Banks are welcoming news that the Basel Committee on Bank Supervision is contemplating revisions to its Basel III leverage ratio framework. This means banks might now be able to utilize clearing houses to reduce the size of their derivatives books for the purposes of leverage ratio calculations.
This also could ultimately be a win for corporate hedgers because pricing may come down as the new rules would lower burden for some banks. Previously under proposed Basel III leverage rules, banks were required to set aside more capital to cover the counterparty risk on derivatives, creating complexities that required more resources. For treasurers, this would have meant pricier hedges or them not choosing to hedge using derivatives at all.
According to International Swaps and Derivative Association, this all good news. That’s because the leverage ratio’s current formulation “doesn’t recognize that properly segregated client collateral reduces exposure for firms that provide clearing services.” This means, ISDA says in a blog post, that “the amount of capital required to support client clearing services is not appropriately calibrated with the risks of that business. The end result: the economics of client clearing becomes extremely difficult for clearing members that provide this service, which runs counter to the objective set by the Group-of-20 nations to encourage central clearing.”
What the Basel Committee now proposes is replacing the current exposure method (CEM) with the standardized approach for counterparty credit risk (SA-CCR) – actually a modified version of SA-CCR, which is as ISDA suggests is akin to replacing a baseball bat with a more fine-tuned instrument. “The CEM is a fairly blunt methodology that doesn’t differentiate between margined and non-margin trades, and doesn’t recognize netting in any meaningful way. In comparison, SA-CCR is more risk-sensitive,” ISDA says.
The Basel Committee is seeking comment on its new proposals and will accept comments “on all aspects of the proposals,” up to July 6, 2016. Comments should be uploaded at www.bis.org/commentupload.htm