GERMANY: BaFin’s Supervisory treatment of individual features of corporate bonds under the PRIIPs Regulation

Monday September 23 2019

On 19^th September 2019, BaFin published the supervisory treatment of individual corporate bonds under the PRIIPs regulation. Earlier in July 2018, the Joint Committee of the European Supervisory Authorities analysed the treatment of corporate bonds under the PRIIPs Regulation and requested the European Commission to publicly clarify the scope of the Regulation or to confirm this analysis.

The European Commission replied by way of a letter dated 14 May 2019.

The PRIIP manufacturers and persons advising on, or selling, such products to retail investors, are initially responsible for determining which products must comply with the requirements of the PRIIPs Regulation. This assessment must consider, in particular, the specific economic features and contractual terms and conditions of each product.

The following were outlined by BaFin’s administrative practice regarding the supervisory treatment of corporate bonds in relation to the interpretation of the PRIIPs Regulation as at the date of this Guidance Notice.

The individual features of a corporate bond must be considered on a case by case basis in order to assess whether the bond must be treated as a PRIP or not.

1) Feature: Perpetual
Perpetual corporate bonds are not treated as PRIPs. This is because in particular the amount repayable (which is defined as comprising both interest and principal repayments) is not subject to fluctuations because of exposure to a reference value, due to the fact that it is perpetual.

2) Feature: Subordinated
Subordinated corporate bonds are not treated as PRIPs. This is because in particular the amount repayable is not subject to fluctuations because of exposure to reference values, due to its subordination. Even cases of qualified subordination do not lead to the corporate bond being classified as a PRIP.

3) Feature: Fixed rate
Fixed-rate corporate bonds are not treated as a PRIPs. This is because in particular the amount repayable is not subject to fluctuations because of exposure to a reference value, due to the fixed interest rate. This also applies in cases in which a corporate bond does not pay any interest, i.e. where it has a zero coupon.

Additionally, a corporate bond is not subject to fluctuations because of exposure to reference values, and therefore does not represent a PRIP, if the terms and conditions of the bond provide for predefined changes in the coupon rate at fixed times prior to maturity, e.g. if the coupon rate increases annually on predefined dates (this is known as a “step-up bond”).

4) Feature: Changes in the amount repayable (interest and principal) depending on exposure to reference values
In principle, predefined conditional or unconditional changes in coupon rates that do not depend on exposure to reference values or to the performance of one or more assets do not lead to the corporate bond being classified as a PRIP. This includes in particular changes in coupon rates as a result of issuer rating downgrades, a change of control, or tax or regulatory events.

5) Feature: Puttable/callable
Where a corporate bond is puttable/callable by the issuer and/or creditor, this in itself does not lead to the bond being a PRIP. Although the amount repayable of the bond is subject to regular fluctuations due to early termination, these fluctuations do not occur because of exposure to a reference value.

6) Feature: Conversion right or right to subscribe for other securities
Where a corporate bond features a conversion right or right to subscribe for other securities (e.g. shares), as is the case for example with (mandatory) convertible bonds and bonds with warrants, it must be treated as a PRIP. In this case the amount repayable is subject to fluctuations because of exposure to a reference value that is not directly purchased in those cases in which the conversion right or option is exercised.

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