07 July 2016

GFMA, IIF, ISDA, JFMC and TCH respond to the Basel consultation on leverage ratio

However, the Associations (The Global Financial Markets Association (GFMA), the Institute of International Finance (IIF), the International Swaps and Derivatives Association (ISDA), the Japan Financial Markets Council (JFMC) and The Clearing House (TCH)) strongly encourage the BCBS to expand the scope of the review and carefully consider the way cash and unencumbered cash-equivalent assets are treated in the leverage ratio.

On July 5, the Bank of England’s Financial Policy Committee published a review of the leverage ratio framework in its Financial Stability Report, and expressed strong concerns regarding the inclusion of central bank cash balances in the leverage ratio. The Associations share the FPC’s concerns that including central bank deposits in the leverage ratio can affect the ability of the banking system to cushion shocks.

The Associations also highlight in their response that the BCBS should consider how other cash-equivalent securities, such as US Treasuries and other high-quality government bonds, are treated in the leverage ratio and the broader Basel framework. These securities underpin the soundness of the financial system and are used as collateral by most market participants for central clearing and as liquidity reserves by all banks and other market participants. If banks are bound by the leverage ratio, they cannot provide financing, even against such high-quality assets, and this may significantly reduce risk warehousing capacity on a system-wide level.

The Associations’ response sets out in detail the recommendations and changes they consider necessary so that the leverage ratio framework captures real leverage without damage to functioning of financial markets. Among others, they make specific recommendations regarding the trade versus settlement date accounting proposals, cash pooling, calibration of credit conversion factors, and treatment of securitizations and derivatives.

The Associations recommend that the BCBS adopts option B on netting for unsettled regular-way purchases and sales of financial assets. The proposed option A would produce an artificial ‘ballooning’ of the bank’s balance sheet and increase volatility in the exposure measure depending on the volume of client transactions. The only way for a bank to manage this exposure would be to constrain execution of client orders. This would be an undesired outcome with a significant impact on broader market liquidity, while not addressing a real leverage concern. Delivery-versus-payment settlement ensures that, at all times, the bank has either the security or the cash associated with buying or selling that security.

The Associations object to proposed changes to the treatment of notional pooling arrangements, in cases when the pools achieve a single unit of account treatment under accounting rules. These are key cash management products for large corporates that provide products and services to the real economy. They benefit from notional pooling due to reduced liquidity management and operational burdens. If this accounting concept is not recognized in the leverage ratio, clients that use these structures would have to absorb higher operational costs or fundamentally change how they operate and manage cash.

The Associations welcome the BCBS's decision to consider recognizing the exposure-reducing effect of initial margin in client clearing transactions, as properly segregated initial margin posted by a counterparty is not a source of leverage and risk exposure for a bank. However, the industry expresses concern that the BCBS chose not to consider the issue of whether to recognize collateral posted by counterparties on derivatives trades more broadly. The Associations also highlight the fact that the lack of recognition of high-quality liquid assets as variation margin will potentially limit the access to derivatives of pension funds and other end users that rely on the ability to post securities collateral.

The Associations also note that a well-calibrated leverage ratio that recognizes the benefits of securitization for originating banks can be both prudent and help meet global and regional policy objectives of reviving the securitization market in order to support growth and the real economy. Where a bank securitizes assets in a traditional securitization and sells tranches to third-party investors, without recourse to or repurchase obligation by the bank, the bank should be permitted to exclude those assets from its leverage ratio.

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