July 12, 2016

Associations Object to Proposed Revisions to the Basel III Leverage Ratio Framework

Steven Lofchie Commentary by Steven Lofchie

In a detailed letter to the Basel Committee on Banking Supervision (the "BCBS"), several financial services associations (collectively, the "Associations") objected to the treatment of cash and cash equivalents in proposed revisions to the Basel III leverage ratio framework (the "LR"). The group was composed of five participating associations: The Global Financial Markets Association, the Institute of International Finance, ISDA, Japan Financial Markets Council and The Clearing House.

The Associations cited an analysis of the LR that was written by the Bank of England's Financial Policy Committee and expressed strong concerns about the inclusion of central bank cash balances in the leverage ratio. The analysis indicated that this inclusion would affect the ability of banks to maintain the necessary liquidity for market functions.

In addition, the Associations emphasized that cash-equivalent securities, such as U.S. Treasury bonds and other high-quality government bonds, are used as collateral by most market participants for central clearing, and also as liquidity reserves. If these high-quality assets are bound by the leverage ratio, then the ratio limits the ability of banks to provide repo and other financing, which, in turn, has a broad impact on wholesale market activity.

The Associations also recommended that the BCBS should:

  • change the way in which cash equivalent assets are treated in the variation margin ("VM") exposure measure;

  • adopt the option regarding the netting of regular-way purchases and sales of financial assets that recognizes delivery-versus-payment settlement dates when calculating the appropriate LR;

  • follow the accounting treatment for certain notional cash pooling arrangements that are treated as single units of account;

  • recognize the exposure-reducing effect of initial margin for cleared and uncleared derivatives transactions; and

  • subject to certain conditions, permit a bank that has placed tranches of a securitization with an unaffiliated third party to exclude the special purpose vehicle from its regulatory calculation and include only tranches that it actually retains.

Commentary

Global regulators should not be adopting increasingly strict regulations without considering the impact on the entire framework. Problems identified in the letter also concern the United States, since U.S. financial institutions are finding it impractical to enter into repurchase agreements, even with respect to government securities, in light of current leverage ratio requirements.

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