Chile: Basel III And Its Implementation In Chile

Last Updated: 1 November 2016
Article by Felipe Moro and Gabriel Acuña
Most Popular Article in Chile, November 2016

BASEL III'S NEW CAPITAL REQUIREMENTS

Chile is one of the few countries that endured the last global financial crisis, and emerged with a solid and stable economy, mainly due to the strength of its banking sector. Conservative Chilean banks and their zealous authorities learned the lessons from the country's financial crisis in 1982; since then, they have carefully avoided systemic risk, over lending and have kept safe levels of liquidity. Additionally, the Chilean banking industry has grown steadily for the last 30 years. Chile did not adopt Basel II, but the GBA already provided for (and still does) a regulatory capital of at least 8% of risk-weighted assets at all times, equivalent to standard capital requirements under Basel III. Regulatory capital under the GBA is almost entirely comprised of equity and undistributed revenue. However, it does not contemplate Tier 2 capital and the new Additional Tier 1 (AT1) feature of Basel III. AT1 is introduced by Basel III as a new high quality capital base intended to strengthen banks' positions when facing risk exposure. As such, the instruments qualifying for AT1 are required to contain certain special features which limit their availability in certain markets. AT1, together with the counter-cyclical buffer, can be considered the most relevant changes from Basel II regarding capital requirements.

BASEL III IN CHILE

The Chilean government is undertaking a major reform of the GBA in order to comply with Basel III's requirements. The motivation for the reform is the internationalisation of the Chilean banking sector, the increasing local presence of foreign banks and the aim to meet international financial standards. One aspect of this reform is the inclusion of AT1. Preliminary estimates by the banking industry indicate that the gap between current levels of capital and those to be achieved under Basel III is around US$4bn. This is a considerable amount which needs to be met by either equity or instruments that meet the criteria to be included in AT1. Bearing this in mind, the industry has begun to analyse the legal framework and the potential amendments required for these instruments to exist in Chile.

AT1 INSTRUMENTS: LEGAL ISSUES

The discretionary character of AT1 instruments and the ability of banks to use these instruments to overcome sudden liquidity crises is essential for Basel III. Some of the main criteria to qualify as an AT1 instrument under Basel III are that: ––the instruments are subordinated to depositors, general creditors and the subordinated debt of the bank;

  • they are unsecured;
  • they are perpetual (no maturity date or incentives to redeem);
  • the instruments may be callable at the sole initiative of the issuer after five years but with prior supervisory approval, among other requirements;
  • repayments (eg through repurchase or redemption) should be made with prior supervisory approval;
  • with regard to dividends or coupons:

    • banks must have full discretion to cancel these payments;
    • discretionary cancellation must not be an event of default;
    • banks must have full access to cancelled payments to meet obligations as they fall due;
    • cancellation of dividends or coupons must not result in any restrictions on the bank, except that the bank cannot distribute dividends to common stockholders; and
  • payments must be paid out of distributable reserves.
  • We will focus on three topics from this list:
  • the perpetuity of the instruments;
  • dividend/coupon payment discretion; and
  • equity-like behaviour (particularly the non-distribution to common stockholders when cancellation takes place).

NOTHING LASTS FOREVER

Perpetuity of debt instruments is an issue in Chile. Under the Chilean Securities Market Law (SML), the public offering of debt securities with terms longer than one year must be made through bonds and subject to the provisions of the SML. For banks, the SML states that banks and financial institutions will not be subject to its rules, and, if authorised by their applicable regulations to issue bonds, must do so under those rules and subject to the supervision of the Banks and Financial Institutions Commission (Superintendencia de Bancos e Instituciones Financieras, (SBIF)).

Although the GBA addresses the issuance of bonds by banks, and deals with subordinated debt issuances and procedures, there are no other relevant provisions. Further, neither the SML nor the GBA define 'bonds' either on a legal or regulatory basis. How then can regulators determine what hybrid features if any, can be included in a bond? Can bonds be perpetual? What are the limits? Going back to basics, the Chilean Civil Code states that the term of an obligation is the time chosen for its fulfilment either by the law, the parties or by the nature of the obligation itself. It also states that the tacit or implicit term is that considered indispensable to fulfil the obligation. The law is silent, however, with regard to termless or perpetual obligations. If we simplify the concept of a bond (which as mentioned above, is not expressly defined under Chilean law) and include it within the traditional definition of a money credit operation, it would comprise an operation by which one party provides funds to another party, the latter which assumes the obligation to pay back those funds in the future. In the case of hybrid instruments with equity features, principal will not be paid at all, unless the instrument is redeemed. Chilean companies have tried to issue perpetual debt instruments in the past, but these issuances have been discarded by the authorities based on the argument that inserting "perpetual" in the section related to "Term" on the requisite form is not acceptable as the concept of a perpetual term is not recognised.

PLAYING IT SAFE

Insurance companies and pension funds, as the largest institutional investors in the country, are the natural target for hybrid instruments. However, the discretion whether to make a payment under hybrid securities is an unattractive feature for Chilean investors, especially institutional ones. AT1 hybrids have performed well in other markets to date, but the Chilean market remains sceptical about its implementation, extending a long shadow over hybrids' future. Risk rating agencies are rating the hybrid debt up to five notches higher than the issuer's credit rating which is not helping matters.The Chilean pension system is based on mandatory savings deducted from employees' salaries. This money is channelled through to different funds depending on the age and risk profile of the employee. The funds are managed and invested by heavily regulated private management entities (Administradoras de Fondos de Pensiones, or "AFP"). AFPs and the entire pension system are currently under intense scrutiny from the public, and investing in instruments for which payment (and yield) can be cancelled at the discretion of the issuer is not an attractive prospect as it creates a higher level of risk when dealing with employee's retirement funds. Insurance companies are heavily regulated too. The Decree with Force of Law No 251 (Insurance Law) provides that insurance companies must back up their technical reserves and equity using specific instruments and assets, which include bonds and other debt instruments. However, the concept of bonds is not defined here either, and AT1 hybrids do not meet the criteria. In this industry, companies are regarded as conservative and not willing to invest without a clear return. Selling payment discretion to these 'natural' buyers will prove to be a formidable challenge for market arrangers, financial advisors and Basel III's promoters.

DIVIDENDS DISTRIBUTION

Basel III imposes two requirements that are a cause of concern for banks' shareholders, and could require specific exemptions: (i) the ability to cancel payments can be exercised by the issuer without imposing restrictions on the issuer, other than on the distribution of dividends to its shareholders; and (ii) payments to holders of hybrid instruments must be made from distributable funds.

In Chile, banks must be incorporated as "special corporations". This subjects them to the Corporations Law (CL), with certain specific exceptions. The CL states that unless otherwise agreed in an extraordinary shareholders' meeting by a unanimous vote of all the shareholders, corporations must distribute at least 30% of their net profits annually. The GBA forbids, as does Basel III, distributions of dividends if as a result of the distribution the minimum regulatory capital is affected. Additionally, banks as corporations subject to the CL, are required to distribute minimum dividends.

Accordingly, no payment on a hybrid instrument can be cancelled if there are distributable profits at the bank, unless all of the bank's shareholders agree to waive their right to receive their minimum mandatory dividends in a given year. Even in highly concentrated banks, it would be difficult to align the interests of all minority shareholders to secure their consent when they are less concerned with diluting their shareholding and more interested in obtaining a return on their investment. Rather than accepting hybrid instruments, shareholders will most likely demand that additional equity be brought in by the controlling entities and majority shareholders.

WHAT NOW?

The implementation of Basel III is on its way, and even though the SBIF's commissioner has clarified that Chile is not adopting Basel III, but adapting it, a tremendous effort will still be required from a regulatory, financial and market standpoint in order to successfully implement the required changes.

All parties involved should take advantage of the unique momentum that is currently active in Chile. The SBIF, the GBA and the Securities and Insurance Commission (Superintendencia de Valores y Seguros) are being modernised, and the country is energetically promoting investments and strengthening its financial sector in order to overcome the consequences of the global financial crisis, low copper prices and the implementation of numerous political reforms that have affected the country's growth. Fulfilling local expectations and at the same time meeting international standards represents a challenge for the financial authorities and industry.

There are a number of difficult issues that must be discussed, adapted, enhanced and possibly discarded in order to move forward, and all stakeholders must work together to find innovative solutions to allow them to overcome these obstacles and move the country to the forefront in hybrid instruments.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
Felipe Moro
 
Some comments from our readers…
“The articles are extremely timely and highly applicable”
“I often find critical information not available elsewhere”
“As in-house counsel, Mondaq’s service is of great value”

Mondaq Advice Centre (MACs)
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
 
Email Address
Company Name
Password
Confirm Password
Mondaq Topics -- Select your Interests
 Accounting
 Anti-trust
 Commercial
 Compliance
 Consumer
 Criminal
 Employment
 Energy
 Environment
 Family
 Finance
 Government
 Healthcare
 Immigration
 Insolvency
 Insurance
 International
 IP
 Law Performance
 Law Practice
 Litigation
 Media & IT
 Privacy
 Real Estate
 Strategy
 Tax
 Technology
 Transport
 Wealth Mgt
Regions
Africa
Asia
Asia Pacific
Australasia
Canada
Caribbean
Europe
European Union
Latin America
Middle East
U.K.
United States
Worldwide Updates
Check to state you have read and
agree to our Terms and Conditions

Terms & Conditions and Privacy Statement

Mondaq.com (the Website) is owned and managed by Mondaq Ltd and as a user you are granted a non-exclusive, revocable license to access the Website under its terms and conditions of use. Your use of the Website constitutes your agreement to the following terms and conditions of use. Mondaq Ltd may terminate your use of the Website if you are in breach of these terms and conditions or if Mondaq Ltd decides to terminate your license of use for whatever reason.

Use of www.mondaq.com

You may use the Website but are required to register as a user if you wish to read the full text of the content and articles available (the Content). You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these terms & conditions or with the prior written consent of Mondaq Ltd. You may not use electronic or other means to extract details or information about Mondaq.com’s content, users or contributors in order to offer them any services or products which compete directly or indirectly with Mondaq Ltd’s services and products.

Disclaimer

Mondaq Ltd and/or its respective suppliers make no representations about the suitability of the information contained in the documents and related graphics published on this server for any purpose. All such documents and related graphics are provided "as is" without warranty of any kind. Mondaq Ltd and/or its respective suppliers hereby disclaim all warranties and conditions with regard to this information, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. In no event shall Mondaq Ltd and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use or performance of information available from this server.

The documents and related graphics published on this server could include technical inaccuracies or typographical errors. Changes are periodically added to the information herein. Mondaq Ltd and/or its respective suppliers may make improvements and/or changes in the product(s) and/or the program(s) described herein at any time.

Registration

Mondaq Ltd requires you to register and provide information that personally identifies you, including what sort of information you are interested in, for three primary purposes:

  • To allow you to personalize the Mondaq websites you are visiting.
  • To enable features such as password reminder, newsletter alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our information providers who provide information free for your use.

Mondaq (and its affiliate sites) do not sell or provide your details to third parties other than information providers. The reason we provide our information providers with this information is so that they can measure the response their articles are receiving and provide you with information about their products and services.

If you do not want us to provide your name and email address you may opt out by clicking here .

If you do not wish to receive any future announcements of products and services offered by Mondaq by clicking here .

Information Collection and Use

We require site users to register with Mondaq (and its affiliate sites) to view the free information on the site. We also collect information from our users at several different points on the websites: this is so that we can customise the sites according to individual usage, provide 'session-aware' functionality, and ensure that content is acquired and developed appropriately. This gives us an overall picture of our user profiles, which in turn shows to our Editorial Contributors the type of person they are reaching by posting articles on Mondaq (and its affiliate sites) – meaning more free content for registered users.

We are only able to provide the material on the Mondaq (and its affiliate sites) site free to site visitors because we can pass on information about the pages that users are viewing and the personal information users provide to us (e.g. email addresses) to reputable contributing firms such as law firms who author those pages. We do not sell or rent information to anyone else other than the authors of those pages, who may change from time to time. Should you wish us not to disclose your details to any of these parties, please tick the box above or tick the box marked "Opt out of Registration Information Disclosure" on the Your Profile page. We and our author organisations may only contact you via email or other means if you allow us to do so. Users can opt out of contact when they register on the site, or send an email to unsubscribe@mondaq.com with “no disclosure” in the subject heading

Mondaq News Alerts

In order to receive Mondaq News Alerts, users have to complete a separate registration form. This is a personalised service where users choose regions and topics of interest and we send it only to those users who have requested it. Users can stop receiving these Alerts by going to the Mondaq News Alerts page and deselecting all interest areas. In the same way users can amend their personal preferences to add or remove subject areas.

Cookies

A cookie is a small text file written to a user’s hard drive that contains an identifying user number. The cookies do not contain any personal information about users. We use the cookie so users do not have to log in every time they use the service and the cookie will automatically expire if you do not visit the Mondaq website (or its affiliate sites) for 12 months. We also use the cookie to personalise a user's experience of the site (for example to show information specific to a user's region). As the Mondaq sites are fully personalised and cookies are essential to its core technology the site will function unpredictably with browsers that do not support cookies - or where cookies are disabled (in these circumstances we advise you to attempt to locate the information you require elsewhere on the web). However if you are concerned about the presence of a Mondaq cookie on your machine you can also choose to expire the cookie immediately (remove it) by selecting the 'Log Off' menu option as the last thing you do when you use the site.

Some of our business partners may use cookies on our site (for example, advertisers). However, we have no access to or control over these cookies and we are not aware of any at present that do so.

Log Files

We use IP addresses to analyse trends, administer the site, track movement, and gather broad demographic information for aggregate use. IP addresses are not linked to personally identifiable information.

Links

This web site contains links to other sites. Please be aware that Mondaq (or its affiliate sites) are not responsible for the privacy practices of such other sites. We encourage our users to be aware when they leave our site and to read the privacy statements of these third party sites. This privacy statement applies solely to information collected by this Web site.

Surveys & Contests

From time-to-time our site requests information from users via surveys or contests. Participation in these surveys or contests is completely voluntary and the user therefore has a choice whether or not to disclose any information requested. Information requested may include contact information (such as name and delivery address), and demographic information (such as postcode, age level). Contact information will be used to notify the winners and award prizes. Survey information will be used for purposes of monitoring or improving the functionality of the site.

Mail-A-Friend

If a user elects to use our referral service for informing a friend about our site, we ask them for the friend’s name and email address. Mondaq stores this information and may contact the friend to invite them to register with Mondaq, but they will not be contacted more than once. The friend may contact Mondaq to request the removal of this information from our database.

Security

This website takes every reasonable precaution to protect our users’ information. When users submit sensitive information via the website, your information is protected using firewalls and other security technology. If you have any questions about the security at our website, you can send an email to webmaster@mondaq.com.

Correcting/Updating Personal Information

If a user’s personally identifiable information changes (such as postcode), or if a user no longer desires our service, we will endeavour to provide a way to correct, update or remove that user’s personal data provided to us. This can usually be done at the “Your Profile” page or by sending an email to EditorialAdvisor@mondaq.com.

Notification of Changes

If we decide to change our Terms & Conditions or Privacy Policy, we will post those changes on our site so our users are always aware of what information we collect, how we use it, and under what circumstances, if any, we disclose it. If at any point we decide to use personally identifiable information in a manner different from that stated at the time it was collected, we will notify users by way of an email. Users will have a choice as to whether or not we use their information in this different manner. We will use information in accordance with the privacy policy under which the information was collected.

How to contact Mondaq

You can contact us with comments or queries at enquiries@mondaq.com.

If for some reason you believe Mondaq Ltd. has not adhered to these principles, please notify us by e-mail at problems@mondaq.com and we will use commercially reasonable efforts to determine and correct the problem promptly.