Case No: HC-2015-001336
Neutral Citation Number: [2015] EWHC 1560 (Ch)
IN THE HIGH COURT OF JUSTICE
CHANCERY DIVISION
Royal Courts of Justice
Strand, London, WC2A 2LL

Date: 03/06/2015
Before :

THE CHANCELLOR OF THE HIGH COURT

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Between :

	BNY MELLON CORPORATE TRUSTEE SERVICES LIMITED
Claimant
-and-

(1) LBG CAPITAL NO. 1 PLC
(2) LBG CAPITAL NO. 2 PLC
Defendants
		
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Jeremy Goldring QC and Stephen Robins (instructed by Allen & Overy LLP) for the Claimants
Robert Miles QC and Gregory  Denton-Cox (instructed by Norton Rose Fulbright LLP) for the Defendants

Hearing dates : 18th and 19th May 2015
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Judgment
The Chancellor (Sir Terence Etherton)
Introduction
1.	The issue in these proceedings is whether the defendants, wholly-owned subsidiaries of Lloyds Banking Group plc (“LBG”), are now entitled to redeem certain enhanced capital notes (“the ECNs”) in advance of their respective maturity dates.  That turns on whether or not a Capital Disqualification Event (a “CDE”) has occurred.  
2.	The dispute concerns approximately £3.3 billion of ECNs, which were issued by the defendants (“the Issuers”) in 33 series in 2009.
3.	The claimant (“the Trustee”) is the trustee of the various series of ECNs.  The Issuers contend that a CDE has occurred which entitles them to redeem the ECNs.  The Trustee contends that no such event has occurred.  The Trustee claims a declaration as to the true position.    
Background
4.	The financial crisis of 2008 caused regulators to require banks to increase their capital.  As part of the process of assessing banks’ regulatory capital the Financial Services Authority (“the FSA”) employed stress tests to determine the ability of a bank to withstand challenging economic conditions and to continue lending on normal commercial criteria.
5.	In March 2009 the FSA stress-tested LBG against a benchmark of a ratio of core tier 1 capital (“CT1 capital”) to risk weighted assets of 4%.  LBG was found by the FSA to have a shortfall against that benchmark of £24 billion to £29 billion of CT1 capital.  LBG announced that it intended to participate in the Government’s Asset Protection Scheme (“GAPS”).
6.	LBG subsequently decided that it would be preferable to improve its own capital position without participating in GAPS, in part because of the substantial participation fee, in excess of £15 billion, it would have been required to pay to participate in GAPS.  Consequently, in late 2009 LBG embarked on a programme of raising further CT1 capital through the private capital markets by (1) raising further equity of £13.5 billion by way of a rights issue; and (2) carrying out exchange offers, under which holders of certain existing securities issued by LBG, which did not qualify as CT1 capital (“the Existing Securities”), were invited to exchange those securities for ECNs.  Following those offers, £8.3 billion of ECNs were issued in December 2009.
7.	The Existing Securities included various notes and securities paying fixed rates (being various rates of up to 15% per annum) in perpetuity.  Among others, approximately 123,000 retail investors were sent the memorandum in which LBG made the exchange offer (“the Exchange Offer Memorandum”).  I was informed at the hearing that about 86% accepted the offer.
8.	£5 billion of those ECNs have recently been exchanged for other instruments, and approximately £3.3 billion across 33 series remain in issue in their original form.  
9.	The outstanding ECNs have various maturity dates from 2019 to 2032 when the Issuers are required to repay the capital amounts of the ECNs.  Until then, or earlier redemption where permitted, interest is payable on the ECNs at an average rate across the outstanding ECNs of around 10.33%.  The ECNs are held by a large number of individuals (“retail investors”) as well as institutional investors. 
10.	The reasons for, and the terms of, the ECNs were set out in the Exchange Offer Memorandum, which included a letter from Sir Winfried Bischoff, the then chairman of LBG.
11.	The ECNs were a new form of capital intended to increase LBG’s “contingent” CT1 capital.  They would qualify as Lower Tier 2 capital, and would convert into ordinary shares, a component of CT1 capital (under the UK’s then implementation of the Second Basel Accord), if LBG’s capital position deteriorated to the extent that its published consolidated CT1 capital ratio fell below 5%.  They would also count as CT1 capital for the purposes of the FSA’s stress testing when that ratio fell below 5% in the stressed projection.  In that way they would assist LBG in meeting the requirements of the FSA’s stress tests.
12.	It is a term of the ECNs that they may be redeemed by the Issuer before the maturity date if a CDE has occurred.  
13.	The possibility of the conversion of the ECNs into ordinary shares has led to the ECNs (and similar securities issued by other banking institutions) being known as ‘contingent convertible bonds’ (or notes) or ‘CoCos’ for short.  As far as the Trustee is aware, the ECNs were the first contingent convertible instruments to be issued by any UK financial institution.
14.	On 1 April 2013 the FSA was abolished pursuant to the Financial Services Act 2012.  The functions of the FSA in respect of the prudential regulation and supervision of banks were transferred to the Prudential Regulatory Authority (“the PRA”), which is a part of the Bank of England.  The Bank of England Financial Policy Committee (“the FPC”) was also established at that time.  
15.	In July 2013 the Basel Committee on Banking Supervision’s report published in December 2010 - “Basel III: A global regulatory framework for more resilient banks and banking systems” - was transposed into law by the EU Fourth Capital Requirement Directive 2013/36/EU (“CRD IV”).  The Capital Requirements Regulation (EU) 575/2013 (“the CRR”) also came into force.
16.	CRD IV and the CRR (together “the CRD IV package”) introduced the concept of Common Equity Tier 1 capital (“CET1 capital”).  CET1 capital includes ordinary shares but is more restrictive than CT1 capital.  The minimum “core” capital ratio was set at a CET1 capital ratio of 4% of risk weighted assets, applicable from 1 January 2014, increasing to 4.5% as from 1 January 2015.  Under the CRR convertible capital instruments would only qualify as Additional Tier 1 capital if the trigger for conversion was set at a CET1 ratio of 5.125% or higher, which was above the minimum permitted ratio of 4%/4.5%.
17.	The PRA required LBG in the course of 2013 to raise a substantial amount of further capital in order to meet new minimum CET1 capital requirements.  LBG did so.
18.	In December 2014 the PRA tested whether UK financial institutions’ CET1 ratio to risk weighted assets would remain above a minimum 4.5% CET1 ratio threshold in the stressed projections.  The results of the stress test were published by the PRA on 16 December 2014.  The stress testing was carried out using figures from December 2013.  So far as concerned LBG, its actual CET1 ratio as at the end of 2013 was 10.1%, and its minimum “stressed” ratio in the stress test was 5% before the impact of strategic management actions, or 5.3% after the impact of such actions. The ECNs were not taken into account by the PRA in the December 2014 stress test.
19.	On 16 December 2014 LBG announced that the ECNs had not been taken into account in the December 2014 stress test and that a CDE had occurred.  It stated that it intended to approach the PRA to seek the appropriate permission to redeem 23 series of outstanding ECNs.
20.	 The PRA has confirmed in a letter of 17 March 2015 that the ECNs did not count towards LBG’s projected CET1 capital ratio in the stress test because LBG remained above the 4.5% CET1 threshold in the stress-testing exercise, and it also remained above the ECN conversion trigger level.  The PRA went on to say in that letter that the question whether the ECNs would have converted before or after the 4.5% CET1 threshold was reached “did not arise” in the December 2014 stress test, but that “as a result of the differences between the definitions of CT1 and CET1 capital, it is likely the ECNs would only reach the contractual conversion trigger [of a 5% CT1 ratio] at a point materially below 4.5% CET1”.
21.	The PRA’s consent to the proposed redemption of the ECNs was necessary as (1) condition 8(b) of the ECNs requires one month’s notice to the PRA, and non-objection from the PRA, and (2) Articles 77 and 78 of the CRR require the prior permission of the PRA for the redemption of any Tier 2 instruments prior to their contractual maturity.  
22.	Permission was received from the PRA on 31 March 2015.  It is common ground that this was based on LBG’s capital position rather than any determination by the PRA as to whether a CDE had taken place.   LBG agreed to defer redemption in the light of the Trustee’s intention to issue the present proceedings, the Trustee having been directed in writing by the requisite proportion of one series of noteholders to commence a claim seeking a declaration that the Issuers are not entitled to redeem the ECNs in this way.
The definition of “Capital Disqualification Event”
23.	The ECNs in each series were constituted by a trust deed dated 1 December 2009 between the Issuers, LBG, Lloyds TSB Bank plc and the Trustee (“the Trust Deed”).  In the Trust Deed before the court in these proceedings the terms and conditions of the relevant ECNs were set out in schedule 4A.
24.	That schedule provided as follows so far as relevant to the right of the Issuers to redeem in issue in these proceedings.
25.	Condition 8(e) provides that:
“If, immediately prior to the giving of the notice referred to below, a Capital Disqualification Event has occurred and is continuing, then the Issuer may, subject to Condition 8(b) and having given not less than 10 nor more than 21 days’ notice to the ECN Holders in accordance with Condition 17, the Trustee, the Issuing, Paying and Conversion Agent and the Registrar (which notice shall, subject as provided in Condition 8(f), be irrevocable), redeem in accordance with these Conditions....all, but not some only, of the ECNs at the Capital Disqualification Redemption Price.....”
26.	The expression “a Capital Disqualification Event” is defined in condition 19.  There are two parts to the definition. The first part is directed to a situation in which the ECNs are no longer eligible to qualify in whole or in part for inclusion in the Lower Tier 2 Capital of LBG on a consolidated basis.  In other words, that part is dealing with the characterisation of the ECNs for regulatory capital purposes prior to their conversion into ordinary shares.  The second part of the definition, which is the part directly relevant to these proceedings, provides as follows:
“a “Capital Disqualification Event” is deemed to have occurred... (2) if as a result of any changes to the Regulatory Capital Requirements or any change in the interpretation or application thereof by the FSA, the ECNs shall cease to be taken into account in whole or in part (save where this is only as a result of any applicable limitation on the amount that may be so taken into account) for the purposes of any “stress test” applied by the FSA in respect of the Consolidated Core Tier 1 Ratio.”
27.	The expression “Regulatory Capital Requirements” is defined in condition 19 as meaning: 
“any applicable requirement specified by the FSA in relation to the minimum margin of solvency or minimum capital resources or capital”
28.	The meaning of the expression “Consolidated Core Tier 1 Ratio” is to be found in condition 7(a)(i), which addresses the conversion trigger, on the occurrence of which the ECNs are converted into ordinary shares.  That condition provides as follows, so far as relevant:
“If the Conversion Trigger occurs at any time, each ECN shall, subject to and as provided in this Condition 7(a) and in the Deed Poll, be converted on the Conversion Date into new and/or existing (as determined by LBG) Ordinary Shares credited as fully paid in the manner and in the circumstances described below and in the Deed Poll … The “Conversion Trigger” shall occur if at any time, as disclosed in the latest published annual or semi-annual consolidated financial statements of LBG or as otherwise publicly disclosed by LBG at any time, LBG’s Consolidated Core Tier 1 Ratio is less than 5 per cent.  As used in these Conditions, “Consolidated Core Tier 1 Ratio” means the ratio of the Core Tier 1 Capital of LBG to the risk weighted assets of LBG, in each case, calculated on a consolidated basis.”
29.	The expression “Core Tier 1 Capital” is defined in condition 19 as meaning:
“core tier one capital as defined by the FSA as in effect and applied (as supplemented by any published statement or guidance given by the FSA) as at 1 May 2009.”
30.	It is common ground that, for the purposes of those definitions, the FSA includes any governmental authority in the United Kingdom having primary supervisory authority with respect to LBG.
The proceedings
31.	The proceedings were commenced by the Trustee under CPR Part 8 by the issue of a claim form on 31 March 2015.  
32.	The Issuers applied for, and were granted, an early hearing date because the coupon on the ECNs is a high one in the context of the current base interest rates.  The coupon payments in respect of the outstanding ECNs across all series amount to some £940,000 each day. 
33.	No individual investors have been joined as parties and none were represented at the trial of the proceedings.  In accordance with its functions under the Trust Deed, the Trustee has advanced the case on behalf of the noteholders generally.  The Trustee was represented at the hearing of the proceedings by Mr Jeremy Goldring QC, leading Mr Stephen Robins.  The Issuers were represented by Mr Robert Miles QC, leading Mr Gregory Denton-Cox.  In addition to the written skeleton arguments of those counsel (although hardly an accurate description in the case of the obese 67 page document for the Trustee), written submissions by Mr Jeremy Cousins QC and Mr Max Mallin were lodged with the court on behalf of various individual retail investors.  There was no objection to that document.      
34.	Four witness statements have been filed in support of the Trustee’s case, all of which were made by Josephine Belinda Murray, a director and chair of the board of directors of the Trustee.  Two witness statements were made in support of the Issuers, one of which was made by Paul Xavier Morris, a partner in Norton Rose Fulbright LLP, the Issuers’ solicitors, and the other by Richard Douglas Shrimpton, group capital markets issuance director of LBG and a director of each of the Issuers.  None of the witnesses gave oral evidence.
The arguments
35.	There was no dispute as to the applicable principles of law for the interpretation of the Trust Deed and the ECNs.  Reference was made in the written submissions to Arbuthnott v Fagan [1995] CLC 1396, Investors Compensation Scheme Ltd v West Bromwich Building Society [1998] 1 WLR 896, Sirius International Insurance Co v FAI General Insurance Ltd [2004] UKHL 54, [2004] 1 WLR 3251, Chartbrook Ltd v Persimmon Homes Ltd [2009] UKHL                                                                                                                                                                                                                                                                                                                    [2009] 1 A.C. 1101, AG of Belize v. Belize Telecom Ltd [2009] UKPC 10, [2009] 1 WLR 1988, Re Sigma Finance Corp. [2009] UKSC 2, [2010] 1 All ER 571 (SC), [2008] EWCA Civ 1303 (CA), Marine Trade SA v Pioneer Freight Futures Co Ltd BVI [2009] EWHC 2656 (Com), [2010] 1 Lloyd’s Rep. 631, Rainy Sky v Kookmin Bank [2011] UKSC 50, [2011] 1 WLR 2900, K/S Victoria Street v House of Fraser (Stores Management) Ltd, [2011] EWCA Civ 904, [2012] Ch 497, Lloyds TSB Foundation for Scotland v Lloyds Banking Group Plc [2013] UKSC 3, [2013] 1 WLR 366, Lewison, The Interpretation of Contracts, 5th ed. and (particularly in the case of the written submissions of Mr Cousins and Mr Mallin) numerous cases mentioned by way of example in that work.
36.	In the event, apart from brief references to Lord Hoffmann’s speech in Chartbrook and to judgments in Sigma and Arbuthnott and the decision of Flaux J in Marine Trade SA, I was not taken during the hearing to those cases or indeed the remainder of the 26 cases in the files of authorities placed before the Court or to Lewison.  Broadly speaking, the approach of both sides was that the Trust Deed and the ECNs should be interpreted in the light of their admissible factual context so as to give effect to their objective commercial purpose.   
37.	The Issuers put forward a positive case that a CDE has occurred.  It is therefore appropriate to consider the arguments they have deployed to establish that positive case.
38.	Before doing so, I must consider a short but critical argument advanced by the Trustee that a CDE has not occurred because the December 2014 stress test was not a stress test “applied … in respect of the Consolidated Core Tier 1 Ratio” as specified in the definition of a CDE in condition 19 but rather it was a test applied in respect of a CET1 ratio.  That is a literally correct reading of the second part of the definition of CDE in condition 19 but I agree with Mr Miles that it produces such an extraordinary commercial result that it cannot have been intended.  
39.	As part of that argument the Trustee relies upon the fact that “Core Tier 1 Capital” is defined in condition 19 by reference to a specific definition used by the FSA as at 1 May 2009 (“as supplemented by any published statement or guidance given by the FSA”) in contrast to a CET1 capital ratio applicable from 1 January 2014.  It is not in dispute that the reference to 1 May 2009 was because on that day the FSA wrote to the British Bankers’  Association setting out the definition of CT1 capital that banks should use for reporting and disclosure purposes.  It has not been suggested that, for the purposes of the definition of “Core Tier 1 Capital” in condition 19, the definition in the letter of 1 May 2009 was supplemented by any relevant published statement or guidance given by the FSA.  
40.	That specificity in referring to the definition as at 1 May 2009 seems to me, however, to be a problem rather than a source of strength for the Trustee’s argument.  On the Trustee’s case, any new stress test which involved a deviation (other than a negligible one) from the definition in that letter would have made the ECNs irredeemable.  The very reason, however, for tying the definition of a CDE to the FSA’s definition of CT1 capital as at 1 May 2009 was to provide some certainty for the conversion trigger in circumstances where, as is common ground, it was already anticipated when the ECNs were issued that there would be changes to the regulatory regime which would make the capital requirements more robust and involve amending or superseding the definition of CT1 capital.  The effect of the Trustee’s interpretation, therefore, produces the very odd result that the definition of a CDE was intended to provide the trigger for LBG’s right to redeem in the event of regulatory change but the parties also intended that the then anticipated changes to the regulatory regime might well have the effect of making the ECNs irredeemable.
41.	Further, on the Trustee’s case, the ability of LBG to redeem would depend upon uncertain events that might well occur within the briefest of times after the issue of the ECNs as a result of even minor changes in the description of the requisite capital.   
42.	In the circumstances I agree with Mr Miles that there has been an obvious mistake in the drafting of the definition of a CDE in condition 19 by treating the meaning of the expression “consolidated core tier 1 ratio” in that definition as the same as the meaning of the defined term “Core Tier 1 Capital” in condition 19.  That defined term is perfectly apt for the description of the “conversion trigger” in condition 7(a)(i) but, for the reasons I have given, it is inapt in the context of the definition of a CDE.  
43.	Mr Miles submitted that, applying a purposive interpretation to the definition of a CDE, the second part of the definition should be read as referring to a stress test which is “in respect of the ratio between risk weighted assets and whatever is the then equivalent of core tier 1 capital” or, as he subsequently expressed it, a stress test applied by the regulator in respect of “core tier 1 capital and risk weighted assets” but without using capitals for “core tier 1 capital”.  I agree with the general sense of that suggestion but I prefer to articulate the correct interpretation as one in which the final line or so of the definition of a CDE is referring to a stress test applied by the regulator in respect of the ratio of top grade loss-absorbing capital (as defined from time to time by the regulator for the purpose of stress testing) to risk-weighted assets.
44.	Turning, then, to the Issuers’ arguments in support of their positive case, one of the two ways in which they put their case is that a CDE occurred when the ECNs were not taken into account in the December 2014 stress test.  It is common ground that the reason the ECNs were not taken into account was because LBG passed the stress test in view of the strength of its capital position without any need to take into account the ECNs, the conversion trigger point for which was well below the CET1 capital pass ratio.  Importantly, Mr Miles submitted that the reason a CDE occurred in those circumstances was because the December 2014 stress test was based upon LBG’s capital position in December 2013 and its capital position at that time had been strengthened as a result of new regulatory capital requirements imposed by the PRA in 2013.  Those new requirements followed from the recommendation made by the interim FPC on 27 March 2013 that the immediate objective was for banks to achieve a CET1 ratio, based on Basel III definitions and after certain adjustments, of 7% of risk weighted assets by the end of 2013.  In June 2013 the PRA announced that it was requiring LBG to raise some £7 billion of additional capital (Mr Shrimpton’s evidence was that the requirement was a further £8.6 billion) by the end of 2013 in order to meet the 7% standard.  The Issuers say that the 7% adjusted ratio was equivalent, for LBG, to an unadjusted CET1 capital ratio of approximately 10%.  
45.	Accordingly, the Issuers submit, a CDE has occurred because, as a result of changes in the regulatory capital requirements in 2013 resulting in a need for LBG to comply with the regulator’s requirement to increase its capital, the ECNs were not “taken into account” in the December 2014 stress test in view of LBG’s improved capital position.  In advancing that argument Mr Miles placed reliance on the difference between the language in the first part of the definition of a CDE in condition 19 – “the ECNs would no longer be eligible to qualify …” – and the language in the second part of that definition – “the ECNs shall cease to be taken into account …” 
46.	I do not agree with that argument.  The definition of a CDE is not looking at the happenstance of the particular strength of LBG’s capital and the particular composition of its capital at any one particular moment of time in the context of a particular stress test imposed by the regulator at that time.  The FSA’s statement on stress tests published on 28 May 2009, following earlier statements made on 14 November 2008 and 19 January 2009, makes clear that there were no fixed rules for the formulation of the severe hypothetical scenario for a stress test.  The assumptions made by the regulator could and would involve an element of judgement about perceived economic risks and would change and evolve over time.
47.	That explains why the expression “shall cease to be taken into account …” is not looking at the actual performance of LBG on a particular stress test at any one particular moment of time but rather connotes a disallowance in principle of the ECNs on stress testing with continuing effect in the foreseeable future.  The very word “Disqualification” in the expression “Capital Disqualification Event” also supports that connotation.  
48.	I do not consider that the slight difference in language between the first part and the second part of the definition of a CDE in condition 19 relied upon by Mr Miles assists in throwing any light on the point.  The expression “taken into account” in the second part is, as Mr Goldring pointed out, entirely appropriate in the context of the results of a stress test and not at all inconsistent with the Trustee’s interpretation.   
49.	Moreover, LBG’s argument involves a test, the outcome of which would depend on the uncertain and unpredictable size and composition of LBG’s assets at any particular fleeting moment of time.  The unattractiveness of the right to redeem being dependent on such uncertainty and unpredictability is not avoided by tying the strength and composition of LBG’s capital position on the occasion of any particular stress test to past requirements of the regulator.  As Mr Goldring observed, that would simply introduce a further layer of uncertainty over causation, that is to say uncertainty over the extent to which and the manner in which the strength and composition of LBG’s capital at any particular moment of time could be shown to be the result of past requirements of the regulator.
50.	I do not consider that the matter is taken any further by a number of other matters which Mr Miles put forward as safeguards against inappropriate redemption, such as the need under condition 8(b) to obtain the consent of the regulator before being allowed to redeem, the requirement under condition 8(b) that at the time of redemption LBG must be in compliance with the Regulatory Capital Requirements applicable to it, and the stipulation under condition 8(e) that the CDE is continuing.
51.	It is not necessary in the circumstances to consider a factual argument advanced in Mr Goldring’s reply submissions on this part of LBG’s case that on the evidence the conversion of the ECNs would not have been triggered even if the additional £8.6 billion had not been raised in response to the PRA’s requirements in 2013. 
52.	The Issuers’ other way of putting their case was that, on its proper interpretation, the second part of the definition of CDE applies whenever, as a result of changes in the regulatory capital requirements, the ECNs do not perform the purpose of providing regulatory capital so as to enable LBG to stay above the pass mark in a stress test.  The Issuers contend that such a situation has occurred because, on the evidence, the effect of the changes to the regulatory regime, in particular the CRD IV package, is that it is inevitable that the stress test will always be failed by LBG before the conversion trigger for ECNs occurs (or, as expressed by Mr Goldring in his oral submissions, is breached) in the hypothetical stress scenario.
53.	In support of that interpretation Mr Miles emphasised the following wording in the second part of condition 19: “the ECNs shall cease to be taken into account … for the purposes of any “stress test” applied by the FSA in respect of the Consolidated Core Tier 1 Ratio”.  His point was that the “Consolidated Tier 1 Ratio” was relevant only to passing of the stress test.
54.	Mr Miles referred to a number of matters which, he submitted, provided a factual context for that interpretation of the definition of a CDE.  They were the FSA’s statement on the regulatory approach to bank capital dated 19 January 2009, the FSA’s statement on its use of stress tests published on 28 May 2009, the Bank of England’s discussion paper – “A framework for stress testing the UK Banking system” – published in October 2013, the Exchange Offer Memorandum and comments made by the chairman of LBG, Sir Winfried Bischoff, and LBG’s Group Finance Director, Tim Tookey, at a Question and Answer session in relation to the proposals in the Exchange Offer Memorandum.  Mr Miles submitted that all of them demonstrated that the primary concern of both the regulator and of LBG at the time the ECNs were issued was that LBG should have at least 4% of CT1 capital after applying the stress test or, putting it more generally, that it should have sufficient capital to be able to absorb losses in the stress scenario and not fall below internationally agreed minimum standards.
55.	I do not agree with that narrow interpretation of the definition of a CDE which focuses only on the role of the ECNs in helping LBG to pass the stress test.  I do not consider that the evidence relied upon by Mr Miles provides anything like a firm foundation for such an interpretation.  What is important is that, as Mr Goldring observed, a stress test does not stop at the point at which it can be seen that the stress test is either passed or failed.  The stress test reveals not only whether a bank is able to meet internationally agreed minimum standards but, if it fails to do so, the extent of the shortfall and the most appropriate remedial measures that the regulator ought to require to be taken.  Even though the minimum standard currently set by the CRD IV package by reference to CET1 means that the conversion trigger for the ECNs will never be reached before the stress test is failed, the ECNs will still be relevant, if LBG were to fail the stress test, in ascertaining the extent of any shortfall in capital and the kind and extent of remedial action required.
56.	The implications of LBG’s interpretation can be seen by postulating a scenario in which, instead of the CRD IV package and the concept of CET1, the regulator had increased the stringency of the minimum capital requirements by increasing the required stress-tested CT1 capital ratio to 5.1%.  Mr Miles accepted that, on LBG’s argument, this would have constituted a CDE because it was above the ECN conversion trigger of 5%.  He accepted that it would have constituted a CDE even if, in the hypothetical stress scenario, the conversion of the ECNs at a 5% ratio would have generated sufficient ordinary share capital to have taken the CTI capital ratio up to or above 5.1% or at any event would have avoided the need for any consequential remedial measures.
57.	It is most improbable that such a consequence was intended.  As Mr Goldring pointed out, there is no suggestion in the Exchange Offer Memorandum that LBG would be entitled to redeem the ECNs in those circumstances.  Critically, everyone was aware at the time the Exchange Offer Memorandum was published and the ECNs were issued that the regulatory response to the financial crisis was still evolving.  That was why CT1 capital was defined in condition 19 by reference to the FSA’s definition as at a particular date, namely 1 May 2009.  It was clear at the time that the effects of the crisis would continue for some time and that there was a possibility that the minimum capital requirements would be made more stringent.  In the FSA’s statement on its use of stress tests published on 28 May 2009 the FSA stated that the then current stress scenario modelled a recession more severe and more prolonged than those which the UK suffered in the 1980s and 1990s and so more severe than any since the Second World War; and it assumed a peak-to-trough fall in GDP of over 6%, with growth not returning until 2011.     
58.	I therefore agree with Mr Goldring’s submission that nothing has changed to bring about a CDE as defined by condition 19 because, as has always been the case, the ECNs will be treated as converted and ordinary shares will be treated as created in any stress test if, in the hypothetical stress scenario, the risk weighted capital has diminished to the point at which the conversion of the ECNs would be triggered.  Until conversion, they rank, as they always have done, as Lower Tier 2 Capital.  After conversion, they rank, as they always have done, as CT1 Capital as defined in condition 19.  There has been no change in the Regulatory Capital Requirements, as defined in section 19, which has caused them to cease to be taken into account in stress tests.
59.	Mr Goldring submitted that, on its proper interpretation, the second part of the definition of a CDE in condition 19 was directed at a regulatory change resulting in ECNs, following their hypothetical conversion in a stress test, no longer qualifying to be treated as CT1 capital.  This spurred the retort from Mr Miles that such an interpretation is commercially absurd since ordinary shares are the very top form of regulatory capital, whether as CT1 capital or as CET1 capital.  He said that it is unthinkable that the regulator would ever change its rules so that LBG’s ordinary share capital could no longer be counted as part of its permanent loss absorbing capital for the purposes of stress testing.  Mr Miles also pointed out that the ECNs were structured in agreement with the FSA specifically to enable LBG to meet the stress tests.  
60.	Mr Goldring did not dispute that ordinary shares would normally be taken into account in a stress test.  His point, which I accept, is that the evidence supports the conclusion that, at the date the ECNs were issued, there could not have been complete confidence in the role they would play in the context of stress tests in the future.  Mr Goldring submitted, in support of that point, that there are a number of differences between ordinary share capital, on the one hand, and ordinary shares resulting from the conversion of the ECNs.  It is not necessary to examine that submission.  What is clear is that the ECNs issued by LBG in December 2009 were entirely novel instruments.  They were a form of hybrid security.  They were issued at a time when the regulatory regime to address the financial crisis was still evolving and was expected to become more rigorous.  Only a few months before the issue of the ECNs the place of hybrid capital instruments in the regulatory regime had been specifically considered by the EU Parliament and the Council of the EU:  see Directive 2009/111/EC of the EU Parliament and of the Council of 16 September 2009.  That directive did not, however, specifically address CoCos because the ECNs issued in December 2009 were the first of their kind.  
61.	Moreover, the conversion trigger for the ECNs was tied to LBG’s published annual or semi-annual consolidated financial statements (unless there was some other public disclosure by LBG that its consolidated CT1 ratio was less than 5%).  It was always possible that the regulator might take the view in the future that this could present a timing difficulty in the context of stress testing.
62.	I accept, therefore, Mr Goldring’s point that the second part of the definition of a CDE is directed to the possibility of a regulatory change which would preclude the ECNs any longer fulfilling the role specified by Sir Winfried Bischoff in his letter in the Exchange Offer Memorandum.  Adapting the language in that letter (so as not to limit the ECNs’ role to the specific stress test carried out in March 2009), the ECNs have not ceased to “count as core tier 1 for the purposes of the [regulator’s] [s]tress [t]est[s] when the stressed projection shows below 5 per cent core tier 1”.     
Conclusion      
63.	For all the reasons given above, there must be a declaration that a Capital Disqualification Event has not occurred.