SUPREME COURT PROVIDES CLARIFICATION OF APPROACH TO INTERPRETATION OF TRUST DEEDS GOVERNING STRUCTURED NOTES
In response to a stress test conducted in March 2009, Lloyd’s Banking Group (LBG) was required by the FSA to raise £21bn in Core Tier 1 (CT1) capital in order to comply with the CT1 capital ratio limit. LBG decided to raise £8.3bn in enhanced capital notes (ECNs), a form of contingent convertible security carrying a very high rate of interest, in part satisfaction of this requirement.
Under the terms of the ECNs, in the event that LBG’s CT1 ratio (i.e., its ratio of CT1 to risk weighted assets of total Tier 1 Capital (CT1 ratio)) fell below 5 percent – a ratio deliberately set 1 percent higher than the 4 percent regulatory minimum, the ECNs would be converted into fully paid up shares, increasing the Bank’s CT1 capital level. This conversion mechanism allowed LBG to count the ECNs towards to its CT1 ratio, while offering the noteholders an unusually high rate of interest – approximately 10 percent per annum, on average.
Crucially, the terms of the ECNs allowed for early redemption if a Capital Disqualification Event (CDE) occurred. Early redemption, like a conversion into equity, would deprive the noteholders of their entitlement to interest from the moment of redemption. The CDE in issue in the case was set out in paragraph 2 of the Trust Deed governing the ECNs: where the notes “[ceased] to be taken into account ... for the purposes of any ‘stress test’ applied by the FSA in respect of the Consolidated [CT1 ratio]”.
Oct-Dec 2016 issue