Federal Reserve, OCC and FDIC changes to the supplementary leverage ratio (SLR) framework have the potential to “adversely impact” the ability of clearing members to provide client clearing services, which could result in a decrease in firms offering those services. That’s according to Bart Everaret, Americas market manager for risk and finance at Wolters Kluwer, reacting to a CFTC comment on the matter.
“This can potentially result in an increased concentration in the availability of client clearing services, which could conflict with the G20 and Dodd-Frank mandates to increase the use of central counterparty (CCP) clearing for derivatives as a means to mitigate systemic risk in the derivatives markets,” said Everaret, in an email. “This issue does not exist in the regulatory capital framework, where under both the CEM and SA-CCR approaches an offset is permitted.”
The Board of Governors of the Federal Reserve System, the Federal Deposit Insurance Corporation (FDIC), and the Office of the Comptroller of the Currency (OCC) issued an invitation for public comment on a proposal which would implement a new approach for calculating the exposure amount of derivative contracts under the agencies’ regulatory capital rule. The proposal offers up the implementation of standardized approach for counterparty credit risk (SA-CCR), a standard published by the Basel Committee in 2014.
“As it applies to advanced approaches banking organizations, the proposed implementation of SA-CCR would provide important improvements to risk-sensitivity and calibration relative to current exposure method (CEM), resulting in more appropriate capital requirements for derivative contracts,” wrote the agencies.
In the consultation, input was requested on “the recognition of collateral provided by clearing member client banking organizations in connection with a cleared transaction for purposes of the SA-CCR methodology”.
A CFTC response claimed that SA-CCR does not include an offset for initial margin that clearing members hold on behalf of their clients.
“The adoption of SA-CCR without offset will maintain or increase the clearing members’ SLRs by more than 30 basis points on average, will continue to disincentivize clearing members from providing clearing services, and thereby limit access to clearing in contravention of G20 mandates and Dodd-Frank,” wrote the CFTC.
Profits and rules
Mayra Rodriguez Valladares, managing principal at MRV Associates, believes that adoption of the margin would not result in a drop in clearing facilities. “US banks […] are in good shape to meet all capital buffers, including, SLR. There is no legitimate reason for them to stop clearing for clients,” she says.
“If indeed a couple of big banks stop clearing for clients, this would increase the concentration of banks that clear. This can pose systemic risk. Yet, what can also happen is that non-banks could also start to clear for clients. Non-banks can pose a lot of competition to banks.”
According to an August 2018 report from the Financial Stability Board’s Derivatives Assessment Team, 89% of client clearing services providers found SLR to have negative impacts on their ability to offer their services. The CFTC response cites data indicating that the number of clearing services in the US has dropped from 84 in 2008 to 55 last year.
A study from the regulator published in June last year concluded that “heterogeneous calibrations of the leverage ratio have shifted market activities toward less constrained market segments, and by a large amount.”
“Bank supervisors need to be stronger on enforcement actions,” says Valladares. “Since the US is in a very long economic expansion, lots of banks are pushing for lighter rules or flat out deregulations. This would be a very big mistake. Compliance of Dodd-Frank is very important to avoid having to bail out banks. The current mood in this administration is continuing to lighten rules for banks. Given banks’ incredible level of profitability, there is no reason why they cannot comply with rules.”