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Participation capital rediscovered

Austrian credit institutions recently rediscovered the benefits of participation capital (partizipationskapital) when it comes to increasing their Core Tier I ratio and to enhancing their risk-bearing capacity. Inspired by the Austrian financial market stability scheme, intended to assist credit institutions and insurance undertakings in the looming financial crisis, institutions appear to have rediscovered this Austrian-specific instrument. Several Austrian banks have announced that they might draw on the state's assistance by issuing participation capital in order to enhance their financial status.


Originally implemented in the Austrian legal system in 1986 to help savings banks and mutual insurance undertakings to raise funds on the capital markets, participation capital takes an intermediate position between share capital and debt. In the early nineties, participation capital began to lose its appeal, due to an alleged lack of international compatibility. Furthermore, other own fund instruments, especially hybrid capital, increasingly appeared on the scene.

Key benefits

Its renewed popularity mainly follows from one big advantage of participation capital, namely its unlimited recognition as Core Tier I capital combined with the absence of voting rights of the participants.

Main statutory criteria

Pursuant to Section 23 of the Austrian Banking Act, Austrian credit institutions may include the proceeds of any such issuance in their Core Tier I capital. In order to allow recognition as Core Tier I capital and as to ensure loss absorbency on a going concern, dividends must be profit-related and non-cumulative.

The most important other statutory minimum criteria include perpetuality and participation in losses alongside share capital. A decrease in participation capital can only be achieved by applying capital decrease standards applicable to joint stock corporations.

Following recent amendments, the Austrian Banking Act states that the right of participation in liquidation proceeds must at least amount to the nominal amount. However, this floor should not be understood as having an impact on the loss absorbency of participation capital.

In addition to those regulatory requirements, the issue of participation capital under the new financial stability framework must meet the state aid-driven terms agreed upon at the EU level.

Balancing considerations

In its Communication C(2008) 8259 of December 5 2008, the Commission illustrated its particular views on certain recapitalisation measures proposed by lawmakers under the various national financial market stability schemes. In relation to participation capital issued by Austrian banks, two main considerations appear of interest: First, in a regulatory own-funds environment (basically linking the quality of own funds to their maturity and their degree of loss absorbency), the catalogue of incentives to redeem must run up against predominant prudential concepts at the outset. It is surprising that step-up features proposed to be applied to participation capital would be greatly in excess of what is allowed for (Austrian) hybrid Tier I (which is of lesser regulatory quality: see draft Article 63a of the proposed amendment to the Capital Requirements Directive and the step-up limits presented under Item 38 of the Committee of European Banking Supervisors' Proposal for a Common EU Definition of Tier I Hybrids dated March 26 2008), thereby creating synthetic maturities (usually being of unfavourable reputation among supervisors). Second, the proposed increased nominal redemption of principal hardly seems to achieve the desired goal (taking into account the perpetual nature of participation capital). It could rather be expected to have the opposite effect (which would be favourable from a supervisory perspective) of encouraging institutions to never redeem.

Government guarantee

As it proves to be quite challenging to bring the Community state-aid regime in line, regulatory requirements, as well as rating and pricing considerations in the context of participation capital and senior bonds backed by a governmental guarantee appear to be a viable funding alternative (if the own-funds situation allows), and Austrian banks have started making use of those instruments. The Austrian Federal Ministry of Finance has published a model guarantee for stand-alone issues and for issues under a debtor in possession on its website. Those guarantees are intended to allow investors to apply the rating of the Republic of Austria to guaranteed exposures subject to national solvency regulation and internal models.

Walter Gapp and Bernhard Marschall

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