UK banks clear Treasury tax hurdle on capital deals
The UK banking sector could now be just months away from receiving the green light on issuing much-needed hybrid capital after the Treasury gave guidance for its tax treatment that went beyond what many market participants had expected.
The Treasury’s long-anticipated draft legislation on regulatory Additional Tier 1 and Tier 2 capital instruments, revealed on Tuesday, follows the finalisation of the Capital Requirements Regulation (CRR).
Crucially, the guidance confirms that these instruments will qualify as a loan relationship for UK tax rules and therefore will be free from withholding tax and stamp duty and will feature tax-deductibility on periodic payments.
But more importantly, bankers said, is the HMRC guidance that there will be no tax liability upon write-down of these instruments, and conversely no tax credit as a result of the principal amount being written up.
“The one thing that could have really held the UK up, and is still under discussion in most other jurisdictions, is whether the write-down on the instruments would be treated as a taxable gain,” said Simon McGeary, head of the new products group at Citigroup.
There is not yet complete clarity under the CRR around any impact on the upfront regulatory capital credit from a theoretical taxable gain, but if there is no taxable gain, this is taken off the table as a potential issue, said McGeary.
“This guidance completely removes that whole uncertainty, and if you assume that the proposals go through as they are by the end of the year, the UK is all set to go from an issuance perspective.”
Above and beyond
Kapil Damani, head of DCM capital solutions at BNP Paribas, agreed that the tax issue in the UK was one of the major obstacles for issuance – and one that is still hanging over most of Europe, with the exception of Sweden.
“We had previously heard that this would all be in force before December 31 this year; and now with this guidance in place, this timetable looks achievable,” said Damani.
He also pointed out safe-harbour language preventing issuers being taxed on fair value fluctuations of any embedded derivative component of AT1 or T2 instruments.
“This is important beyond just the UK, as it addresses the concern that still exists in a lot of jurisdictions where even if tax deductibility is assured, there is a concern around the “efficiency” of the Tier 1 as there is a potential issue if the write-down creates a taxable gain.”
Both bankers said they did not expect to see an imminent flood of deals, but think issuance is likely to pick up early next year, or possibly towards the end of this year.
What is still uncertain, for example, is whether AT1 will count as capital under the PRA’s definition of the leverage ratio. This measure, of equity held as a percentage of assets, without adjustments for risk, has gained higher profile in recent weeks following a global push by regulators for harmonised, higher levels.
“At the moment, under PRA rules, AT1 does not count. But the market will be waiting to see if that changes, especially after Basel continues to propose that these instruments count as capital in the numerator,” said Damani.
McGeary said that although the PRA is focused on CET1, the fact that UK banks will need to replace Tier 1 and Tier 2 in their capital structures should drive issuance.
“There is no grandfathering from a tax standpoint, so the UK banks may wait until early next year before announcing new capital deals.”