Trade Associations Comment on Proposed Regulatory Capital Reforms
Commentary by Sebastian Souchet
In a series of comment letters, trade associations expressed support for reforms proposed by US banking regulators. The associations called for quick adoption and further adjustments to ease market constraints.
In the proposed rulemaking, the banking regulators proposed changes to the enhanced supplementary leverage ratio ("eSLR"), including replacing the fixed 2 percent buffer with a calibration tied to each GSIB's Method 1 surcharge and adjusting related requirements for their depository subsidiaries. (See previous coverage.) The proposal, which also includes conforming changes to total loss-absorbing capacity ("TLAC") and long-term debt ("LTD") rules, has drawn a range of industry responses as part of the agencies' effort to update capital standards.
The Bank Policy Institute ("BPI") emphasized that the reform constitutes an important first step to restore the eSLR to its intended role as a backstop rather than a binding constraint. BPI urged the federal banking agencies to finalize the eSLR recalibration promptly so that it is effective by January 1, 2026. BPI also recommended that the federal banking agencies take, among other things, the following actions: (i) cap the eSLR leverage buffer at 2 percent "to keep the buffer from exceeding the current calibration;" (ii) generally revise Tier 1 leverage ratio requirements so that "all leverage ratio requirements generally serve as a backstop to risk-based capital requirements throughout the economic cycle and during periods of stress rather than as a binding constraint;" (iii) eliminate separate LTD requirements for US GSIBs and covered US intermediate holding companies of foreign banking organizations ("IHCs"); and (iv) withdraw the agencies' 2023 LTD proposal requiring certain large depository institution holding companies, IHCs and insured depository institutions to issue and maintain outstanding a minimum amount of LTD.
ISDA, SIFMA and the FIA (collectively, "ISDA/SIFMA/FIA") stressed that finalization of the rule by January 1, 2026 is critical to ensure the eSLR functions as a backstop while preserving Treasury market liquidity. In addition, to the regulatory capital recalibrations recommended by BPI, ISDA/SIFMA/FIA recommended that the federal banking agencies: (i) recognize the risk-reducing benefits of cross-product netting agreements by extending the existing standardized approach for counterparty credit risk to incorporate securities financing transactions when covered under a qualifying cross-product master netting agreement; (ii) reassess the scope of firms subject to the global market shock ("GMS") component of the Federal Reserve's supervisory stress tests, "as well as the calibration of shocks in the GMS;" and (iii) recalibrate the weighted short-term wholesale funding indicator determined in the FR Y-15 with respect to US Treasury-backed repos, including cleared repos.
The Financial Services Forum and American Bankers Association made substantially similar recommendations to those made by BPI and ISDA/SIFMA/FIA.
The Institute of International Bankers ("IIB") urged the agencies to broaden regulatory capital reforms beyond adjustments to the eSLR, which only applies to US GSIBs. The IIB emphasized the role that international banks play in the market for US Treasuries, noting that "currently 16 of the 25 primary dealers are branches, agencies, or subsidiaries of international banks, and those primary dealers supported over 19 [percent] of the $22.7 trillion in [US Treasuries] issued in 2023."
The IIB recommended that the federal banking agencies also adjust regulatory capital requirements applicable to IHCs and make changes to the calculation of certain risk-based indicators ("RBIs") under the federal banking agencies' tailoring framework to include international banks that play a critical role in Treasury markets. Specifically, the IIB recommended: (i) adjusting RBIs by excluding Treasury financing activities from weighted short-term wholesale funding, excluding cash and repo Treasury positions from non-bank asset RBIs, excluding from the calculation of off-balance-sheet exposures "those exposures arising from a clearing member clearing [US Treasury] transactions for customers," and indexing RBI thresholds for growth and inflation; (ii) excluding Category III firms and IHCs under $250 billion in assets from application of the SLR; (iii) recalibrating the Tier 1 leverage ratio minimum to 3 percent for bank holding companies and IHCs in Category III and below, with a 4 percent well-capitalized minimum Tier 1 leverage ratio for bank subsidiaries; and (iv) revising the calibration and narrowing the application of certain stress capital buffer requirements.
Commentary
The banking industry seems broadly aligned in its support for the U.S. prudential regulators' recalibration of the eSLR. However, the various comment letters also indicate that the proposed eSLR reform is not a panacea for bank regulatory capital-related issues affecting Treasury market liquidity and intermediation.
Given the significant impact of the SEC's Treasury clearing mandate over the next several years, the U.S. prudential regulators will very likely need to consider broader reform of leverage and risk-based capital requirements to account for the market impact of such clearing requirements. To that end, the banking regulators should pay particular attention to the ISDA/SIFMA/FIA comment letter's extensive discussion of the critical importance of enhancing regulatory recognition of the risk-reducing benefits of cross-product netting arrangements, including through extension of SA-CCR to securities financing transactions.
As the ISDA/SIFMA/FIA comment letter notes: "Recognizing the risk-mitigating effects of these netting agreements reduces otherwise excessive capital requirements and expands the capacity of banks to intermediate in capital markets—not just in the U.S. Treasury market but also across, for example, sovereigns, agencies, TBAs, and equity markets" (p. 14). Whether or not the banking regulators decide to expand recognition of the risk-mitigating effects of cross-product netting arrangements will arguably also be a core determinant of the viability of certain Treasury repo clearing business models.
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