REQUIREMENTS FOR PREFERENCE SHARES

CHANGE IN THE REQUIREMENTS FOR PREFERENCE SHARES TO BE ELIGIBLE AS OWN FUNDS

In order to adapt the legal regime governing credit institution preference shares to international
requirements and thus ensure they are an effective instrument for meeting solvency
requirements, Spanish legislation has been changed in certain respects.
Specifically, the issuance conditions may not include early redemption incentives and
must set the remuneration to which the securityholders are entitled, provided always that
it shall be conditional on the existence of distributable profit or reserves. The Board of
Directors or equivalent body of the issuing or parent credit institution has the power to
cancel, at its discretion, when necessary, the payment of interest or dividends for an unlimited
period of time, on a non-cumulative basis. Payment may also be cancelled if the
issuing or parent credit institution or its consolidatable group or sub-group does not meet
the minimum capital requirements. In any event, the Banco de España may require the
cancellation of remuneration payments based on the financial and solvency situation of
the issuing or parent credit institution or on that of its consolidatable group or sub-group.
Also, a mechanism should be established to ensure that preference shareholders participate
in the absorption of present or future losses of the issuer or controlling institution.
That mechanism should be defined clearly and not hinder possible recapitalisation processes,
whether they be through the conversion of preference shares into ordinary shares,
non-voting equity units or capital contributions to credit cooperatives, or through the reduction
of the nominal value.
The mechanism must be applied in either of the following circumstances: a) where the issuing
or parent institution, or its consolidatable group or sub-group, has an original own
funds ratio, calculated in the same way as the solvency ratio, below 4% (the Banco de
España may set any other solvency ratio provided it is more demanding), or b) where the
issuing or parent institution, or its consolidatable group or sub-group, has an original own
funds ratio below 6% and material accounting losses.
When the mechanism is that of conversion into ordinary shares, non-voting equity units or
capital contributions to credit cooperatives of the issuing or parent credit institution, the
issuer has to allow immediate conversion and specify an exchange ratio which sets a floor
on the number and nominal amount of shares to be delivered. When the mechanism consists
in reducing the nominal amount of the preference shares, the losses incurred by the
issuer shall be apportioned between total capital and reserves, on the one hand, and total
preference shares outstanding, on the other.
The Banco de España may specify the preference share conversion conditions in accordance
with the aforementioned criteria and the manner of determining the losses and the
other indicators stated, particularly in the case of issues guaranteed by various institutions,
on the basis that the stipulated loss absorption mechanisms do not hinder possible
recapitalisation processes.
The limit on the outstanding nominal amount of preference shares remains at 30% of the
original own funds of the consolidatable group or sub-group of the controlling entity of the
issuing subsidiary, including the amount of the issue itself, without prejudice to any additional
limitations that may be imposed for solvency purposes. However, from now on, the
Banco de España may change this percentage, although it may never exceed 35%.
Preference shares continue to be perpetual and the issuer continues to have the option
of agreeing to early redemption from the fifth year after they were paid in, following
prior authorisation from the Banco de España. From now on, this authorisation is subject
to the financial situation or solvency of the credit institution or its consolidatable
group or sub-group being unaffected. It may also be made subject to the institution
replacing the redeemed preference shares with eligible capital items of the same or
higher quality.
In this respect the Banco de España may authorise at any time the early redemption of
dated or undated instruments in the event of any change in the fiscal regime or in the eligibility
of such instruments as own funds that was not envisaged at the issue date.
The payment of remuneration may be replaced, if so stipulated in the terms of issue, by the
delivery of ordinary shares of commercial banks or non-voting equity units of savings
banks or capital contributions to credit cooperatives, provided that this enables the institution
to preserve its financial resources.
This delivery of capital instruments will only be permissible if it produces the same economic
result as redemption, i.e. if it does not entail the reduction of capital of the institution,
10 and the issuer has full discretion to opt not to pay the remuneration in cash and,
furthermore, may cancel delivery of the capital instruments when necessary.
Lastly, the transitional regime envisaged in Law 6/2011 is implemented, such that the preference
shares issued before the entry into force of this Law (13 April 2011) and not meeting
the requirements under it may continue to be eligible as the own funds of credit institutions
and of their groups, subject to certain limits detailed in Royal Decree 771/2011.

The most noteworthy developments from the standpoint of financial regulation

The most noteworthy developments from the standpoint of financial regulation are as follows:
SECURITISATION.- Law 6/2011 makes it compulsory for credit institutions and investment firms to meet certain requirements to allow them to assume exposures to securitisation positions and to
initiate such securitisation.
Under these requirements, which are set out in Royal Decree 771/2011, a credit institution,
other than when acting as an originator, a sponsor or original lender, shall be exposed to
the credit risk of a securitisation position in its trading book or non-trading book only if the
originator, sponsor or original lender has explicitly disclosed to the credit institution that it
will retain, on an ongoing basis, a material net economic interest.
For these purposes, “retention of net economic interest” means: a) retention of no less
than 5% of the nominal value of each of the tranches sold or transferred to the investors;
b) in the case of securitisations of revolving exposures, retention of the originator’s interest
of no less than 5% of the nominal value of the securitised exposures;7 c) retention of
randomly selected exposures, equivalent to no less than 5% of the nominal amount of
the securitised exposures, provided that the number of potentially securitised exposures
is no less than 100 at origination; or d) retention of the first loss tranche and, if necessary,
other tranches having the same or a more severe risk profile than those transferred
or sold to investors and not maturing any earlier than those transferred or sold to investors,
so that the retention equals in total no less than 5% of the nominal value of the
securitised exposures.
The Banco de España may specify the conditions of application of this Law and how those
institutions will communicate the retention requirement to investors. This communication
must allow them ready access to all pertinent data on exposures. Also, the Banco de España
may opt to suspend temporarily the aforementioned requirements during periods of
general market liquidity crisis.

Amendment of the law on credit institutions

Amendment of the law on credit institutions’ own funds and on credit institution deposit guarantee funds.

Law 6/2011 of 11 April 2011 (BOE of 12 April 2011) amended Law 13/1985 of 25 May 19851 on investment ratios, own funds and reporting requirements for financial intermediaries, Law 24/1988 of 28 July 19882 on the securities market and Legislative Royal Decree 1298/1986 of 28 June 19863 on the adaptation of current credit institution law to EU legislation.
The purpose of the Law is to commence transposition of Directive 2009/111/EC of the European Parliament and of the Council of 16 September 2009 amending Directives 2006/48/ EC, 2006/49/EC and 2007/64/EC as regards banks affiliated to central institutions, certain own funds items, large exposures, supervisory arrangements, and crisis management.

More recently, Royal Decree 771/2011 of 3 June 2011 (BOE of 4 June 2011) amended Royal Decree 216/2008 of 15 February 20084 on financial institutions’ own funds and Royal Decree 2606/1996 of 20 December 19965 on credit institution deposit guarantee funds. This Royal Decree implements Law 2/2011 of 4 March 2011 on sustainable economy and Law 6/2011 of 11 April 2011. It also makes headway in the transposition of Directive 2009/111/EC and of Dire ctive 2010 /76/E U o f the European Parliament and of the Council of 24 November 20106 amending Directives 2006/48/EC and 2006/49/EC as regards capital
requirements for the trading book and for resecuritisations and the supervisory review of remuneration policies.
It also takes the opportunity to introduce a new legal regime governing additional contributions to credit institution deposit guarantee funds based on the remuneration of the deposits, in line with the provisions being adopted in this connection in the EU.
More information:  Management

CREDIT INSTITUTION REMUNERATION POLICIES

In accordance with the transposition of Directive 2010/76/EU of the European Parliament and of the Council of  24 November 2010, credit institutions have to apply certain requirements for those categories of staff whose professional activities have a material impact on their risk profile at group, parent and subsidiary levels.
Most notable among other requirements are the following:
a) a list indicating the categories of the aforementioned staff must be submitted to the Banco de España ;
b) the remuneration policy is consistent with sound and effective risk management, does not encourage risk-taking that exceeds the level of tolerated risk of the credit institution and incorporates measures to avoid conflicts of interest;
c) the management body adopts and periodically reviews the general principles of the remuneration policy at least annually, and the implementation of the remuneration policy is subject to central and independent internal review for compliance with the remuneration policies and procedures in place;
d) staff engaged in control functions are independent from the business units they oversee, and are remunerated in accordance with the achievement of the objectives linked to their functions; and
e) the remuneration of the senior officers in the risk management and compliance functions is directly overseen by a remuneration committee or, if such a committee has not been established, by the relevant management body.
The new legislation regulates the design of remuneration schemes, in which the fixed and variable components should be appropriately and efficiently balanced. The variable remuneration components should be sufficiently flexible such that their adjustment includes the possibility to pay no variable remuneration component.
For these purposes, the Banco de España may establish specific criteria for determining the appropriate proportion between fixed and variable components. The variable remuneration components should create incentives aligned with the long-term interests of the institution and meet certain requirements set out in Royal Decree 771/2011.
The remuneration schemes of credit institutions which receive government financial support
for restructuring purposes have to meet, in addition to the foregoing requirements, the following ones:
a) where variable remuneration is incompatible with a sound capital base and with an appropriate waiver of government support, it shall be strictly limited to a percentage of net income and
b) the directors and managers who effectively direct the activity of the institution may not receive variable remuneration unless it is duly justified in the opinion of the Banco de España, which may, moreover, set limits on their total remuneration.

Most of the remuneration policy is extended to investment firms, such that the references
to the Banco de España and to credit institutions shall be deemed to be to the CNMV and
to investment firms, respectively.

Financial Regulation 2011

In 2011 Q2 a relatively small number of new financial provisions was promulgated in comparison with previous periods.
In the field of financial institutions, Spanish solvency law was amended to adapt it partially to recent Union legislation. The opportunity was taken to introduce a new legal regime governing additional contributions to credit institution deposit guarantee fund based on the remuneration of these instruments.
Also, amendments were made to adapt Spanish law on payment and securities settlement systems to Union legislation, particularly to recognise so-called “interoperable systems” and to extend to them the legal provisions on settlement finality in credit transfer orders.
In the European Union area, there were four notable new provisions: the amendment of TARGET legislation to enable the ECB to provide overnight credit to certain counterparty institutions not licensed as credit institutions; the regulation of mergers of public limited companies in order to unify the protection of shareholders’ and third parties’ interests in these processes in Member States; the updating of legislation on purchases of euro banknotes; and the amendment of the EU regulation on credit rating agencies to include the functions acquired by the new European Securities and Markets Authority.
Within the securities market, there were three new pieces of legislation: the adaptation of Spanish law to EU legislation on credit rating agencies; certain changes to the information required of foreign collective investment institutions registered in the CNMV registers; and the updating of collective investment institution categories based on investment policy.
Finally, a new law on consumer credit agreements writes into Spanish law the recent European legislation in this connection.