The Danish Act on Government Tier 1 Hybrid Capital Injections in Credit Institutions and other Credit Package Initiatives

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1 The Danish Act on Government Tier 1 Hybrid Capital Injections in Credit Institutions and other Credit Package Initiatives 1 Introduction On 10 October 2008, the Danish Parliament passed a legislative package, the Danish Act on Financial Stability (the Financial Stability Act ) introducing a guarantee scheme whereby the Kingdom of Denmark unconditionally guarantees the claims of unsubordinated creditors against banks participating in the scheme to the extent such claims are not otherwise covered (the Guarantee Scheme ). The Guarantee Scheme had effect as of 5 October 2008 and expires as of 30 September On 18 January 2009, a political agreement on a credit package was made between the vast majority of parties represented in Parliament whereby the Kingdom of Denmark will in addition to a three-year transition scheme with respect to the government guarantee in the Financial Stability Act, ensuring a gradual phase-out of the Guarantee Scheme and a number of other initiatives including new information requirements and regulation of the remuneration of management - offer Danish banks and mortgage credit institutions state-funded injection of tier 1 hybrid capital and provide funding for export projects. The bills implementing the credit package, including a proposal for a new Act on Government Capital Injections in Credit Institutions (the Credit Act ), entered into force on 4 February This memo describes the Credit Act, other credit initiatives and regulatory elements of the credit package. A separate memo has been prepared describing the Guarantee Scheme and the three-year transition scheme introduced by the credit package. 2 Form of the government capital injections The offered capital injections will be in the form of tier 1 hybrid capital without a set maturity and a possibility for redemption after three years. Redemption will be subject to approval from the Danish Financial Supervisory Authority (the Danish FSA ). Danish banks and mortgage credit institutions that are in compliance with the statutory solvency requirements will be eligible to apply for a state capital injection. The Danish Ship Finance (in Danish: 1

2 Dansk Skibskredit A/S) which is established by legislation but primarily owned by banks, shipping companies and yards will also be able to apply. The Kingdom of Denmark will either fund the injection directly or underwrite an issue of hybrid capital in the market if the credit institution in question renders it probable that private investors will subscribe to the issue. Regardless of the initial set up, hybrid capital held by the Kingdom of Denmark can be transferred to new creditors. An injection must as a general rule be of a size ensuring that the credit institution attains 12 per cent in tier 1 capital as a minimum. Credit institutions which has a tier 1 capital of 9 per cent or above before any capital injection will be entitled to apply for an injection of tier 1 capital of 3 percentage points but may chose a lower amount if the 12 per cent minimum after the injection is met, whereas credit institutions with a tier 1 capital below 9 per cent must generally apply for a capital injection equivalent to the difference between 12 per cent tier 1 capital and their existing tier 1 capital. For credit institutions which has a tier 1 capital of below 6 per cent before any capital injection, individual solutions may be negotiated which give such credit institutions the highest possible tier 1 ratio. In order to facilitate the inclusion of the state-funded hybrid capital injections in the tier 1 capital, the general rules for inclusion of hybrid core capital in the tier 1 capital of banks, mortgage credit institutions, investment companies and investment management companies in the Danish Financial Business Act have been amended with the effect that hybrid capital may depending on the terms thereof make up a maximum of 50 per cent of the aggregate tier 1 capital of the credit institution, etc (previously a 15 per cent limit applied). The capital injection must be convertible upon decision from the Danish FSA if the hybrid tier 1 capital will make up more than 35 per cent of the aggregate tier 1 capital after the injection. Such decision can only be made if the institution is distressed. The conversion rate will be the market price of the shares at the time of the conversion. As a consequence of conversion, any limits on voting rights will be cancelled. The Credit Act implements into Danish law certain other rules on hybrid capital and its inclusion in the tier 1 capital set out in the proposal for a Directive changing Directive 2006/48/EC relating to the taking up and pursuit of the business of credit institutions. 3 Pricing and redemption rates For the purpose of determining the interest rate on the hybrid capital, applicants will be divided into three main groups according to rating: Group I with AA- or better ratings; Group II with A- and A+; and Group 2

3 III with ratings of BBB+ or below. Applicants which are not rated will be assessed on certain key parameters in comparison to the rated applicants and placed in the group they resemble the most. The minimum annual interest rate is approx. 9 per cent but may vary as it is calculated based on the interest of a government bond with 5 years duration, added a risk premium of 6 per cent. The minimum rate will be offered to Group I borrowers, and Group III borrowers per cent. Group II borrowers will be dividend into 3 subcategories reflecting the differences in quality and risk between the institutes. In these subcategories, the interest rate is expected to be approx. 9.55, 10.1, and per cent. To the extent the credit institution is allowed to make dividend payments (cf. section 4 below), these will trigger a possible increase of the interest payment on the hybrid capital for the year the dividend payment was made depending on inter alia the size of the dividend payment and the original ratio of the loan amount to the value of the credit institution at the time of the loan agreement. If the hybrid capital is not redeemed within 5 years, the redemption price will be increased to 105 per cent of the principal amount in year six and 110 per cent of the principal amount in case redemption takes place later than 7 years after the capital injection. 4 Requirements for participating credit institutions As interest rate on state funded capital injections is partly linked to the size of dividend payments of the borrowers, it is a requirement under Section 43 of the Danish Public Companies Act that the general assembly either approves the specific loan agreement or authorises the board of directors to decide entering into agreements on such loan. If hybrid tier 1 capital will make up more than 35 per cent of the aggregate tier 1 capital after the injection, the loan must be convertible and any limits on voting rights cancelled. Loan applications must be submitted to the Ministry of Economic and Business Affairs no later than 30 June The Minister of Economic and Business Affairs is authorised to extend the deadline. The application must contain (a) a statement from the credit institution on its financial position and prospects, (b) an account of its individual solvency need, (c) an audited annual report for 2008 and a copy of any subsequent quarterly financial statements and (d) a report from the credit institution s auditor. Accepted borrowers must cover the government s cost for external advisors and the loan administration which is placed with the Danish Agency for Governmental Management under the Ministry of Finance. 3

4 Under the duration of the loan, the borrower must submit semi annual reports on lending development and the lending policy in accordance with guidelines to be issued by the Minister of Economic and Business Affairs. The reports must also be made publicly available. Share repurchase programmes are prohibited until the hybrid capital is fully redeemed and dividend payments can only be based on the profit of the year (for participants in the Guarantee Scheme any dividend payments are restricted and share repurchase programmes prohibited until 30 September 2010). Further, any upstreaming or lending of hybrid capital to sister companies is restricted. The following restrictions on the remuneration to the members of the management board of credit institutions which have received state-funded capital injections apply until the hybrid capital is fully redeemed (unless this would violate agreements made prior to the proposal of the bill): (i) management must not receive variable remuneration exceeding 20 per cent of the aggregate base pay, including pension payments; (ii) prohibition of introduction or renewal of stock option programmes (for participants in the Guarantee Scheme, this already applies until 30 September 2010); and (iii) no more than half of the executive pay can be deducted in the tax accounts and in the annual report the deducted amount must be stated and included in the auditor s report. These restrictions are supplemented by general restrictions on the financial sector, cf. section 6 below. 5 The new export credit and guarantee programme As part of the credit package, Parliament s Finance Committee has authorised the supply of the Export Credit Fund (in Danish: Erhvervs Kredit Fonden) with DKK 20 billion for a 3 year programme under which both credit, as a new product for the Export Credit Fund, and partly matching payment guarantees will be available for export projects. Under the programme, loans can only be issued in combination with guarantees. Companies can apply through their banks which must cover no less than 5 to 10 per cent of the risk in the project. The loan must be on commercial terms and conditions, including a variable interest rate. 4

5 6 New rules and restrictions for financial undertakings In addition to the specifics restrictions of credit institutions under the Credit Act and participants in the Guarantee Scheme or the transition scheme under the Financial Stability Act, certain general restrictions will be introduced to different parts of the financial sector. Specifically for credit institutions, their individual solvency requirement must be published. This applies independently of the credit institutions participation in the Guarantee Scheme or the transition scheme. Furthermore, the solvency requirements of all credit institutions with a working capital in excess of DKK 250 million will be subject to examination form the Danish FSA on an annual basis. Banks will be prohibited from conducting programmes under which loans are provided to finance purchases of shares issued by the banks themselves. Remuneration of the management of any financial undertaking will be subject to a 50 per cent limit on variable pay elements compared to the fixed pay elements, including pension payments. This requirement is disapplied if in conflict with agreements made prior to the proposal of the Credit Act. In addition, the chairman of the board of directors of any financial undertaking will be required to discuss the company s policy on remuneration of the members of the management board at the annual general meeting of the financial undertaking. For further information, please contact * Michael Steen Jensen, partner Lotte Eskesen, partner (+45) (+45) msj@gfklaw.dk le@gfklaw.dk Morten Nybom Bethe, partner Tobias Linde, partner (+45) (+45) mnb@gfklaw.dk tl@gfklaw.dk 23 February 2009 Gorrissen Federspiel Kierkegaard * 5

6 This newsletter does not constitute legal advice and is not intended to replace legal advice. Gorrissen Federspiel Kierkegaard disclaims all liability for direct or indirect losses suffered as a result of acts undertaken in reliance on any information in this newsletter irrespective of whether such losses may have arisen as a result of incorrect information in the newsletter or whether due to other circumstances in relation to the newsletter. 6