BaFin approves for the first time unpaid equity commitment as a Tier 2 ancillary own-fund item, creating a cash-efficient alternative to group-internal own-fund financing

Previously, other supervisory authorities in Europe (including the National Bank of Belgium and the Italian insurance regulator IVASS) had already accepted capital instruments as own-fund items under which the shareholder commits to the insurance undertaking upon its request to inject additional equity. In the past, German insurance undertakings have traditionally issued unpaid shares when a group-internal capitalization was intended only to increase the own funds and no new liquidity had to be injected into the insurance undertaking. Germany‘s insurance regulator BaFin has already been approving these unpaid shares as Tier 2 ancillary own-funds. This form of intra-group financing however had the disadvantage that a rather elaborate process (a capital increase through cash contributions) had to be completed, the equity could be released again only by going through another special process (a capital decrease) and only with BaFin‘s approval, and at least one quarter of the amount of the capital increase was required to be actually paid into the undertaking.

Now, for the first time, BaFin has accepted commitments given by a shareholder as Tier 2 ancillary own-funds under which that shareholder commits upon the request of the insurance undertaking to inject an amount as cash payment into the insurance undertaking‘s free capital reserves. This means that, already at this stage, the full outstanding amount qualifies as own-fund item, making it possible to strengthen the regulatory own funds of a subsidiary without injecting additional liquidity. In times when the costs of external financing are rising again, BaFin‘s decision has not only established a competitive framework for German insurance undertakings to receive funding from within their groups but also created a level playing field for them to compete on with their European counterparts.

The legal basis for the approval is Article (74)(i) of Commission Delegated Regulation (EU) 2015/35 and Section 89(4) sentence 2 no. 4 of the German Insurance Supervision Act (VAG). For a capital instrument to be recognised as an ancillary own-fund item, BaFin‘s prior approval is required under Section 90(1) of the VAG. In addition to qualitative requirements relating to the counterparty of the equity commitment, BaFin examines in particular the specific structure and design of such a commitment, for example its term, the cancellation provisions and the conditions that must be met for funds to be called and disbursed. Therefore, when drafting any equity commitment letter, it is necessary to make sure that the regulatory requirements as to recoverability and loss-absorbing capacity are satisfied.

Once again, BaFin has shown its willingness to favourably examine innovative instruments that strengthen insurance undertakings‘ own funds. Prior to this decision, BaFin was open to develop together with the German Insurance Association (GDV) template terms and conditions for convertible bonds and write-down bonds, which insurance undertakings can issue as subordinated Tier 1 bonds (restricted Tier 1). In the past, BaFin had, under certain conditions, also approved subordinated credit lines as Tier 3 ancillary own-fund items.