In response to the financial crisis, the Basel Committee (an international supervisory group with members from 27 countries) undertook "Basel II" to raise and tighten minimum bank capital requirements under the existing international bank capital accord. The Basel Committee released a near final version of its amendments to Basel II, referred to as Basel III, in December 2010. The December release, "Basel III: A Global Regulatory Framework for More Resilient Banks and Banking Systems", set out a list of several requirements that capital instruments would need to meet in order to qualify as non-common or so-called Additional Tier 1 (generally speaking, perpetual preferred stock and debt instruments), and/or Tier 2 (mainly subordinated debt) capital.

On 13 January 2011, the Basel Committee issued a statement describing the further requirement addressed in this article, which the Basel Committee referred to as "minimum requirements to ensure loss absorbency at the point of non-viability" and characterised as a "final element" of Basel III. While the Committee did not use the specific term "contingent capital" to describe the requirement, the term has been attached to the proposal as its requires capital instruments to be automatically converted into equity or written down, when a predetermined "trigger event" occurs (for example; the hallmark characteristic of a "contingent capital" instrument).

Under the new "loss absorbency" requirement, all Additional Tier 1 and Tier 2 instruments would either need to:

Whether required by contract or national law, the instruments would have to be either written off or converted into common equity upon the occurrence of a "trigger event2. Basel III grants national supervisors with the exclusive authority to call a "trigger event" for these instruments (rather than, for example, a market- or capital-ratio-based trigger approach).

More specifically, a trigger event is the earlier decision by a home country regulator of the bank issuer of the capital instrument:

The Basel III "loss absorbency" requirement is specifically designed to ensure that holders of Additional Tier 1 and Tier 2 instruments would fully absorb losses before taxpayers in the event government assistance is provided to the issuing bank. In these cases, holders could either lose the entire value of their investment (for example, a write-off) or, alternatively, receive some amount of common stock of the bank or the bank's parent company (for example, a conversion and recapitalisation of the bank). Whether the instrument would be written off or converted into common stock would depend either upon the terms and conditions of the instrument and/or the applicable law of the home country of the bank. In cases where the holder receives common stock for the instrument, the stock must be issued prior to any public sector injection of capital in order to ensure that the government’s interests are not diluted by the conversion.

As noted above, the scheduled date for implementation of Basel III is 1 January 2013. In this regard, Basel III specifically requires:

As a practical matter, this means that Basel III requires existing "hybrid" instruments (preferred stock and debt) issued by internationally active banks to be phased out as regulatory capital over time by 2023, unless the terms/conditions of such instruments are modified as necessary in order to ensure their conformance with the "loss absorbency" requirement.

Basel member states, such as the US and the European Union, have pledged to apply the Basel III framework in their respective countries. Nonetheless, since Basel III is not legally binding in any jurisdiction, the precise manner in which the new standards will be applied in member states will be determined through future regional and national rulemaking. The fact that there is not yet an established market or proven legal framework for securities with the required "loss absorbency" feature, coupled with the fact that the new requirement leaves several issues open to national interpretation, suggests that there will almost certainly be regional variation in its adoption. For example, variations in the implementation of the requirement may reflect differing national and regional laws and attitudes towards:

The following aspects of the Basel III "loss absorbency" requirement appear particularly likely to be subject to some national/regional variation:

The Basel III "loss absorbency" requirement raises numerous complicated questions that will need to be addressed by Basel Committee members from both a practical and legal standpoint. For example, implications of the requirement will need to be evaluated from both a financial markets perspective and from the perspective of existing tax laws, accounting treatment, bankruptcy laws, corporate laws, and banking laws. As a consequence, it will almost certainly take some time and effort to create sufficient confidence in the legal treatment and marketability of Basel III-compliant Additional Tier 1 and Tier 2 instruments before any sizeable market in them will form.