4.26. Valuation approaches and related adjustments

(1) A Bank must use the same approach for valuing regulatory adjustments to its capital as it does for balance-sheet valuations. An item that is deducted from capital must be valued in the same way as it would be for inclusion in the Bank’s balance sheet.

(2) The Bank must use the corresponding deduction approach and the threshold deduction rule referred in Rules 4.29 and 4.30, in making adjustments to its capital.

4.27. Definitions for Section 4D

In this Section: entity concerned means any of the following entities:

• (a) a Bank;
• (b) any other financial or insurance entity;
• (c) an entity over which a Bank exercises control. significant investment, by a Bank in an entity concerned, means an investment of 10% or more in the common shares, or other instruments that qualify as capital, of the entity concerned. investment includes a direct, indirect and synthetic holding of capital instruments.

4.28. Adjustments to CET1 Capital

(1) Form of adjustments: Adjustments to CET 1 Capital must be made in accordance with this rule. Regulatory adjustments are generally in the form of deductions, but they may also be in the form of recognition or derecognition of items in the calculation of a Bank’s capital.

(2) Goodwill and intangible assets: A Bank must deduct from CET 1 the amount of its goodwill and all other intangible assets (except mortgage servicing rights). The amount must be net of any related deferred tax liability that would be extinguished if the goodwill or assets become impaired or derecognised under IFRS or any other relevant accounting standards.

(3) Deferred tax assets:

• (a) A Bank must deduct from CET 1 Capital the amount of deferred tax assets (except those that relate to temporary differences) that depend on the future profitability of the Bank.
• (b) A deferred tax asset may be netted with a deferred tax liability only if the asset and liability relate to taxes levied by the same taxation authority and offsetting is explicitly permitted by that authority. A deferred tax liability must not be used for netting if it has already been netted against a deduction of goodwill, other intangible assets or defined benefit pension assets.

(4) Cash flow hedge reserve: In the calculation of CET 1 Capital, a Bank must derecognise the amount of the cash flow hedge reserve that relates to the hedging of items that are not fair valued on the balance sheet (including projected cash flows).

(5) Cumulative gains and losses from changes to own Credit Risk: In the calculation of CET 1 Capital, a Bank must not take into account any unrealised gains and unrealised losses that have resulted from changes in the fair value of liabilities that are due to changes in the Bank’s own Credit Risk.

(6) Defined benefit pension fund assets:

• (a) A Bank must deduct from CET 1 Capital the amount of a defined benefit pension fund that is an asset on the Bank’s balance sheet. The amount must be net of any related deferred tax liability that would be extinguished if the asset becomes impaired or derecognised under IFRS or any other relevant accounting standards.
• (b) The Bank may apply to the AFSA for approval to offset from the deduction any asset in the defined benefit pension fund to which the Bank has unrestricted and unfettered access. Such an asset must be assigned the risk-weight that would be assigned if it were owned directly by the Bank.

(7) Securitisation gains on sale: In the calculation of CET 1 capital, a Bank must derecognise any increase in equity capital or CET 1 capital from a securitisation transaction (for example, an increase associated with expected future margin income resulting in a gain-on- sale).

(8) Higher capital imposed on overseas branch

• (a) If a Bank has an overseas branch, the Bank must deduct from CET 1 capital whichever is the higher of any capital requirement imposed by the AFSA or the financial regulator in the jurisdiction in which the branch is located.
• (b) This rule does not apply if the overseas branch is a consolidated entity of the Bank. A branch is a consolidated entity if it is included in the Bank’s consolidated returns.
• (c) Despite sub-rule (b) above, if the financial regulator in the jurisdiction in which a branch is located imposes a capital requirement for the foreign branch, a Bank must deduct from CET 1 capital the amount of any shortfall between the actual capital held by the foreign branch and that capital requirement.

(9) Assets lodged or pledged to secure liabilities

• (a) A Bank must deduct from CET 1 capital the amount of any assets lodged or pledged by the Bank if:
• (i) the assets were lodged or pledged to secure liabilities incurred by the Bank; and
• (ii) the assets are not available to meet the liabilities of the Bank.
• (b) The AFSA may determine that, in the circumstances, the amount of assets lodged or pledged need not be deducted from the Bank’s CET 1 capital. The determination must be in writing.

(10) Acknowledgments of debt

• (a) A Bank must deduct from CET 1 capital the net present value of an acknowledgement of debt outstanding issued by it to directly or indirectly fund instruments that qualify as CET 1 capital.
• (b) This rule does not apply if the acknowledgement is subordinated in rank similar to that of instruments that qualify as CET 1 capital.

(11) Accumulated losses: A Bank must deduct from CET 1 Capital the amount of any accumulated losses.

4.29. Deductions from Regulatory Capital

(1) Deductions using corresponding deduction approach:

1. (a) The deductions that must be made from CET 1 capital, AT 1 capital or T2 capital under the corresponding deduction approach are set out in the sub-rules (2) to (7) of this rule. A Bank must examine its holdings of index securities and identify any underlying exposures to its own CET1, AT1 or T2 capital instruments in those index securities to determine whether an deductions are required as a result of such indirect holdings.
2. (b) Deductions must be made from the same Tier for which the capital would qualify if it were issued by the Bank itself or, if there is not enough capital at that category, from the next higher category.
3. (c) The corresponding deduction approach applies regardless of whether the positions or exposures are held in the Banking Book or Trading Book. Note If the amount of T2 capital is insufficient to cover the amount of deductions required to be made from T2 capital, the shortfall must be deducted from AT1 capital and, if AT1 capital is still insufficient, the remaining amount must be deducted from CET 1 capital.

(2) Investments in own shares and capital instruments

1. (a) A Bank must deduct direct or indirect investments in its own common shares or own capital instruments (except those that have been derecognised under IFRS). The Bank must also deduct any of its own common shares or instruments that it is contractually obliged to purchase.
2. (b) The gross long positions may be deducted net of short positions in the same underlying exposure only if the short positions involve no counterparty risk. However, gross long positions in its own shares resulting from holdings of index securities may be netted against short positions in its own shares resulting from short positions in the same underlying index, even if those short positions involve counterparty risk.

(3) Reciprocal cross holdings: A Bank must deduct reciprocal cross holdings in shares, or other instruments that qualify as capital, of an entity concerned.

(4) Non-significant investments—where the Bank does not own more than 10% of issued common equity of the entity

1. (a) This rule applies if:
2. (i) a Bank makes a non-significant investment in an entity concerned;
3. (ii) the entity concerned is an unconsolidated entity (that is, the entity is not one that is included in the firm’s consolidated returns);
4. (iii) the Bank does not own more than 10% of the common shares of the entity concerned; and
5. (iv) after applying all other regulatory adjustments, the total of the deductions required to be made under this rule is less than 10% of the Bank’s CET 1 capital.
6. (b) A Bank must deduct any investments in common shares, or other instruments that qualify as capital, of an entity concerned.
7. (c) The amount to be deducted is the net long position (that is, the gross long position net of short positions in the same underlying exposure if the maturity of the short position either matches the maturity of the long position or has a residual maturity of at least 1 year).
8. (d) Underwriting positions held for more than 5 business days must also be deducted.
9. (e) If a capital instrument is required to be deducted and it is not possible to determine whether it should be deducted from CET 1 capital, additional tier 1 capital or tier 2 capital, the deduction must be made from CET 1 capital.

(5) Non-significant investments—aggregate is 10% or more of Bank’s CET 1 capital

1. (a) This rule applies if, after applying all other regulatory adjustments, the total of the deductions required to be made under Rule 4.29 (4) is 10% or more of the Bank’s CET 1 Capital.
2. (b) A Bank must deduct the amount by which the total of the deductions required to be made under Rule 4.29 (4) exceeds 10% of the Bank’s CET 1 Capital. This amount to be deducted is referred to as the excess.
3. (c) How much of the excess gets to be deducted from each category of regulatory capital under the corresponding deduction approach is calculated in accordance with the following formula:

where:

A is the amount of CET 1 capital, additional tier 1 capital or tier 2 capital of the Bank, as the case may be;

B is the total capital holdings of the Bank.

(6) Significant investments

1. (a) This rule applies if:
2. (i) a Bank makes a significant investment in an entity concerned;
3. (ii) the entity concerned is an unconsolidated entity (that is, the entity is not one that is included in the Bank’s consolidated returns); and
4. (iii) the Bank owns 10% or more of the common shares of the entity concerned.
5. (b) A Bank must deduct the total amount of investments in the entity concerned (other than investments in common shares, or other instruments that qualify as CET 1 capital, of the entity).
6. (c) The amount to be deducted is the net long position (that is, the gross long position net of short positions in the same underlying exposure if the maturity of the short position either matches the maturity of the long position or has a residual maturity of at least 1 year).
7. (d) Underwriting positions held for more than 5 business days must also be deducted.
8. (e) If a capital instrument is required to be deducted and it is not possible to determine whether it should be deducted from CET 1 capital, AT1 capital or T2 capital, the deduction must be made from CET 1 capital.

(7) Banks may use estimates or exclude deductions

1. (a) If it is impractical for a Bank to examine and monitor the Bank’s exposures to the capital of entities concerned (including through holdings of indexed securities), the Bank may apply to the AFSA for approval to use an estimate of such exposures. The AFSA will grant such an approval only after the Bank satisfies the AFSA that the estimate is conservative, wellfounded and reasonable.
2. (b) A Bank may also apply to the AFSA for approval not to deduct an investment made to resolve, or provide financial assistance to reorganise, a distressed entity.

4.30. Deductions from CET1 Capital

(1) In addition to the other deductions to CET 1 Capital under this Chapter, deductions may be required to CET 1 Capital under the threshold deduction rule.

(2) The threshold deduction rule provides recognition for particular assets that are considered to have some limited capacity to absorb losses. The following items come within the threshold deduction rule:

• (a) significant investments in the common shares, or other instruments that qualify as CET 1 Capital, of an unconsolidated entity concerned;
• (b) mortgage servicing rights;
• (c) deferred tax assets that relate to temporary differences (for example, allowance for credit losses).

(3) Instead of full deduction, the items that come within the threshold deduction rule receive limited recognition when calculating CET 1 Capital. The total of each of the items in sub-rule (2) do not require adjustment from CET 1 Capital and are risk-weighted at 300% (for items listed on a regulated exchange) or 400% (for items not so listed) provided that:

• (a) each item is no more than 10% of the Bank’s CET 1 Capital (net of all regulatory adjustments except those under this Subdivision); or
• (b) in total, the 3 items are no more than 15% of the Bank’s CET 1 Capital (net of all regulatory adjustments except those under this Subdivision).

(4) A Bank must deduct from CET 1 Capital any amount in excess of the threshold in sub-rule (3) (a) or (b) above.