REPORT FROM THE COMMISSION TO THE EUROPEAN PARLIAMENT AND THE COUNCIL on the review of the appropriateness of the definition of "eligible capital" pursuant to Article 517 of Regulation (EU) No 575/2013
Date: 2016-01-26
Institutions: Directorate-General for Financial Stability, Financial Services and Capital Markets Union, European Commission
Subjects: banking policy, credit institution, financial legislation, financial requirements, investment company, shareholding

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   EN 

   EUROPEAN COMMISSION  Brussels, 26.1.2016  COM(2016) 21 final   REPORT FROM THE COMMISSION TO THE EUROPEAN PARLIAMENT AND THE COUNCIL on the review of the appropriateness of the definition of "eligible capital" pursuant to Article 517 of Regulation (EU) No 575/2013  
 
 
TABLE OF CONTENTS 

1. INTRODUCTION ........................................................................................................... 3 

2. THE DIFFERENCE BETWEEN ‘ELIGIBLE CAPITAL’ AND ‘OWN FUNDS’ ....... 3 

3. THE SCOPE OF APPLICATION OF THE CONCEPT OF ‘ELIGIBLE CAPITAL’ ... 4 

4. THE APPROPRIATENESS OF THE NOTION OF ‘ELIGIBLE CAPITAL’ ............... 5 

5. CONCLUSION ............................................................................................................... 5 

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1. INTRODUCTION 

The capital requirements applicable to investment firms with limited investment services, the 
prudential treatment of an institution's qualifying holdings outside the financial sector and the 
definition of institutions' ‘large exposures’ and its limits have been based, until 31 December 
of 2013, on the notion of ‘own funds'1.  

The  ‘own  funds’  definition  was  substituted  from  1  January  2014  with  the  definition  of 
‘eligible  capital’  for  the  purposes  to  be  used  in  the  above  mentioned  fields  regulated  by 
Regulation  (EU)  No  575/2013  on  prudential  requirements  for  credit  institutions  and 
investment firms of 26 June 2013 (hereafter also Capital Requirement Regulation or CRR). 

The definition of 'eligible capital' was introduced without conducting an impact assessment. 
For  this  reason,  the  implementation  of  the  new  regime  is  however  subject  to  a  three-year 
transitional period (ending on 31 December 2016)2 and it is subject to review before its full 
implementation. 

The  report  fulfils  the  obligation  laid  down  in  Article  517  of  the  Capital  Requirement 
Regulation,  according  to  which  the  Commission  shall  review  and  report  to  the  European 
Parliament and the Council on the appropriateness of the definition of ‘eligible capital’ being 
applied  for  the  purposes  of  Title  III  of  Part  Two  and  Part  Four  of  the  CRR  and  whether 
deemed appropriate, submit a legislative proposal. 

The  report  is  based  on  the  opinion  issued  by  the  European  Banking  Authority  (EBA)  in 
consultation with national competent authorities on 17 February 20153. 

2. THE DIFFERENCE BETWEEN ‘ELIGIBLE CAPITAL’ AND ‘OWN FUNDS’ 

Article 4(1)(71) of the CRR has introduced a new capital base, called ‘eligible capital’ for the 
application of Title III of Part Two, Part Four and Article 97 of the same Regulation.  

According to this article, ‘eligible capital’ is defined as the sum of Tier 1 capital and Tier 2 
capital. However, the amount of Tier 2 capital recognized as ‘eligible capital’, at the end of 
the transitional period, cannot exceed one third of Tier 1 capital4.  

The  concept  of  ‘eligible  capital’  is  thus  more  constraining  than  the  concept  of  ‘own  funds’ 
due  to  the  fact  that  the  amount  of  Tier  2  capital  instruments  in  excess  of  the  one-third 
threshold cannot be recognized as ‘eligible capital'5. 

1 Article  4  (1)  (118)  of  Regulation  (EU)  No  575/2013/EU  of  the  European  Parliament  and  of  the  Council  on 
prudential  requirements  for  credit  institutions  and  investment  firms  and  amending  Regulation  (EU)  No 
648/2012, (OJ L 176, 27.6.2013, p. 1). 
2 Article 494 of Regulation (EU) No 575/2013/EU of the European Parliament and of the Council on prudential 
requirements  for  credit  institutions  and  investment  firms  and  amending  Regulation  (EU)  No  648/2012,  (OJ  L 
176, 27.6.2013, p. 1). 
3 EBA Opinion on the review of the appropriateness of the definition of 'eligible capital' pursuant to Article 517 
of Regulation (EU) N. 575/2013, 17 February 2015. 
4 The definition of 'eligible capital' used for the purposes of calculating qualifying holdings slightly differs from 
the one used for other purposes. 

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On the contrary, there is no limit for the inclusion of Tier 2 capital in the ‘own funds’, which 
simply consists in the sum of Tier 1 capital and Tier 2 capital6. 

The  notion  of  ‘eligible  capital’  was  introduced  in  the  CRR  to  limit  credit  institutions  and 
investment firms’ incentives to reduce the regulatory constraints by issuing only Tier 2 capital 
(e.g.  supplementary  Tier  2  capital  would  allow  these  institutions  to  increase  the  size  of 
exposures  to  their  counterparties  or  the  volume  of  their  qualifying  holdings  in  an  easier 
manner than by issuing Tier 1 capital). 

The quality of Tier 2 capital is, in fact, lower than the Tier 1 one. Whilst Tier 1 capital is used 
to absorb losses in going concern situation, Tier 2 Capital can only be used to absorb losses in 
gone concern situations. 

3. THE SCOPE OF APPLICATION OF THE CONCEPT OF ‘ELIGIBLE CAPITAL’ 

From the 1st of January 2014, ‘eligible capital’ has been used as capital base for the purposes 
of: 

1.  Determining  the  prudential  treatment  for  qualifying  holdings  outside  the  financial 

sector.  
Under  the  new  regime,  Article  89  of  the  CRR  specifies  that  competent  authorities 
shall apply alternatively two different prudential treatments to qualifying holdings in 
undertakings carrying on non-financial activities: 

-  prohibiting (i) every qualifying holdings from exceeding 15% of the institution’s 
eligible capital and (ii) the total portfolio of qualifying holdings from exceeding 
60% of the institution’s eligible capital. 

-  applying  a  1250%  risk  weight  to  the  amounts  exceeding  the  15%  and  60% 

thresholds. 

2.  Determining  the  capital  requirements  for  investment  firms  with  limited  investment 
services. Investment firms referred to in Articles 95(1), 96(1) and point 2(c) of Article 
4(1) of CRR shall hold eligible capital of at least one quarter of the fixed overheads of 
the preceding year as laid down in Article 97 of CRR.  

3.  Defining  a  large  exposure.  A  large  exposure  is  an  institution’s  exposure  to  a  single 
counterparty the value of which is equal to or exceeds 10% of the institution’s eligible 
capital as laid down in Article 392 of CRR. 

4.  Setting the maximum amount above which institutions are not allowed to be exposed 
to  a  single  counterparty.  An  institution’s  exposure  to  a  single  counterparty  is  not 
allowed to exceed 25% of its eligible capital (unless otherwise stated) as laid down in 
Article 395 of CRR. 

According to Article 494 of the CRR, the implementation of the ‘eligible capital’ definition is 
subject  to  a  transitional  regime  of  three  years  which  has  started  in  2014.    Whilst  in  2014, 
credit  institutions  and  investment  firms  were  still  allowed  to  recognize  Tier 2  capital  as 

5 Article    4  (1)  (71)  of  Regulation  (EU)  No  575/2013/EU  of  the  European  Parliament  and  of  the  Council  on 
prudential  requirements  for  credit  institutions  and  investment  firms  and  amending  Regulation  (EU)  No 
648/2012, (OJ L 176, 27.6.2013, p. 1). 
6 Article  4  (1)  (118)  of  Regulation  (EU)  No  575/2013/EU  of  the  European  Parliament  and  of  the  Council  on 
prudential  requirements  for  credit  institutions  and  investment  firms  and  amending  Regulation  (EU)  No 
648/2012, (OJ L 176, 27.6.2013, p. 1). 

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‘eligible capital’ up to 100% of Tier 1 capital, from 2015 they are allowed to recognize Tier 2 
capital as ‘eligible capital’ up to 75% and in 2016 up to 50% of Tier 1 capital. 

Once  the  transitional  period  will  be  finished,  the  EU  system  will  limit  Tier  2  capital 
recognized  as  ‘eligible  capital’  to  one  third  of  Tier  1  capital,  approximating  Union 
requirements to the recently issued Basel standards on large exposure, which exclude Tier 2 
capital from being considered for the purpose of the application of the large exposure regime7. 

4. THE APPROPRIATENESS OF THE NOTION OF ‘ELIGIBLE CAPITAL’ 

The European Banking Authority (EBA) and national authorities have been consulted in order 
to gather information on the impact of the new regime on institutions. The experience gained 
during  the  first  year  of  application  of  the  'eligible  capital'  notion  has  not  revealed  any 
particular concern. The EBA concluded in its opinion that it is neither "aware of any concerns 
raised by institutions regarding the use of the definition" nor "of any empirical evidence that 
would lead to the conclusion that the new stricter capital base for the large exposures regime 
would have significant detrimental impact on institutions' exposures".  

The  results  of  the  assessment  are  related,  however,  to  the  limited  experience  gained  so  far. 
The new system has applied since 2014 and it will be fully implemented only in 2016.  

A proper collection of data could be performed only at the end of the transitional period. 

5. CONCLUSION 

The analysis of the available information has not revealed to date any particular issue which 
may call into question the appropriateness of the use of the 'eligible capital' definition for the 
purpose  of  Title  III  of  Part  Two,  Part  Four  and  Article  97  of  the  Capital  Requirement 
Regulation. 

It does not appear thus suitable at this stage to put forward any legislative proposal amending 
the current system.  

The Commission, in cooperation with the European Banking Authority (EBA) will however 
continue monitoring the application of the new regime and further reflect, on the basis of the 
data gathered, on whether the definition of 'eligible capital' should be maintained. 

The experience gained by competent authorities in the implementation of the 'eligible capital' 
definition during the transitional period will contribute to the reflection of the Commission on 
whether amendments to the current system would be appropriate. 

7  BCBS,  Supervisory  framework  for  measuring  and  controlling  large  exposures,  April  2014,  available  at 
http://www.bis.org/publ/bcbs283.pdf. 

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