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US lightens and tightens

The five leading US regulatory agencies, collectively referred to as the “prudential regulators”[1], met yesterday to finalise the US iteration of the Basel III Liquidity Coverage Ratio, to adopt a supplementary leverage ratio rule and to propose new margin requirements for uncleared swaps.

Liquidity Coverage Ratio– a deleveraging rule to protect financial institutions from temporary liquidity shortage. The ratio takes a bank’s High Quality Liquid Assets (HQLA) as numerator and estimated cash outflows over 30 days as denominator[2]. The final rule imposes a minimum ratio of 80% from 1 January 2015, increasing by 10% annually until 100% from 1 January 2017, a more stringent deadline than the Basel III 1 January 2019 recommendation. It will initially apply to the approx. 30 US banks who hold total consolidated assets in excess of $250 bn[3]. Smaller banks with assets of $50-250 bn. have an extra year to prepare, compliance will begin 1 January 2016; they may also elect to calculate their liquidity position on a monthly, rather than daily, basis. The Fed intends to extend the LCR rule to the US holding companies of large foreign banks from July 2016. The rule applies only to banks, other entities designated as a systemic risk by the FDIC will be covered by further legislation at an unspecified date. The rule widens the definition of HQLA, which now includes investment grade corporate bonds and equities of a proven liquidity, as well as the typical categories of: cash, federal deposits and Treasury securities. Muni bonds are initially excluded from the HQLA classification; though, subject to liquidity, they are likely to be included in future proposals. Regulators estimate that full compliance with the LCR would require banks to hold a total of $2.5tr. HQLA, $100bn. more than current holdings.

Supplementary Leverage Ratio Rulefinal rule to adopt the 8 April 2014 proposal to modify the supplementary leverage ratio in accord with BCBS recommendation[4]. The rule modifies the calculation method for the SLR to capture off-balance sheet items in the denominator, by the inclusion of repos, credit derivatives and lines of credit. Leverage arising from on-balance sheet items is to be calculated using daily averages, off-balance using the average of three end-of-month calculations. The final rule comes into full effect from 1 January 2018, with certain public disclosures beginning in the first quarter of 2015. The SLR only applies to those banks subject to the advanced approached risk-based capital rule, which defines a core bank along the same lines as above- consolidated total assets of $250 bn. or more, and/or has consolidated on-balance sheet FX exposure of $10bn. or is a subsidiary of either.

Swap margin proposal– requires the posting of IM and VM for bilateral, non-cleared swaps dealer-to-dealer and dealer-to-large financial. End-users are exempted from an automatic obligation to post margin, unless they are deemed systemically significant, and will be exempted from posting the first $65 m. of collateral arising from their trades. There will be no automatic, collateral-triggering credit thresholds, dealers will be allowed to make their own credit assessments on a case by case basis. This represents a significant climbdown by the regulators, answering most of the industry criticism levied at the previous April 2011 proposal, and is broadly in accord with BCBS\IOSCO, whose September 2013 report[5] jointly viewed end-user transactions “as posing little or no systemic risk”. In practice, this will mean business as usual for the vast majority of non-financial US OTC swap users, they will simple continue not to post margin; the joint regulators intend “for the proposed requirements to be consistent with current market practice and understand that, in many cases, a covered swap entity would exchange little or no margin with these counterparty types.”. Margin requirements for dealers and financial institutions remain unchanged. The proposal is expected to undergo a last round of public comment, lasting no longer than 60 days, prior to final adoption.

This is an interesting, if not entirely surprising, mix of adjustments. On balance, a material lightening of the burden on end-users, combined with considerable tightening of capital requirements on large banks. The widening of the HQLA classification is more than outweighed by the accelerated implementation timeline and the extensions to the supplementary leverage.

[1] The Federal Reserve Board (FRB), the Federal Deposit Insurance Corporation (FDIC), the Office of the Comptroller of the Currency (OCC), the Farm Credit Administration, and the Federal Housing Finance Agency

[2] Estimate calculated using 30 day run-off rates set by the regulator

[3] The “full” LCR will also apply to all banking organisations that have $10bn or more in on-balance sheet FX exposure and to deposit-taking subsidiaries of previously-qualifying banks that have assets of $10bn. or more

[4] “Revised Basel III leverage ratio framework and disclosure requirements”. June 2013. BIS

[5] “Margin requirements for non-centrally cleared derivatives”. September 2013. BIS

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