeping securities firms to have sufficient capital to underpin the risks inherent in their business. It sets down three main types of eligible capital:

• Common Equity Tier 1, which includes paid-up share capital and disclosed reserves;
• Additional Tier 1 (AT1);
• Tier 2.

Additional Tier 1 and Tier 2 include capital instruments that are recognised under debt on the balance sheet but can serve to absorb losses.

FINMA assesses capital quality

FINMA assesses the capital quality of new instruments. It restricts itself mainly to planned issues of specially structured bonds that qualify either as Additional Tier 1 or as Tier 2. In order to be eligible for inclusion in capital adequacy calculations, these debt instruments must be able to make a decisive contribution to the resolution of the bank or account-keeping securities firm before it becomes insolvent (Art. 29 CAO). They do this by means of contractually defined conversion into equity or a complete and irreversible write-off.

Banks and account-keeping securities firms are generally not required to have these new components of eligible regulatory capital authorised in advance by FINMA. An exception applies to AT1 Capital in the form of debt. Whereas systemically important banks are required to demonstrate compliance with all requirements for approval (Article 11 para. 4 of the Banking Act in conjunction with Article 127 para. 2 CAO), in the case of any other bank (or securities firm) Article 27 para. 5 let. a CAO provides for FINMA approval merely in regard to the trigger event for their loss-absorbing AT1 instruments.

It is quite common for banks to submit plans for further new capital instruments to FINMA in order to clarify whether or not they are eligible.