Almost a Full Picture -- New Banking Regime Under Basel III

Almost a Full Picture -- New Banking Regime Under Basel III

by Peter Green and Jeremy Jennings-Mares

This commentary summarizes the Basel III rules. The rules are contained in two separate documents: (1) Basel III: A global regulatory framework for more resilient banks and banking systems and (2) Basel III: International framework for liquidity risk measurement, standards and reporting, together with the results of the BCBS's comprehensive quantitative impact study.

Excerpt:

Following endorsement of its proposed reforms of the Basel II framework at the G20 Seoul Summit in November 2010, the Basel Committee on Banking Supervision ("BCBS") published the final Basel III rules on 16 December 2010. The rules are contained in two separate documents: (1) Basel III: A global regulatory framework for more resilient banks and banking systems and (2) Basel III: International framework for liquidity risk measurement, standards and reporting, together with the results of the BCBS's comprehensive quantitative impact study ("QIS"). Certain key features of the new Basel III rules are summarized below.

Quality and Quantity of Capital

As foreshadowed in their December 2009 proposals and the revised July 2010 proposals, BCBS has resolved that the predominant form of bank capital should be common shares (or the equivalent for non-joint stock companies), retained earnings and other reserves ("Common Equity Tier 1 Capital"); deductions from capital and prudential filters must be harmonized internationally and generally applied at the level of common equity; Tier 1 capital instruments other than Common Equity Tier 1 Capital ("Additional Tier 1 Capital") must have very strong equity-like characteristics, such as deep subordination and fully discretionary, non-cumulative dividend/coupon payments, and must be perpetual and contain no incentive to redeem; capital instruments other than Tier 1 Capital ("Tier 2 Capital," since Tier 3 will be eliminated) will need to contain certain minimum, harmonized characteristics; and all elements of capital will be required to be disclosed and reconciled to the bank's reported accounts.

1. Definition of Capital

The definition of capital is substantially the same as initially proposed in December 2009, except as to certain regulatory adjustments applicable to Common Equity Tier 1 Capital which were modified and relaxed in July 2010.

Total Capital consists of (i) Tier 1 Capital (going-concern capital), comprising Common Equity Tier 1 and Additional Tier 1 Capital, and (ii) Tier 2 Capital (gone-concern capital).

Common Equity Tier 1 Capital consists of (i) common shares issued by the bank; (ii) any resulting stock surplus (share premium); (iii) retained earnings; (iv) accumulated other comprehensive income and other disclosed reserves; and (v) common shares issued by its consolidated subsidiaries qualifying as Common Equity Tier 1 Capital and held by third parties (i.e., minority interests), subject to regulatory adjustments.

Common shares must satisfy certain specified criteria, including the following: (i) in a liquidation, be the most subordinated claim; (ii) be perpetual (i.e., no redemption/maturity date), without creating any expectation for redemption; (iii) have non-obligatory distributions (i.e., non-payment is not an event of default); (iv) absorb losses on a going-concern basis; and (v) be neither secured nor guaranteed.

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Peter Green, a partner at Morrison & Foerster, focuses primarily on structured credit and structured products transactions. He represents investment banks, issuers, investors and other providers of financial services in relation to public offerings and private placements of debt instruments. He has advised in relation to the unwinding and restructuring of a number of such transactions.

Jeremy Jennings-Mares is a partner in Morrison & Foerster's Capital Market practice. His practice specializes in structured products, derivatives and structured financings, including structured notes, derivatives, and medium-term note programs and other cross-border debt securities offerings. He is a contributor to Covered Bonds Handbook, published by Practising Law Institute (2010).