Prudential Regulation Authority Rulebook

3B.1

The features referred to in 3A are the following:

1. (1) the basic own funds item:
   1. (a) in the case of items referred to in 3A.1(1)(a) and 3A.1(1)(b), ranks after all other claims in the event of winding-up proceedings regarding the firm; and
   2. (b) in the case of restricted Tier 1 own funds, ranks to the same degree as, or ahead of, the items referred to in 3A.1(1)(a) and 3A.1(1)(b), but after items listed in 3D and 3F that display the features set out in 3E and 3G respectively and after the claims of all policyholders and non-subordinated creditors;
2. (2) the basic own funds item does not include features which may cause the insolvency of the firm or may accelerate the process of the firm becoming insolvent;
3. (3) the basic own funds item is immediately available to absorb losses;
4. (4) the basic own funds item absorbs losses at least once there is non-compliance with the SCR and does not hinder the recapitalisation of the firm;
5. (5) the basic own funds item, in the case of restricted Tier 1 own funds, possesses one of the following principal loss absorbency mechanisms to be triggered at the trigger event specified in 3B.10 and complies with the conditions set out in 3B.9:
   1. (a) the nominal or principal amount of the basic own funds item is written down as set out in 3B.5 and 3B.6;
   2. (b) the basic own funds item automatically converts into a basic own funds item listed in 3A.1(1)(a) or 3A.1(1)(b) as set out in 3B.7 and 3B.8; or
   3. (c) a principal loss absorbency mechanism that achieves an equivalent outcome to the principal loss absorbency mechanisms set out in 3B.1(5)(a) or 3B.1(5)(b);
6. (6) the basic own funds item meets one of the following criteria:
   1. (a) in the case of items referred to in 3A.1(1)(a) and 3A.1(1)(b), the item is undated or, where the firm has a fixed maturity, is of the same maturity as the firm; or
   2. (b) in the case of restricted Tier 1 own funds items, the item is undated or the first contractual opportunity to repay or redeem the basic own funds item does not occur before five years from the date of issuance;
7. (7) a restricted Tier 1 own funds item may only allow for repayment or redemption of that item between 5 and 10 years after the date of issuance where the firm’s SCR is exceeded by an appropriate margin taking into account the solvency position of the firm including the firm’s medium-term capital management plan;
8. (8) the basic own funds item, in the case of items referred to in 3A.1(1)(a), 3A.1(1)(b), 3A.1(1)(c), 3A.1(1)(e), and 3A.1(2), is only repayable or redeemable at the option of the firm and provides that the repayment or redemption of the basic own funds item is subject to the firm receiving prior permission from the PRA;
9. (9) the basic own funds item, in the case of items referred to in 3A.1(1)(a), 3A.1(1)(b), 3A.1(1)(c), 3A.1(1)(e), and 3A.1(2), does not include any incentives to repay or redeem that item that increase the likelihood that a firm will repay or redeem that basic own funds item where it has the option to do so;
10. (10) the basic own funds item, in the case of items referred to in 3A.1(1)(a), 3A.1(1)(b), 3A.1(1)(c), 3A.1(1)(e), and 3A.1(2), provides for the suspension of repayment or redemption of that item where there is non-compliance with the SCR or repayment or redemption would lead to such non-compliance until:
    1. (a) the firm complies with the SCR; and 
    2. (b) the repayment or redemption would not lead to non-compliance with the SCR,
    3. other than in the circumstances set out in 3B.1(11);
11. (11) notwithstanding 3B.1(10), the basic own funds item may allow for repayment or redemption of that item where the firm does not comply with the SCR or repayment or redemption would lead to such non-compliance, only where all of the following conditions are met:
    1. (a) the firm has received prior permission from the PRA to repay or redeem that item; 
    2. (b) the item is to be exchanged for or converted into another Tier 1 own funds item of at least the same quality; and
    3. (c) the MCR will be complied with after the repayment or redemption;
12. (12) the basic own funds item meets one of the following criteria:
    1. (a) in the case of items referred to in 3A.1(1)(a) and 3A.1(1)(b), either the legal or contractual arrangements governing the basic own funds item or legislation applicable in the UK allow for the cancellation of distributions in relation to that item where there is non-compliance with the SCR or the distribution would lead to such non-compliance until: 
       1. (i) the firm complies with the SCR; and 
       2. (ii) the distribution would not lead to non-compliance with the SCR,
       3. other than in the circumstances set out in 3B.1(13);
    2. (b) in the case of restricted Tier 1 own funds items, the terms of the contractual arrangement governing the basic own funds item provide for the cancellation of distributions in relation to that item where there is non-compliance with the SCR or the distribution would lead to such non-compliance until: 
       1. (i) the firm complies with the SCR; and 
       2. (ii) the distribution would not lead to non-compliance with the SCR,
       3. other than in the circumstances set out in 3B.1(13); 
13. (13) notwithstanding 3B.1(12), the basic own funds item may allow for a distribution to be made where the firm does not comply with the SCR or the distribution on a basic own funds item would lead to such non-compliance, only where this provision is subject to all of the following conditions:
    1. (a) the firm has received prior permission from the PRA that the distribution can be made;
    2. (b) the distribution would not further weaken the solvency position of the firm; and
    3. (c) the MCR will be complied with after the distribution is made;
14. (14) the basic own funds item, in the case of items referred to in 3A.1(1)(a), 3A.1(1)(b), 3A.1(1)(c), 3A.1(1)(e), and 3A.1(2), provides the firm with full flexibility over the distributions on the basic own funds item in accordance with the conditions set out in 3B.3 or 3B.4; and
15. (15) the basic own funds item is free from encumbrances and is not connected with any other transaction, which when considered with the basic own funds item, could result in that basic own funds item not complying with 3.1.

3B.2

For the purposes of 3B, the exchange or conversion of a basic own funds item into another Tier 1 own funds item or the repayment or redemption of a Tier 1 own funds item out of the proceeds of a new basic own funds item of at least the same quality will not be deemed to be a repayment or redemption, provided that the exchange, conversion, repayment or redemption is subject to receiving prior permission from the PRA.

3B.3

For the purposes of 3B.1(14), in the case of basic own funds items referred to in 3A.1(1)(a) and 3A.1(1)(b), the item provides full flexibility over distributions only where all of the following conditions are met:

1. (1) there is no preferential distribution treatment regarding the order of distribution payments and the terms of the contractual arrangement governing the own funds item do not provide preferential rights to the payment of distributions;
2. (2) distributions are paid out of distributable items;
3. (3) the level of distributions is not determined on the basis of the amount for which the own funds item was purchased at issuance and there is no cap or other restriction on the maximum level of distribution;
4. (4) notwithstanding 3B.3(3), in the case of instruments issued by mutual and mutual-type undertakings, a cap or other restriction on the maximum level of distribution may be set, provided that cap or other restriction is not an event linked to distributions being made, or not made, on other own funds items;
5. (5) there is no obligation for a firm to make distributions;
6. (6) non-payment of distributions does not constitute an event of default by the firm; and
7. (7) the cancellation of distributions imposes no restrictions on the firm.

3B.4

For the purposes of 3B.1(14), in the case of restricted Tier 1 own funds items, the item provides full flexibility over distributions only where all of the following conditions are met:

1. (1) distributions are paid out of distributable items;
2. (2) the firm has full discretion at all times to cancel distributions in relation to the own funds item for an unlimited period and on a non-cumulative basis and the firm may use the cancelled payments without restriction to meet its obligations as they fall due;
3. (3) there is no obligation to substitute the distribution by a payment in any other form;
4. (4) there is no obligation to make distributions in the event of a distribution being made on another own funds item;
5. (5) non-payment of distributions does not constitute an event of default by the firm; and
6. (6) the cancellation of distributions imposes no restrictions on the firm.

3B.5

For the purposes of 3B.1(5)(a), the nominal or principal amount of the basic own funds item must be written down in such a way that all of the following are reduced:

1. (1) the claim of the holder of that item in the event of winding-up proceedings;
2. (2) the amount required to be paid on repayment or redemption of that item; and
3. (3) the distributions paid on that item.

3B.6

For the purposes of 3B.1(5)(a), the provisions governing the write-down of the nominal or principal amount of the basic own funds item must provide for all of the following:

1. (1) if the trigger event specified in 3B.10 has occurred in the circumstances described in 3B.10(3) and a partial write-down would be sufficient to re-establish compliance with the SCR, there is a partial write-down of the nominal or principal amount for an amount that is at least sufficient to re-establish compliance with the SCR;
2. (2) if the trigger event specified in 3B.10 has occurred in the circumstances described in 3B.10(3) and a partial write-down would not be sufficient to re-establish compliance with the SCR, the nominal or principal amount as determined at the time of original issuance of the basic own funds item is written down at least on a linear basis in a manner which ensures that full write-down will occur when 75% coverage of the SCR is reached, or prior to that event;
3. (3) if the trigger event specified in 3B.10 has occurred in the circumstances described in 3B.10(1) or 3B.10(2), the nominal or principal amount is written down in full; and
4. (4) following a write-down in accordance with 3B.6(2) (‘the initial write-down’):
   1. (a) if the trigger event specified in 3B.10 subsequently occurs in the circumstances described in 3B.10(1) or 3B.10(2), the nominal or principal amount is written down in full;
   2. (b) if, by the end of the period of three months from the date of the trigger event that resulted in the initial write-down, no trigger event has occurred in the circumstances described in 3B.10(1) or 3B.10(2) but the solvency ratio has deteriorated further, the nominal or principal amount as determined at the time of original issuance of the basic own funds item is written down further in accordance with 3B.6(2) to reflect that further deterioration in the solvency ratio; and 
   3. (c) a further write-down is made in accordance with 3B.6(4)(b) for each subsequent deterioration in the solvency ratio at the end of each subsequent period of three months until the firm has re-established compliance with the SCR.

For the purposes of 3B.6(4), the ‘solvency ratio’ means the ratio of eligible own funds (to cover a firm’s SCR) and the firm’s SCR using the latest available values.

3B.7

For the purposes of 3B.1(5)(b), the provisions governing the conversion into basic own funds items listed in 3A.1(1)(a) or 3A.1(1)(b) must specify either of the following:

1. (1) the rate of conversion and a limit on the permitted amount of conversion; or
2. (2) a range within which the instruments will convert into the basic own funds item listed in 3A.1(1)(a) or 3A.1(1)(b).

3B.8

For the purposes of 3B.1(5)(b), the provisions governing the conversion into basic own funds items listed in 3A.1(1)(a) or 3A.1(1)(b) must provide for all of the following:

1. (1) if the trigger event specified in 3B.10 has occurred in the circumstances described in 3B.10(3) and a partial conversion would be sufficient to re-establish compliance with the SCR, there is a partial conversion of the item for an amount that is at least sufficient to re-establish compliance with the SCR;
2. (2) if the trigger event specified in 3B.10 has occurred in the circumstances described in 3B.10(3) and a partial conversion would not be sufficient to re-establish compliance with the SCR, the item is converted in such a way that the remaining nominal or principal amount of the item decreases at least on a linear basis ensuring that full conversion will occur when 75% coverage of the SCR is reached, or prior to that event;
3. (3) if the trigger event specified in 3B.10 has occurred in the circumstances described in 3B.10(1) or 3B.10(2), the item is converted in full; and
4. (4) following a conversion in accordance with 3B.8(2) (‘the initial conversion’):
   1. (a) if the trigger event specified in 3B.10 subsequently occurs in the circumstances described in 3B.10(1) or 3B.10(2), the item is converted in full;
   2. (b) if, by the end of the period of three months from the date of the trigger event that resulted in the initial conversion, no trigger event has occurred in the circumstances described in 3B.10(1) or 3B.10(2) but the solvency ratio has deteriorated further, the item is converted further in accordance with 3B.8(2) to reflect that further deterioration in the solvency ratio; and
   3. (c) a further conversion is made in accordance with 3B.8(4)(b) for each subsequent deterioration in the solvency ratio at the end of each subsequent period of three months until the firm has re-established compliance with the SCR.

For the purposes of 3B.8(4), the ‘solvency ratio’ has the same meaning as it has for the purposes of 3B.6.

3B.9

The nominal or principal amount of the basic own funds item must absorb losses at the trigger event. Loss absorbency resulting from the cancellation of, or a reduction in, distributions does not constitute a principal loss absorbency mechanism in accordance with 3B.1(5).

3B.10

The trigger event referred to in 3B.1(5) is significant non-compliance with the SCR. Non-compliance with the SCR is considered significant for these purposes where any of the following conditions is met:

1. (1) the amount of own funds items eligible to cover the SCR is equal to or less than 75% of the SCR;
2. (2) the amount of own funds items eligible to cover the MCR is equal to or less than MCR; or
3. (3) compliance with the SCR is not re-established within a period of three months from the date when non-compliance with the SCR was first observed.

A firm may specify, in the provisions governing the instrument, one or more trigger events in addition to the events referred to in 3B.10(1) to 3B.10(3).

3B.11

For the purposes of 3B.1(4), 3B.1(10) and 3B.1(12), references to the SCR must be read as references to the MCR where non-compliance with the MCR occurs before non-compliance with the SCR.

3B.12

Notwithstanding the requirement in 3B.1(5) for the principal loss absorbency mechanism to be triggered at the trigger event specified in 3B.10, the basic own funds item may provide for the principal loss absorbency mechanism not to be triggered at that event only where this provision is subject to all of the following conditions:

1. (1) the trigger event occurs in the circumstances described in 3B.10(3);
2. (2) there have been no previous trigger events in the circumstances described 3B.10(1) or 3B.10(2); and 
3. (3) the firm has received prior permission from the PRA to waive the triggering of the principal loss absorbency mechanism on the basis of the following information: 
   1. (a) projections provided to the PRA by the firm when that firm submits the recovery plan required by 4.4(2) of the Group Supervision Part and 3.1(2) of the Undertakings in Difficulty Part, demonstrate that triggering the principal loss absorbency mechanism in that case would be very likely to give rise to a tax liability that would have a significant adverse effect on the firm’s solvency position; and 
   2. (b) a certificate issued by the firm’s statutory auditors certifying that all of the assumptions used in the projections are realistic.

3B.13

Notwithstanding the requirement in 3B.1(6)(b), the basic own funds item may allow for repayment or redemption earlier than that period where the following conditions are met: 

1. (1) the firm’s SCR, after the repayment or redemption, will be exceeded by an appropriate margin taking into account the solvency position of the firm, including the firm’s medium-term capital management plan; and
2. (2) the circumstances are as described in (a) or (b), either; 
   1. (a) there is a change in the regulatory classification of the basic own funds item which would be likely to result in its exclusion from the own funds or reclassification as a lower tier of own funds and both of the following conditions are met; 
      1. (i) the PRA considers such a change to be sufficiently certain; and 
      2. (ii) the firm demonstrates to the satisfaction of the PRA that the regulatory reclassification of the basic own funds item was not reasonably foreseeable at the time of its issuance; or
   2. (b) there is a change in the applicable tax treatment of the basic own funds item which the firm demonstrates to the satisfaction of the PRA: 
      1. (i) is material; and 
      2. (ii) was not reasonably foreseeable at the time of its issuance.

3B.14

A firm must not:

1. (1) redeem or repay a basic own funds item referred to in 3A.1(1)(a), 3A.1(1)(b), 3A.1(1)(c), 3A.1(1)(e), and 3A.1(2); 
2. (2) redeem or repay a basic own funds item referred to in 3A.1(1)(a), 3A.1(1)(b), 3A.1(1)(c), 3A.1(1)(e), and 3A.1(2) when redemption or repayment has been suspended in the circumstances referred to in 3B.1(10); 
3. (3) make a distribution under a basic own funds item in the circumstances referred to in 3B.1(12); or
4. (4) redeem or repay a basic own funds item in the circumstances set out in 3B.13,

unless, in each case, it has received prior permission from the PRA pursuant to section 138BA of FSMA.

3B.15

For the purposes of 3B, a firm may only:

1. (1) exchange or convert a Tier 1 own funds item into another Tier 1 own funds item; or 
2. (2) repay or redeem a Tier 1 own fund item out of the proceeds of a new basic own funds item of at least the same quality,

without it being deemed as a repayment or redemption, if the firm has received prior permission from the PRA pursuant to section 138BA of FSMA for the exchange, conversion, repayment or redemption (as applicable).

3B.16

A firm must treat significant non-compliance with the SCR (as defined in 3B.10) as a trigger event for the principal loss absorbency mechanism referred to in 3B.1(5) unless it has received prior permission from the PRA pursuant to section 138BA of FSMA not to treat that non-compliance as a trigger event.