The Bangko Sentral ng Pilipinas (BSP) has initiated disclosure requirements for debt instruments issued by banks which qualify as Basel III-eligible capital.
The move is a pro-active stance to strengthen investor protection in light of the so-called loss absorbency feature. Under the Basel III framework, debt instruments that are treated as part of bank capital must have a provision that requires such instruments, at the option of the relevant authority, to either be written off or converted into common equity upon the occurrence of trigger events. This puts these instruments on equal footing as traditional bank equity as far as the ability to absorb losses from operations.
Among the requirements is the conduct of a client suitability test to determine the prospective investor’s understanding of the risks. These types of instruments may not be suited to the general class of investors given the potential loss of principal once thresholds are breached during periods of stress.
Banks issuing securities with the loss absorbency feature must issue a risk disclosure statement. This document outlines to potential investors the financial risks involved with investing in the security as well as the processes that must be followed once the thresholds are breached. Investors must sign off on the risk disclosure statement to signify categorically that the investor has read the disclosure and understands the investment risks involved.
Loss absorbency of capital instruments is a key reform introduced in the Basel III reform agenda. Regulatory capital is now packaged to absorb losses before public funds are infused in troubled institutions.
Basel III is a set of reforms introduced by the Basel Committee on Banking Supervision. The standards include strengthening the definition of regulatory capital to withstand economic and financial stress. The guidelines apply to all issuances that qualify as banks’ additional Tier 1 or Tier 2 capital. These instruments, which possess capital-like properties, may form part of the 10 percent capital adequacy ratio (CAR) that banks must maintain.