Maximum Distributable Amount – some clarity achieved

Maximum Distributable Amount – some clarity achieved

Despite the clarity offered by the EBA and ECB, confusion still looms.

Director, ECB Office

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CRD IV introduced the concept of Maximum Distributable Amount (MDA) which requires regulators to automatically restrict earnings distribution if a bank’s total capital falls below the sum of its Pillar 1, Pillar 2 and CRD buffer requirements (see graph).

In an earlier article on MDA, we highlighted the varying approaches by regulators across the EU in applying MDA that were generating some confusion among industry participants. Both the EBA and ECB clarified their understanding of MDA and how it works, however, the ECB clarification emerged nearly 2 months after the EBA.  As a result, regulatory uncertainty emerged and had a knock-on effect on the market for bank subordinated debt which was disrupted and saw large sell offs in early 2016. 

Total capital requirements

In December 2015, the EBA issued an opinion on the trigger calculation of MDA. It clarified that MDA should be calculated taking into account both Pillar 1 and Pillar 2 requirements as well as the combined CRD buffer requirements. They also endorsed transparency in Pillar 2 outcomes for all banks to facilitate investors in bank capital. In addition, they called upon the European Commission to revisit the CRR text to ‘ensure consistency and enable limited supervisory flexibility regarding distributions’. In short, they asked the Commission to revisit the Level 1 text.

The EBA announcement brought about an unintended consequence of further uncertainty among investors in bank bonds, while the lack of clarity from the ECB complicated matters further. Uncertainty prevailed in Q1 2016 with regard to how much room individual banks had before they got close to the MDA trigger. Additional Tier 1 bonds (also known as CoCo bonds - Convertible Capital bonds) suffered a huge sell-off as it was clear that AT1 coupons would be affected by MDA restrictions and investors did not have full visibility of all banks’ total regulatory capital requirements. In addition, the ECB had not endorsed transparency for public disclosure of Pillar 2 outcomes. The combined impact, alongside concerns about bank profitability, was to see the AT1 bond market sell-off and a reduction in issuance.

However, in late February 2016, the ECB did issue a clarification that helped calm the market and delivered some regulatory certainty. The ECB issued an insightful publication entitled, SSM SREP Methodology Booklet (PDF 920 KB).

The publication alongside commentary from senior officials clarified that:

  • The current Level of capital requirements imposed on banks represents close to a steady state for the quantum of capital required;
  • For calculating a MDA trigger point, the ECB will use the CET1 requirement instead of total regulatory capital, plus the Pillar 2 add-ons and CRD buffers;
  • As CRD buffers such as the capital conservation buffer are phased in, the Pillar 2 capital requirements will fall (all other things being equal);
  • The ECB has not formally stated a position on transparency of Pillar 2 outcomes but media commentary suggests a more neutral approach to such disclosures;
  • Finally, the ECB has also criticized the automatism of the MDA and suggested that it may be worthwhile to review it.

It is our understanding that the European Commission technical groups are looking at this issue and new proposals for the CRR text on MDA may emerge that may ultimately carve out AT1 coupons from the MDA restrictions.

The revisiting of the Level 1 text is also an opportunity for the ECB to simultaneously articulate more clearly how they set Pillar 2 requirements. One possibility is to replicate the PRA approach to setting Pillar 2 requirements into 2A and 2B requirements whereby Pillar 2B requirements would not form part of the binding capital requirements for MDA purposes. The ECB will also need to adopt a clearer position on Pillar 2 transparency. 

For clients, the clarity in how MDA will work is welcome and the less onerous requirement of using CET1 instead of total regulatory capital for the MDA trigger will help boost the market for AT1 bonds. It will also be interesting to see how this plays out in terms of how the ECB articulates Pillar 2 requirements to banks (will a forward looking non-binding element of Pillar 2 requirements be explicitly articulated?).

Furthermore, the move to full transparency to the market of Pillar 2 outcomes which has been floated by some ECB Supervisory Board members looks like an issue that will also need to be resolved quickly by the ECB. Changes in this area will force banks to revisit their own disclosure approaches and communication strategy around capital requirements.

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