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Bank regulatory capital: legal opinions


Since 1 April 2020, UK banks issuing new shares and entities applying for banking licences must provide the Prudential Regulation Authority (PRA) with a legal opinion. We have experience of drafting these, and of other rule changes made by the PRA on the same date.

  • New rules: The capital rules for UK banks, building societies and designated investment firms changed on 1 April 2020 with the overall aim of improving the quality and governance of their Common Equity Tier 1 capital (CET 1) instruments The changes reflected amendments to the Capital Requirements Regulation (CRR), together with some PRA amendments.

  • Legal opinion for CET 1: Under one of the PRA's amendments, in-scope firms now need to obtain and provide a properly reasoned draft independent legal opinion when applying to the PRA for approval of new issuances, or variations of the terms of existing issuances, of 'CET 1 instruments', such as ordinary shares. Firms seeking authorisation by the PRA as banks or building societies will also need to provide such an opinion as part of their authorisation application. The legal opinion requirement brings CET 1 instruments into line with notifications regarding 'AT 1' and 'Tier 2' instruments (such as 'CoCos' and certain forms of long-term subordinated debt, respectively), which have required an accompanying legal opinion for some time.

  • Other CET 1 impacts: Other changes in the PRA package included:
    • guidance on the new CRR provision that CET 1 issuances on substantially the same terms as previous issuances do not generally require approval;
    • a gloss on the tightened definition under CRR of what is eligible as CET 1; and
    • increased expectations of the holder of the Senior Management Function with regulatory capital responsibilities and, in certain circumstances, firm's boards.

  • Brexit: UK institutions must continue to comply with these requirements, which are retained in UK law following Brexit.

  • Changes for AT1 and Tier 2: The amended PRA rules also made changes to the requirements for firms issuing or varying AT 1 or Tier 2 instruments. These are outside the scope of this Briefing.
The details: what exactly has changed?


In June 2019, certain parts of "CRR II", an EU regulation amending parts of CRR, came into force. These amended the rules in CRR setting out the criteria for what counts as Common Equity Tier 1 (CET 1), the best form of regulatory capital. They also altered the scope of the requirement in CRR to obtain approval from the regulator to count particular instruments as CET 1.

In terms of capital instruments, only equity instruments have ever been able to qualify as CET 1, and the typical example is plain vanilla ordinary voting shares. Any instrument has always had to meet several criteria to count as CET 1, and this list has been amended by CRR II – for instance, there is now an explicit requirement for the instrument to be fully paid up and not funded directly or indirectly by the firm.

The PRA's capital rules

The CRR II changes that came into effect in June 2019 led to some temporary amendments to the PRA's capital rules applicable to UK banks, building societies and the eight PRA-designated investment firms. However, on 1 April 2020, permanent amendments came into force for those firms. They go beyond the requirements of CRR II (including as onshored in the UK since the expiry of the Brexit transitional period), because the PRA unilaterally wanted to tighten the rules on CET 1 further. The changes, relating to a pre-issuance notification regime, are contained in a new Chapter 7A of the Definition of Capital Part of the PRA Rulebook. The PRA has also updated its Supervisory Statement on the Definition of Capital; Pre/post-Issuance Notification form for CRR firms; and CET 1 compliance template.  The UK has preserved these changes in its onshored post-Brexit legislation.

A reasoned draft legal opinion

When preparing to issue or vary the terms of an existing CET instrument is a requirement (not contained in CRR II), firms must now obtain a "properly reasoned draft legal opinion" from an external law firm confirming that newly issued instruments that a firm is seeking to classify as CET 1 meet the relevant criteria. The opinion must be filed with the PRA as part of a firm's application for the instruments to be approved as CET 1. The requirement also applies where a firm is varying the terms of an existing CET 1 instrument.

Subsequent issuances

Under CRR II, subsequent issuances only require approval and (under the amended PRA rules) an accompanying draft legal opinion, where they are not on "substantially the same terms" as a previous issuance for which the firm has already received approval (whether before or after 1 April 2020).

The PRA has provided guidance on when an issuance will not normally be considered substantially the same as a previous issuance (and so triggering the need for a new legal opinion). This includes, for example, where there any change to voting rights, subordination or distributions, or where the transactions involve new side agreements or material amendments to an existing side agreement.

Previously, further regulatory approval was always required for a new issuance of a CET 1 instrument except where it was on "identical terms" to a previously approved issuance.  The fact that CRR II provides that approval is not required for issuances on "substantially the same terms", and associated PRA guidance, will generally be a welcome development for firms.

Other key changes

The other two key changes made by the PRA in relation to CET 1 are:

  • Stricter CRR criteria for qualifying as CET 1. CRR II amended the pre-existing criteria slightly – in particular, it established a new, somewhat vague, requirement that firms "shall have regard to the substantial features of instruments and not only their legal form when assessing compliance with the [criteria]". The PRA has overlaid this with a statement that, wherever possible, it expects firms to meet their CET 1 requirements entirely with voting common shares and associated reserves, as it is "imperative" that the composition of a firm's CET 1 be as straightforward and transparent as possible. Any instruments with more "complex features" will be subject to particular scrutiny by the PRA.

  • An explicit link to SMCR. The PRA expects that the holder of the Senior Manager Function with the Prescribed Responsibility for managing the allocation and maintenance of the firm's capital, funding and liquidity (or, for small firms, managing the firm's financial resources) to be accountable for applications and notifications to the PRA. This includes responsibility for obtaining the draft legal opinion. The PRA also expects the issuance or variation to be subject to appropriate board-level review and discussion, in particular where it relates to instruments other than plain vanilla voting common shares.
What do you need to bear in mind in obtaining and providing a draft legal opinion?

As noted above, a draft legal opinion on the eligibility of instruments to count as CET 1 ought to be more straightforward than an opinion on AT 1 or Tier 2 instruments, where an in-depth and sometimes complex analysis of the terms of the issuance is needed. However, even with 'vanilla' ordinary shares, there are a number of issues which firms will need to consider on a CET 1 issuance or variation which are not addressed in PRA guidance on:

  • Substantial features: As mentioned above, CRR II introduced a new criterion, requiring consideration of the "substantial features" of the instruments rather than just their legal form. Firms will need to discuss with their lawyers (and possibly even their accountants) how – in the draft legal opinion or otherwise – they can mitigate the risk of the PRA raising questions on the substantial features of the instrument.

  • Accounting treatment: Unlike on an application in relation to an AT 1 issuance or variation, there is no requirement to provide a separate draft opinion by their auditors in addition to the legal opinion. However, firms' accountants may nonetheless need to be involved in other areas of the legal opinion. The criteria cross-refer to the treatment of the instruments under the applicable accounting framework.

  • English Company Law treatment: The CET 1 criteria do not always align neatly with English company law (for example in relation to distributions and reductions of capital), and areas of the opinion may need to crafted carefully so as address this appropriately.
Will Brexit make a difference to the amended PRA requirements?

CRR, including the CRR II changes discussed in this Briefing, has been onshored into UK law following the end of the Brexit transitional period at the end of last year. We think that it is unlikely that the requirements covered here will change in the short-medium term, especially given that many of them, including the legal opinion requirement, constituted gold-plating by the PRA.

Is it only banks and designated investment firms which are affected?

Only banks and the eight PRA-designated investment firms that have so far been designated by the PRA are subject to the amended PRA rules. (Solvency II insurance firms are already subject to separate capital rules, which include a requirement to provide a legal opinion in certain circumstances.)

The changes under CRR II, including in particular the strengthening of the criteria for eligibility for CET 1 status, are applicable to all investment firms within scope of CRR – a much wider group, which includes many investment banks, asset managers, brokers and wealth managers. However, the FCA has not amended its rules applicable to these firms in line with the PRA's changes, nor indicated any intention (for example as part of the implementation of the Investment Firms Prudential Regime, due to come into force on 1 January 2022) to do so.

How we can help

We have considerable experience in preparing legal opinions in support of applications and notifications relating the eligibility of instruments for regulatory capital purposes; these include opinions on AT 1 and Tier 2 instruments, and most recently, on CET 1 instruments as required by the amended PRA rules.


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