Ordinance concerning Capital Adequacy (Capital Adequacy Ordinance, CAO) 252.03 dated 1 July 2016 FINANCIAL SERVICES Ordinance concerning Capital Adequacy and Risk Diversification for Banks and Securities Dealers (Capital Adequacy Ordinance, CAO) 952.03 dated 1 July 2016 1 Table of Contents I. Capital Adequacy Ordinance pg. 2 II. Annex 1: Credit Conversion Factors when applying SA-BIS pg. 60 III. Annex 2: Position Categories as per SA-BIS when applying External Ratings and their Risk Weighting pg. 62 IV. Annex 3: Position Categories according to SA-BIS without the Use of External Ratings and their Risk Weighting pg. 65 V. Annex 4: Risk Weights for Equity Shares and Shares in Collective Investment Schemes according to SA-BIS pg. 67 VI. Annex 5: Rates for Calculating Capital Adequacy Requirements for the Specific Risk of Interest Rate Instruments according to the Standardized Approach to Market Risk pg. 69 VII. Annex 6: Amendments to the Previous Law pg. 70 VIII. Annex 7: Counter-cyclical Buffer pg. 71 IX. Annex 8: Minimum regulatory capital, capital buffer and total capital ratio pg. 72 X. Annex 9: Surcharges pg. 73 2 Other Languages DE: Verordnung über die Eigenmittel und Risikoverteilung für Banken und Effektenhändler (Eigenmittelverordnung, ERV) FR: Ordonnance sur les fonds propres et la répartition des risques des banques et des négociants en valeurs mobilières (Ordonnance sur les fonds propres, OFR) IT: Ordinanza sui fondi propri e sulla ripartizione dei rischi delle banche e dei commercianti di valori mobiliari (Ordinanza sui fondi propri, OFoP) Unofficial translation issued in July 2016 FINANCIAL SERVICES Ordinance concerning Capital Adequacy and Risk Diversification for Banks and Securities Dealers (Capital Adequacy Ordinance, CAO) dated 1 June 2012 (version as at 1 July 2016) The Swiss Federal Council, pursuant to Article 3(2)(b), 3g, 4(2) and (4), 4bis(2) and 56 of the Banking Act of 8 November 19341 (BA), decrees: Title 1: General provisions Chapter 1: Object, Scope and Definitions ARTiCLe 1 Principle 1 To protect the interests of creditors and the stability of the financial system, banks and securities traders shall ensure that risks are appropriately mitigated and that they hold adequate capital in view of their business operations and risk exposure. 2 They shall ensure that they hold adequate capital to cover credit risk, market risk, non-counterparty risk and operational risk. ARTiCLe 2 Subject 1 This Ordinance regulates: a. the eligible capital; b. the risks subject to capital adequacy requirements and the extent of such requirements; c. risk diversification, in particular the limits for large exposures and the treatment of intra-group positions; and d. the specific requirements for systemically important banks. 2 The Swiss Financial Market Supervisory Authority (FINMA) may issue implementing provisions. ARTiCLe 3 Scope This Ordinance applies to banks as defined in the Swiss Banking Act and securities dealers as defined in the Swiss Stock Exchange and Securities Trading Act of 24 March 19952 (hereinafter ’banks’). 1 SR 952.0 2 SR 954.1 Ordinance concerning Capital Adequacy and Risk Diversification for Banks and Securities Dealers | 2 FINANCIAL SERVICES ARTiCLe 4 Definitions For the purpose of this Ordinance, the following terms shall have the following meaning: a. regulated securities exchange: any institution that is adequately regulated and supervised in accordance with internationally recognized standards, the purpose of which is to facilitate the simultaneous purchase and sale of securities among several securities dealers and for which sufficient market liquidity is ensured; b. main index: an index comprising all securities traded on a regulated securities exchange (total market index) or a selection of major securities on such an exchange, or any index comprising the major securities of various regulated securities exchanges; c. regulated company: a company active in the financial sector that must comply with appropriate capital adequacy requirements in particular in regard to its business risks and that is supervised by a banking, securities exchange, or an insurance regulatory authority; d. equity shares: securities that represent interests in the share capital of a company; e. equity instrument: equity shares that qualify as Common Equity (CET1) or Additional Tier 1 Capital (AT1), as well as debt instruments that qualify as Additional Tier 1 Capital (AT1) or Tier 2 Capital (T2); and f. corresponding deduction approach: the “corresponding deduction approach” described in the Basel Minimum Standards; g. qualified interest rate instrument: an interest rate instrument: 1. rated between 1 and 4 by at least two recognized rating agencies; 2. rated between 1 and 4 by a single recognized rating agency, provided it is not rated lower by any other recognized rating agency; 3. not rated by a recognized rating agency but with a yield to maturity and residual term compa- rable to that of securities rated 1–4, provided that the securities of the corresponding issuer are traded on a regulated securities exchange or on a representative market where at least three independent market makers quote rates on a daily basis that are regularly published; or 4. not rated by a recognized rating agency (external rating), but is rated with a bank-internal rating of 1–4, provided the securities of the corresponding issuer are traded on a regulated securities exchange or on a representative market where at least three independent market makers quote rates on a daily basis that are regularly published. h. Basel Minimum Standards: the standards defined by the Basel Committee for Banking Supervi- sion that are relevant for calculating the capital adequacy requirements.3 3 The current Basel Minimum Standards may be obtained from the Bank for International Settlements at Centralbahnplatz 2, 4002 Basel, or downloaded online atwww.bis.org/bcbs. Ordinance concerning Capital Adequacy and Risk Diversification for Banks and Securities Dealers | 3 FINANCIAL SERVICES ARTiCLe 5 Trading Book 1 Banks may keep a trading book containing positions in financial instruments and commodities held with the intent of trading or in order to hedge other trading-book positions. 2 Banks may only allocate positions to the trading book, if: a. there are no contractual restrictions on their tradability; or b. they can be fully hedged at any time. 3 Trading intent exists if the bank intends to: a. hold the positions for a short term; b. take advantage of short-term price movements; or c. realize arbitrage gains. 4 Positions shall be valued frequently and accurately. The trading book shall be actively managed. ARTiCLe 6 Rating Agencies 1 The FINMA may recognize a rating agency, if: a. its rating methodology and ratings are objective; b. it and its rating methodology are independent; c. it makes its ratings and the corresponding underlying data publicly available; d. it discloses its rating methodology, its code of conduct, its remuneration policy and the primary characteristics of its ratings; e. it has adequate resources at its disposal; and f. it and its ratings are credible. 2 The FINMA shall publish a list of recognized rating agencies. 3 The FINMA shall withdraw recognition if a recognized rating agency no longer satisfies the recog- nition criteria. Ordinance concerning Capital Adequacy and Risk Diversification for Banks and Securities Dealers | 4 FINANCIAL SERVICES Chapter 2: Consolidation ARTiCLe 7 Consolidation requirement 1 Capital adequacy and risk diversification requirements have to be met at the single-entity level; in addition, they must also be met at the level of the financial group and the financial conglomerate (consolidation requirement). 2 The consolidation shall include all of the group companies active in the financial sector as described in Article 4 in conjunction with Article 22 of the Banking Ordinance of 30 April 20144 (BO), with the following exceptions:5 a. equity interest in insurance companies are only to be consolidated for the purpose of meeting risk diversification requirements, subject to Article 12; b. there is no requirement to consolidate collective capital investment schemes where such investments are managed on behalf of investors, or where founding capital is held in invest- ment companies. 3 Should the bank hold equity instruments in the capital of non-consolidated companies as per (2)(a), the corresponding deduction approach applies. 4 Should the bank hold equity instruments in non-consolidated companies as per (2)(b), the applicable deduction approach applies without threshold value. ARTiCLe 8 Types of Consolidation and Choices Open to the Bank 1 Majority equity interests in companies subject to consolidation shall be fully consolidated. 2 In the case of interests jointly held with another shareholder or partner with 50% of the voting rights each (joint ventures), the bank has the choice of applying the full or proportionate consolidation, or the corresponding deduction approach. 3 Minority interests of 20% or more in companies subject to consolidation, in which the bank exerts a controlling influence either directly or indirectly jointly with other investors, may be consolidated proportionately or by applying the corresponding deduction approach. 4 For all other minority interests the corresponding deduction approach is applicable. 5 When applying the proportionate consolidation, the eligible and required capital as well as large exposures shall be accounted for in proportion to the investments made. 4 SR 952.02 5 Version according to Annex 2 Sect. 4 of the Banking Ordinance of 30 April 2014, in force since 1 January 2015 (AS 2014 1269). Ordinance concerning Capital Adequacy and Risk Diversification for Banks and Securities Dealers | 5 FINANCIAL SERVICES 6 Equity interests accounted for in the corresponding deduction approach shall not be considered for the risk diversification. 7 The corresponding deduction approach according to (2) and (3) shall be made without referring to a threshold value. ARTiCLe 9 Exceptional Treatment Approved by the Auditor 1 With the auditor’s approval, the following equity interests may be treated as exempt from the con- solidation requirement: a. equity interests in companies which, on account of their size and business activities, are of no significance to the compliance with the capital adequacy provisions; b. significant group companies held for less than a year. 2 Equity interests conferring more than 50% of the voting rights may, by way of exception, be con- solidated on a proportionate basis, provided that the auditor consents to such a method and an agreement has been contractually stipulated that: a. the bank’s support of the company subject to consolidation is limited to the bank's own holding quota; and b. the remaining shareholders or partners are obliged to provide support in proportion to their holding quota and are legally and financially able to fulfill that obligation. 3 Equity interests exempt from consolidation as per (1) are subject to the corresponding deduction approach without referring to a threshold value. ARTiCLe 10 Special Requirements 1 In exceptional circumstances, the FINMA may exempt specific banks from selected or all of the cap- ital adequacy and risk diversification requirements at the level of single-entity institutions, provided the conditions set out in Article 17 of the BO6 have been met.7 2 In the context of capital adequacy requirements to be met by a financial group or financial conglom- erate, the FINMA may specify additional requirements regarding the adequate level of capitalization of a company heading a financial group or financial conglomerate and which is not subject to super- vision at single-entity level. 3 The FINMA may permit a bank to consolidate its group companies active in the financial sector already at the level of the single-entity institution (solo consolidation) due to their especially close relationship with the bank. 6 SR 952.02 7 Version according to Annex 2 Sect. 4 of the Banking Ordinance of 30 April 2014, in force since 1 January 2015 (AS 2014 1269). Ordinance concerning Capital Adequacy and Risk Diversification for Banks and Securities Dealers | 6 FINANCIAL SERVICES ARTiCLe 11 Financial Sub-Groups 1 The consolidation requirement applies to any financial group, even if such a financial group is con- trolled by a financial group or financial conglomerate already subject to supervision by the FINMA. 2 The FINMA may, by way of exception, exempt a financial sub-group from the consolidation require- ment, in particular, if: a. their group companies operate exclusively within Switzerland; and b. the financial parent group or financial conglomerate is subject to adequate consolidated super- vision by a financial market supervisory authority. ARTiCLe 12 Captives for Operational Risks Subject to the FINMA's approval, subsidiaries set up for the sole purpose of providing intra-group insur- ance cover for operational risk (captive insurers) can be fully consolidated at financial group level in the same way as subsidiaries operating within the financial sector and, if appropriate, solo consolidation may be used (Article 10(3)). ARTiCLe 13 Equity Interests Outside the Financial Sector The upper limits on a bank's qualifying interests in a company outside the financial sector as specified in Article 4(4) BA shall not be applicable where: a. such equity interests are acquired only temporarily in the course of a corporate restructuring or rescue; b. securities are acquired for the standard underwriting period; or c. the difference between the book value and applicable upper limits for such interests is fully covered by unencumbered eligible capital. Chapter 3: Statement and Disclosure of Adequate Capital ARTiCLe 14 Capital Adequacy Report 1 Banks must prove on a quarterly basis that they dispose of adequate capital. The FINMA shall define the mandatory contents of the capital adequacy reports. 2 The capital adequacy reporting form on a consolidated basis must be prepared semi-annually. 3 The forms have to be submitted to the Swiss National Bank within six weeks after the end of each quarter or half-year. Ordinance concerning Capital Adequacy and Risk Diversification for Banks and Securities Dealers | 7 FINANCIAL SERVICES ARTiCLe 15 Calculation Basis When calculating the eligible and required capital for the capital adequacy report, the bank shall rely on the financial statements that have been prepared according to the accounting standards prescribed by the FINMA. The FINMA may grant exceptions to this general principle. ARTiCLe 16 Disclosure 1 Banks must adequately inform the public of their risks and their capital adequacy. The calculation of the eligible capital must obviously be based on the financial reports. 2 Private bankers that do not publicly offer to accept deposits are excluded from this obligation. 3 FINMA shall enact technical implementing provisions. It in particular specifies which information must be disclosed in addition to the annual financial statements and the interim financial statements. Chapter 4: Simplified Application ARTiCLe 17 1 Banks may apply specific provisions of this Ordinance including the FINMA's clarifying implement- ing provisions in a simplified manner, if: a. this allows them to avoid disproportionate efforts; b. they manage risks appropriately in view of their business operations; and c. the bank's ratio of minimum required capital to eligible capital is at least maintained. 2 They shall make sure that the requirements are met and document the simplifications used. Title 2: eligible capital Chapter 1: General ARTiCLe 18 Capital Components 1 Eligible capital consists of Tier 1 Capital (T1) and the Tier 2 Capital (T2). 2 Tier 1 Capital consists of Common Equity Tier 1 Capital (CET1) and Additional Tier 1 Capital (AT1). ARTiCLe 19 Loss Absorbency 1 Capital components absorb losses according to the following principles: Ordinance concerning Capital Adequacy and Risk Diversification for Banks and Securities Dealers | 8 FINANCIAL SERVICES a. Common Equity Tier 1 capital absorbs losses before the Additional Tier 1 capital; b. Additional Tier 1 capital absorbs losses before Tier 2 capital. 2 Should individual instruments of the same capital component (outside CET1) absorb losses differ- ently, the bank must specify this in its articles of incorporation or at issue of the instrument. ARTiCLe 20 Common Requirements regarding Capital 1 Capital must be paid in or generated internally in the amount used to cover capital adequacy require- ments. 2 At issuance, the capital must not: a. be directly or indirectly funded by the bank’s lending to third parties; b. be netted with other assets; or c. be secured by the bank’s own assets. 3 Capital is to be subordinated to the unsubordinated claims of all other creditors in the case of liqui- dation, bankruptcy or restructuring of the bank. 4 Capital instruments with conditional conversion or debt reduction that become applicable not only at the point of non-viability (Article 29) shall be accounted for as capital components depending on their characteristics before the conversion or the debt reduction, with the exception of the following: a. if they are used to meet the requirements for additional capital as per Article 45(2); and b. the provisions for conversion capital of systemically important banks as per Title 5. Chapter 2: Calculation Sub-section 2: Common equity Tier 1 Capital (CeT1) ARTiCLe 21 Eligible Elements 1 The following shall be eligible as Common Equity Tier 1 capital: a. paid-in share capital; b. disclosed reserves; c. reserves for general banking risks after deduction of deferred taxes, if no corresponding provi- sions have been formed; Ordinance concerning Capital Adequacy and Risk Diversification for Banks and Securities Dealers | 9