286 6 Mezzanine
may be included in supplementary capital. In addition to perpetual preference shares carry-
ing a cumulative fixed charge, the following instruments, for example, may qualify for in-
clusion: long-term preferred shares in Canada, titres participatifs and titres subordonnés à
durée indéterminée in France, Genussscheine in Germany, perpetual debt instruments in the
United Kingdom and mandatory convertible debt instruments in the United States ...”^8
The recognition of subordinated term debt instruments as Tier 2 capital instru-
ments is more problematic.
This has also been stated in the Basel II Accord: “The Committee is agreed that subordi-
nated term debt instruments have significant deficiencies as constituents of capital in view
of their fixed maturity and inability to absorb losses except in a liquidation. These deficien-
cies justify an additional restriction on the amount of such debt capital which is eligible for
inclusioin within the capital base. Consequently, it has been concluded that subordinated
term debt instruments with a minimum original term to maturity of over five years may be
included within the supplementary elements of capital, but only to a maximum of 50% of
the core capital element and subject to adequate amortisation arrangements.”^9
In exceptional cases and only where permitted by national regulatory capital rules,
short-term subordinated debt instruments may be recognised as Tier 3 capital.
One can again cite the Basel II Accord: “The principal form of eligible capital to cover
market risks consists of shareholders’ equity and retained earnings (Tier 1 capital) and sup-
plementary capital (Tier 2 capital) as defined in paragraphs 49(i) to 49(xii). But banks may
also, at the discretion of their national authority, employ a third tier of capital (Tier 3), con-
sisting of short-term subordinated debt as defined in paragraph 49(xiv) below for the sole
purpose of meeting a proportion of the capital requirements for market risks, subject to the
following conditions ...”^10
Reasons to use mezzanine finance. A non-financial firm can use the mezzanine
technique for various reasons.
The availability of funding can play a role. Sometimes it is used because there
is not enough shareholders’ capital and senior debt available to cover the firm’s
funding needs.^11 Mezzanine capital is often applied in the context of buy-outs and
venture capital. It is suitable for so-called “pre-IPO bridge financing” as well as
for rescue and restructuring of companies and for growth financing, acquisitions,
leveraged buy-outs (LBOs) or management buy-outs (MBO) or buy-ins (MBIs). It
is, however, not suitable for covering the ongoing financing needs of a company.^12
Mezzanine instruments can match the risk-reward preferences of some inves-
tors. The issuing of a wider range of capital instruments may enable the firm to
raise more funding and to reduce the overall cost of external funding.
(^8) Paragraph 49(xi) of the Basel II Accord.
(^9) Paragraph 49(xii) of the Basel II Accord.
(^10) Paragraph 49(xiii) of the Basel II Accord. For short-term subordinated debt eligible as
Tier 3 capital, see paragraph 49(xiv) of the Basel II Accord.
(^11) Diem A, Akquisitionsfinanzierungen. C.H. Beck, München (2005) § 4 number 7.
(^12) Wiehe H, Jordans R, Roser E, Mezzanine Finance Structures under German Law, JIBLR
22(4) (2007) p 219.