Prudential Regulation Authority Rulebook

4.1

This section is relevant to all firms assessing the quality of their own-fund items by reference to the features determining classification as Tier 1.

4.2

The same considerations can also apply where own-fund items are classified in Tier 2 and the Solvency II Regulations require deferral as opposed to cancellation of distributions.

4.3

All items of basic own funds must meet the criteria in Own Funds 3 and the features determining classification in the Solvency II Regulations. In relation to paid-in ordinary share capital, matters such as the absence of mandatory fixed charges or encumbrances will be a characteristic until such time as a dividend is declared but the shares would cease to meet this criterion unless there is the ability to cancel a dividend after this point but prior to payment. 

4.4

The PRA considers that where a firm’s articles of association do not prohibit the cancellation of a dividend at any time, including after declaration, then they may be said to allow such cancellation so that the firm may be able to declare a dividend on a conditional basis, allowing cancellation of the dividend at any time prior to payment, if the applicable conditions are not met. Firms should ensure that they review their own articles to establish the absence of any such prohibition. Firms should also consider whether it is appropriate to amend their articles to include a specific power for the firm to declare dividends subject to conditions or even for all declarations of dividend to be conditional upon fulfilment of the requirements in the Solvency II Regulations. Firms should give consideration to amending their articles so that all declarations of dividends are conditional, particularly if they have concerns that otherwise they may inadvertently declare an unconditional dividend. 

4.5

Article 71 of the Solvency II Regulations sets out in more detail the nature of the conditionality that firms will need to apply to their declaration of dividends for these purposes. In order to link these provisions with the PRA Rulebook, Own Funds 3.7(1) requires firms to include in their classification of Tier 1 own funds only ordinary share capital in respect of which a dividend or other distribution is capable of being cancelled and withheld at any time prior to payment and where the firm exercises its rights to do so, where necessary. Where firms whose articles so permit adopt the practice of declaring all dividends conditionally (or amend their articles to provide that all dividends are conditional) and the conditions applied satisfy the requirements of Article 71 of the Solvency II Regulations, they would be in a position to satisfy Own Funds 3.7(1).

4.6

There may be additional considerations for any firms with publicly traded shares for which an ‘ex dividend’ date may apply. Such firms may also have disclosure or other obligations arising from their listing arrangements in relation to possible non-payment of a declared dividend. The PRA expects firms to continue to monitor their solvency positions carefully during this time and to engage with supervisors at an early stage to be assured that the need to cancel dividends is unlikely to arise.

4.7

The same considerations as to cancellation (or, in the case of Tier 2 own funds, deferral) of distributions apply to relevant Tier 1 own-fund items of mutuals. These comprise paid-in initial fund, members’ contributions and any other equivalent items. While for many mutuals, distributions in relation to these items may not be relevant or common, reference to the firm’s constitution or governing statute should be made to confirm that there are no provisions in relation to distributions which would disqualify the item as Tier 1 own funds.

4.8

The PRA is adopting this approach in order to provide clarity as to the manner in which relevant firms can demonstrate when classifying items as own funds that ordinary share capital can qualify as Tier 1 (or Tier 2) own funds. While firms may incur some administrative and legal costs in order to achieve compliance with this approach, the benefits of retaining compliant own funds will outweigh these.