On 28 June 2013, the Basel Committee on Banking Supervision (BCBS) published a consultative document entitled “Capital treatment of bank exposures to central counterparties” (CCPs). The purpose of the document is to consult on possible changes to the BCBS’ July 2012 interim rules on Capital requirements for bank exposures to central counterparties (the “Interim Rules”). The deadline for responses is 27 September 2013.
The changes would only affect exposures to Qualifying CCPs (“QCCPs”), being CCPs that are supervised in a manner consistent with the CPSS-IOSCO principles for financial market infrastructures. They do not apply to non-qualifying CCPs or affect the capital treatment of clearing member exposures to clients. In proposing the changes, the BCBS is mindful of the need to:
- ensure that banks’ exposures to central counterparties are adequately capitalised;
- preserve incentives for central clearing, and promote robust risk management by banks and CCPs; and
- avoid creating disincentives to the maintenance of generous default funds.
The Interim Rules set out a method for calculating a “hypothetical” minimum level of CCP default resource, based on the “Current Exposure Method” (CEM). The capital charge is then calculated by comparing this hypothetical level to the actual level of pre-paid member contributions to the QCCP default fund. However, there is concern that CEM may not be an appropriate method for calculating CCP risk exposures with the result that capital charges on member contributions to default funds vary significantly between CCPs in a way that is difficult to justify. There is also concern that very small capital charges may not meet the objective of ensuring adequate capital is held against CCP exposures, while very large charges could undermine the objective of incentivising firms to centrally clear. In order to address perceived weaknesses in the Interim Rules, the BCBS proposes two “approaches”:
- the Ratio Approach, and
- the Tranches Approach.
Broadly, under the Ratio Approach, if clearing members contribute default funds sufficient to exactly match the hypothetical required level and there is no contribution to the default fund from the QCCP which is junior to that provided by clearing members, then a 100% capital charge would apply to the clearing member contributions. If clearing members make default contributions above the required level, the per unit capital charge decreases in a broadly proportional way so that total capital charges are not materially increased. However, as the QCCP makes increasing contributions to the default fund, the total capital charge on clearing members is reduced, reflecting the decrease in risk borne by the clearing members. This effect is magnified where the QCCP’s contribution to the default fund is junior to that provided by clearing members.
Broadly, the tranches approach is a modified and simplified version of “Method 1” found in the Interim Rules. Again, the prepaid member contribution to a QCCP default fund are compared with a required hypothetical level. Thereafter, for the purposes of calculating capital charges, clearing member contributions to the default fund are divided into two tranches:
- the part (if any) which is below the hypothetical level, and
- the part (if any) which is above the hypothetical level.
A capital charge is calculated on each tranche.