The Capital Adequacy Ordinance (CAO) requires banks and securities dealers to have sufficient capital to underpin the risks inherent in their business. It sets down three main types of eligible capital:
Additional Tier 1 and Tier 2 include capital instruments that are recognised under debt on the balance sheet but can serve to absorb losses.
Banks and securities dealers are in principle not required to have these components of eligible regulatory capital authorised in advance by FINMA. However, it is quite common for them to submit plans for new capital instruments to FINMA in order to clarify whether or not they are eligible.
FINMA assesses the capital quality of new instruments. It restricts itself mainly to planned issues of specially structured bonds that qualify either as Additional Tier 1 or as Tier 2. In order to be eligible for inclusion in capital adequacy calculations, these debt instruments must be able to make a decisive contribution to the resolution of the bank or securities dealer before it becomes insolvent. They do this by means of contractually defined conversion into equity or a complete and irreversible waiver of claims.
Systemically important banks must seek FINMA’s authorisation to include convertible capital and bonds with a waiver of claims as required in Article 127 para. 2 CAO. The aim of this rule is to ensure that these instruments absorb losses as intended.