Principal loss-absorbency mechanism


The PRA recognises that firms issuing restricted Tier 1 instruments (rT1) will need to achieve clarity as to the manner in which a principal loss-absorbency mechanism (PLAM) would operate2 and expects the instrument’s terms and conditions to be sufficiently clear, for the PRA to be confident that the mechanism works as expected and meets the requirements of the Solvency II Regulations. The Solvency II Regulations contain a number of high-level requirements which instruments with a PLAM will have to meet. The European Insurance and Occupational Pensions Authority (EIOPA) guidelines also clarified some aspects of how these requirements might apply in practice.


  • 2. Article 71(1)(e) of Regulation 2015/35.


The PRA considers that the minimum trigger point for an instrument with a PLAM will be that specified in the Solvency II Regulations3 and recognises that firms may choose a higher point or points for the mechanism to operate should they so wish.


  • 3. Article 71(8) of Regulation 2015/35.


If a trigger higher than the minimum is specified, the PRA expects this to be sufficiently clearly defined so that the firm could identify at any point in time whether or not that trigger is met.


Once the trigger point is reached, the PRA expects the instrument with a PLAM to achieve the write-down or conversion required by the Solvency II Regulations so that the nominal or principal amount absorbs loss.


Similarly if firms issue several instruments with a PLAM with differing trigger points, the PRA expects them to be mindful of the need for clarity and transparency regarding how they interact with each other, and the firm’s overall capital arrangements.


The PRA considers that any temporary write-down mechanism needs to be considered carefully in order to ensure that the potential for any subsequent write-up does not act to hinder future recapitalisation through the raising of new ordinary share capital. The PRA considers that the potential for eligible future profits to be used to restore the position of holders of the written-down instrument could be viewed by future potential shareholders as limiting the extent to which they might receive dividends and thus could act as a disincentive to their providing investment to recapitalise.


In addition, the Solvency II provisions require firms to demonstrate that any write-up mechanism has a basis for apportioning eligible future profits that does not undermine the loss absorbency of the instrument4, eg if appropriate, by adopting a similar basis as between all Tier 1 instruments, including ordinary share capital and the reconciliation reserve.