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.
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
Quality and Quantity of Capital
As foreshadowed in their December 2009 proposals and the revised July 2010
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
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