Dividends under Solvency II
As you will be aware, Solvency II will impose requirements as to the quality of the capital held by a firm. Core tier 1 capital is the best, and will typically be made up by ordinary share capital.
The Solvency II Regulations (otherwise known as the Level 2 measures) look set to take this a step further. From the latest draft that we have seen, an ordinary share would not meet the tier 1 criteria unless the firm is able - in certain circumstances - to cancel a dividend that has been declared but not yet paid. The circumstances in question are where the firm is in breach of its solvency capital requirement (SCR), or where the payment of the dividend would put it in breach. The PRA has in its latest Solvency II consultation adopted this with a draft rule, and associated Supervisory Statement. So far so good, and indeed it seems quite legitimate for the EU and the PRA to specify what may or may not constitute Tier 1 capital for regulatory purposes.
However, the PRA goes further. It goes on to say that: "The PRA considers that where a firm's articles of association do not prohibit the cancellation of a dividend at any time, including after declaration, then they may be said to allow such cancellation so that the firm may be able to declare a dividend on a conditional basis, allowing cancellation of the dividend at any time prior to payment, if the applicable conditions are not met. Firms should ensure that they review their own articles to establish the absence of any such prohibition. Firms should also consider whether it is appropriate to amend their articles to include a specific power for the firm to declare dividends subject to conditions or even for all declarations of dividend to be conditional."
This statement merits some careful consideration. Under English company law, a final dividend when declared and approved by shareholders becomes a debt of the company. Is it right that a company may declare a conditional dividend without express powers to do
One can imagine scenarios where problems in following the PRA's analysis may arise, particularly in the case of a delay between declaration and payment. For instance, where the firm suffers a material adverse change. Or where the SCR simply increases, e.g. where the PRA imposes a capital add-on. There may be additional considerations for a firm with publicly traded shares for which an 'ex dividend' date applies. These firms will likely have disclosure or other obligations arising from their listing arrangements in relation to possible non-payment of a declared dividend. How would shareholders/ buyers respond to being told that a declared dividend was to be pulled? Not well, one suspects.
The legal fix would be for a firm to amend its constitutional documents to expressly provide for payment of dividends to be conditional in this way. This should be a relatively simple exercise, although this may raise questions amongst the investor base. Alternatively a firm may choose to rely on the PRA's interpretation of company law. But it will need to brace itself for shareholder challenge if things turn bad. We would strongly suggest that a firm takes its own advice on whether such an approach will stand up in the face of this.