Buy-Side Trade Associations Criticize Basel II Capital Requirements (with Lofchie Comment)

The Asset Management Group of SIFMA ("SIFMA AMG") and FIA Global each sent comment letters to the Basel Committee on Banking Supervision ("BCBS") regarding how segregated margin is treated in the leverage calculations that determine bank capital requirements.

According to SIFMA AMG, the derivatives exposure measure contained in the Basel III Leverage Ratio Framework and Disclosure Requirements ("LR Framework") may "substantially reduce" members' ability to hedge risk and reduce volatility in the funds they manage through the use of cleared derivatives. SIFMA AMG stated that the LR Framework has been applied in a manner that imposes outsize capital requirements on central counterparties ("CCPs") acting through clearing brokers that are members of CCPs ("Clearing Firms"). SIFMA AMG urged the BCBS to "clarify that Clearing Firms (i) may account for segregated initial margin in calculating their exposure on cleared derivatives transactions and . . . (ii) need not include segregated initial margin in their calculation of on-balance sheet items."

Similarly, FIA Global urged the BCBS to consider how segregated margin is treated, requesting that segregated margin be excluded from Basel III capital requirements. The FIA Global letter sets forth the reasons why the Basel III leverage ratio "should recognize the exposure-reducing effect of margin that is segregated, because segregated margin cannot be used to increase the bank's leverage." According to the letter, "if not clarified or amended, the failure of the leverage ratio to recognize the exposure-reducing effect of segregated margin . . . will likely have seriously negative effects on cleared derivatives markets and market participants, including end users."

Lofchie Comment: These letters demonstrate the fact that risk is not as easily eliminated as it is moved around, and not always for the better. If in fact the bank regulators are setting clearing margin requirements too high, then the regulators are effectively (i) reducing banks' ability to engage in profitable business and (ii) leaving the capital markets less able to transfer risk.

See: SIGMA AMG Letter; FIA Global Letter.