External rT1 instruments which write down on trigger or which convert on trigger and contain a conversion share offer


For any external rT1 instrument which writes down on trigger, issued on or after Thursday 21 February 2019, the PRA expects the issuing firm to deduct an amount to reflect the maximum tax charge generated on write-down when calculating its own funds. Firms are expected to do this both when calculating solo own funds and, where relevant, group own funds of a SII group to which the issuer belongs.


The PRA expects external rT1 instruments which convert on trigger and have a conversion share offer (CSO) issued on or after 16/03/20 to deduct an amount to reflect the maximum tax charge, before the set off of any prior year losses generated in the same manner, unless either condition A or condition B applies:

  • condition A is that the issuing firm has provided the PRA with a properly reasoned, independent tax opinion from an appropriately qualified person, taking into account HMRC precedent, statements and guidance, confirming that before the set off of any prior year losses, the exercise of the CSO would not create a tax charge (a ‘tax opinion’). Where a firm that has issued an rT1 instrument containing a CSO arrangement (the ‘original instrument’) and has provided the PRA with a corresponding tax opinion (the ‘original tax opinion’) proposes to issue a new rT1 instrument with a CSO arrangement on terms identical to those of the original instrument, instead of providing a new tax opinion, the firm may choose to obtain a confirmation from the original provider of the tax opinion that, taking into account any HMRC precedent, statements and guidance from time to time, the original tax opinion applies equally to the terms of the new rT1 instrument. The provider of the original tax opinion must continue to be independent of the firm for this condition to be fulfilled. The PRA would generally expect either a tax opinion or a subsequent confirmation to be provided at least 10 days before issuance of any rT1 instrument; and
  • condition B is that the terms of the external rT1 instrument expressly forbid the issuer from exercising the CSO unless it has provided the PRA with a tax opinion (no later than 10 days before it intends to exercise the CSO). The PRA expects such tax opinion to be current, and in any event issued not earlier than three months from the date of exercise of the CSO.


HMRC has informed us that they will calculate the tax charge before the set off of any prior year losses based on the face value of the rT1 instrument less the value of cash transferred to the rT1 noteholders by the ordinary shareholders through the CSO mechanism. However, the CSO price will not be known until after the instrument has been triggered and a CSO offer made.


Since the trigger event only occurs on significant breach of solvency capital requirement (SCR), it is realistic to assume that the market price of shares are impacted and therefore that the CSO price will be very low and potentially near the face value of the ordinary shares. For the purposes of the calculation of the maximum tax charge generated, the PRA therefore expects firms to calculate the tax adjustment on the assumption that the CSO price is set at the face value of the ordinary shares unless, at the point of issuance, the terms and conditions of the instrument state a higher minimum price, on or above which any CSO will be offered.


Where such a minimum CSO price is included in the terms and conditions, the PRA will expect the deduction to be calculated based on the difference between the face value of the rT1 instrument and the minimum CSO price.


That deduction should be calculated using the corporation tax rate applicable at the date the own funds is calculated. That being the case, the PRA expects that the deduction may change over the life of the instrument, if the relevant tax rate changes.


Firms that calculate their SCR using an approved internal model should not capture this loss of own funds in their modelling, as otherwise it would be double counted.

Instruments that convert on trigger unless the issuer has been taken over, in which case they write down


Certain rT1 instruments have been issued with features requiring that an instrument converts on trigger, but with provisions that if a takeover occurred then the instrument would revert to writedown instead. The PRA does not expect firms that have issued (or that issue in future) such instruments to adjust the amount of rT1 recognised as basic own funds (so long as if the instrument has a CSO they have observed the PRA’s expectation set out in paragraph 5.1A above) unless and until the principal loss absorbency mechanism has changed. At that point, the PRA does not expect the firm to restate its regulatory returns pertaining to periods before the change in rT1 instrument’s principal loss absorbency mechanism.