Five financial industry associations have joined forces to express their strong concern about the implications of including central bank cash balances within Basel III’s leverage ratio framework.
The warning came in a joint statement from five associations, including the International Swaps and Derivatives Association (ISDA).
They also all submitted comment letters in response to the Basel Committee on Banking Supervision’s (BCBS) consultation on revisions to the Basel III leverage ratio framework, which was issued in April. The BCBS hopes to complete the review by the end of the year.
The associations noted and echoed the sentiments of the Bank of England’s Financial Policy Committee, which raised its the same concern with the leverage ratio framework in its review on 5 July.
All five associations reiterated their support for the BCBS’s broad aims to mitigate market risk and boost transparency, but also highlighted the need to expand the scope of the BCBS’s review and “carefully consider the way cash and unencumbered cash equivalent assets are treated in the leverage ratio”.
They said they share the Financial Policy Committee’s concerns that including central bank deposits in the leverage ratio could affect the ability of the banking system to cushion shocks.
Kenneth Bentsen, CEO of the Global Financial Markets Association (GFMA), a trade group that joined ICMA in submitting to the consultation, explained: “Even client transactions that are designed to reduce risk will require broker-dealers to expand their balance sheets. Regulations should not impair clients’ ability to conduct risk-reducing transactions in cases where these transactions do not add risk to banks’ balance sheets.”
“By excluding cash and cash equivalents from the exposure measure of the leverage ratio, regulators could alleviate the constraints on these important market activities, especially in distressed markets.”
Scott O'Malia, ISDA's CEO, added: “The leverage ratio as it stands makes the economics of client clearing extremely difficult for clearing members, which runs counter to the objective set by the G20 nations to encourage central clearing.”
“We welcome the decision by the BCBS to collect data to study the impact of the leverage ratio on client clearing, but we are disappointed it has not taken the opportunity to consult on the recognition of initial margin more widely.”
The associations also noted that the BCBS did not resolve the issue of whether to recognise collateral posted by counterparties on derivatives trades more broadly.
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, they argued.
The associations added in their joint statement: “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 went on to make proposals and comments on trade versus settlement date accounting proposals, cash pooling, calibration of credit conversion factors, and the treatment of securitisations and derivatives.
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