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Basel III Global Regulatory Framework: the First Cracks Appear

In a widely-flagged move, U.S. regulators have signalled a clear break with their European counterparts in their implementation of the Basel III regulations – the “Final Rules”.  Basel III imposes a credit valuation adjustment (CVA) to ameliorate counterparty credit risk.  These charges will be significant, particularly for lower-rated counterparties, or those that do not typically post collateral.  In mitigation, the European Basel III implementation (CRD IV) contains CVA exemptions for corporates, sovereigns and pension funds. The U.S. has taken a stricter interpretation, allowing no such exemptions. The decision may lead to differential pricing by jurisdiction, the potential for regulatory arbitrage, and raises the spectre of an unlevel playing field.  Whilst questions remain as to the real extent of the ruling’s effect on U.S. banks’ ability to compete, clear discrepancies on such a central point do not constitute a global, unified approach and may be seen to discredit the whole Basel framework.  As referenced in an earlier post, Germany’s Bafin is considering the effective re-imposition of the CVA via its Pillar II National powers, which may lead to a fragmented CVA picture within Europe itself.

The announcement also dealt with two other CVA bones of contention. The U.S. has indicated that the IRS portion of a CVA hedge should not be subject to market risk capital requirements, thereby removing the “split-hedging” disincentive.  U.S. rules also apply the controversial removal of the “AOCI” filter to only those banks that use the Basel III advanced approaches to regulatory capital. This clarification effectively restores smaller banks to the status quo ante in this respect.

The OCC has indicated that it will approve the Final Rules for publication by 9 July 2013.  Larger banks will be required to begin compliance by 1 January 2014.

Further comment and analysis courtesy of Risk’s 3 July 2013 article can be found here.

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