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By Natalie Harrison
LONDON, July 16 (IFR) - The UK banking sector could now bejust months away from receiving the green light on issuingmuch-needed hybrid capital after the Treasury gave guidance forits tax treatment that went beyond what many market participantshad expected.
The Treasury's long-anticipated draft legislation onregulatory Additional Tier 1 and Tier 2 capital instruments,revealed on Tuesday, follows the finalisation of the CapitalRequirements Regulation (CRR).
Crucially, the guidance confirms that these instruments willqualify as a loan relationship for UK tax rules and thereforewill be free from withholding tax and stamp duty and willfeature tax-deductibility on periodic payments.
But more importantly, bankers said, is the HMRC guidancethat there will be no tax liability upon write-down of theseinstruments, and conversely no tax credit as a result of theprincipal amount being written up.
"The one thing that could have really held the UK up, and isstill under discussion in most other jurisdictions, is whetherthe write-down on the instruments would be treated as a taxablegain," said Simon McGeary, head of the new products group atCitigroup.
There is not yet complete clarity under the CRR around anyimpact on the upfront regulatory capital credit from atheoretical taxable gain, but if there is no taxable gain, thisis 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 bythe end of the year, the UK is all set to go from an issuanceperspective."
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 majorobstacles for issuance - and one that is still hanging over mostof Europe, with the exception of Sweden.
"We had previously heard that this would all be in forcebefore December 31 this year; and now with this guidance inplace, this timetable looks achievable," said Damani.
He also pointed out safe-harbour language preventing issuersbeing taxed on fair value fluctuations of any embeddedderivative component of AT1 or T2 instruments.
"This is important beyond just the UK, as it addresses theconcern that still exists in a lot of jurisdictions where evenif tax deductibility is assured, there is a concern around the"efficiency" of the Tier 1 as there is a potential issue if thewrite-down creates a taxable gain."
Both bankers said they did not expect to see an imminentflood of deals, but think issuance is likely to pick up earlynext year, or possibly towards the end of this year.
What is still uncertain, for example, is whether AT1 willcount as capital under the PRA's definition of the leverageratio. This measure, of equity held as a percentage of assets,without adjustments for risk, has gained higher profile inrecent weeks following a global push by regulators forharmonised, higher levels.
"At the moment, under PRA rules, AT1 does not count. But themarket will be waiting to see if that changes, especially afterBasel continues to propose that these instruments count ascapital in the numerator," said Damani.
McGeary said that although the PRA is focused on CET1, thefact that UK banks will need to replace Tier 1 and Tier 2 intheir capital structures should drive issuance.
"There is no grandfathering from a tax standpoint, so the UKbanks may wait until early next year before announcing newcapital deals."
