The Australian Prudential Regulation Authority has issued a reminder to regulated entities that it has the final say as to whether a capital instrument can be called, and its approval should not be taken as a given.
APRA has written to ADIs, general insurers and life insurers saying they must take care to meet prudential requirements when calling capital instruments in an environment of higher credit spreads.
It said that with credit spreads widening, “uneconomic calls” may create an expectation that the issuer will exercise a call option on other outstanding additional tier 1 capital and tier 2 capital instruments with call options.
“It is critical that an APRA regulated entity’s capital base is high quality and has a high degree of permanence. To that end, an instrument issued by an ADI or insurer must meet all applicable criteria specified in the relevant prudential standard relating to the measurement of capital,” the regulator said.
The criteria include a requirement that additional tier 1 capital provide a permanent and unrestricted commitment of funds and that tier 2 capital be amortised in the five years to maturity.
“The issuer must not create an expectation that a call will be exercised,” APRA said.
It said ADIs and insurers generally should not call additional tier 1 or tier 2 capital instruments and replace them with instruments with higher credit spreads, or that are otherwise more expensive, as it may create the expectation that the issuer will exercise a call option on their outstanding instruments.
“An exception would be where an issuer can satisfy APRA as to the economic and prudential rationale of the call, and that such action will not create an expectation that other instruments will be called in similar circumstances.”
Nick Chaplin, lead portfolio manager at BondAdviser, said there had been examples where instruments have been called and new capital issued at higher spreads, and this was likely to continue.
“But what APRA is saying is that the market should not expect that instruments will always be called. If conditions demand that it does not give approval for the instrument to be called, it does not want the market to be surprised,” Chaplin said.
“APRA feels it is important now to restate that additional tier 1 and tier 2 capital instruments are long-term capital to be used to absorb losses.”