Banks Gain Ground in Push to Change Derivatives Capital Rule

  • Basel leverage rule said to punish banks for handling trades
  • IOSCO head joins Bank of England, EU officials seeking change

The world’s biggest banks have argued for years that capital rules punish them for handling clients’ derivatives trades. All that lobbying is starting to pay off.

The European Union’s financial-services chief, Jonathan Hill, and members of the bloc’s parliament recently joined the Bank of England in saying the global capital standard needs to be fixed. At issue is the Basel Committee on Banking Supervision’s restriction on bank leverage, which forces lenders to have capital against billions of dollars in collateralized trades done by clients and settled at clearinghouses.

The International Organization of Securities Commissions called on its members, who regulate more than 95 percent of the world’s securities markets, to “help shift this debate” by telling the Basel Committee exactly what they think, according to Paul Andrews, the group’s secretary general. IOSCO itself has made the case to the Basel Committee for how the leverage ratio requirement could hurt the clearing industry.

“We will engage further with the Basel Committee if appropriate depending upon what the evidence is showing,” Andrews said in a speech in London this week. “If we need to step in, it’s our intention that we’ll try to step in and do what we can to sort of get this along the right track.”

Segregated Accounts

The industry lobbying is tied to one aspect of how banks must meet the leverage ratio requirement, designed to discourage banks from piling on assets.

As currently written, the rule forces derivatives dealers to consider the collateral they receive from clients, and which is held in segregated accounts, when adding up their total assets. As a result, banks must have more capital to handle the transactions. When U.S. regulators completed their version of the leverage rule in 2014, they rejected industry pleas to exclude this collateral from the calculation.

Since then, the Futures Industry Association, which represents banks such as Goldman Sachs Group Inc., Barclays Plc and Credit Suisse Group AG, has fought for a change in the regulation and is working with consultants to prepare data about the scope of the rule’s impact. Executives from the world’s biggest clearinghouses, including those owned by CME Group Inc. and London Stock Exchange Group Plc., also have pushed for a change, alongside lobbying groups for mutual funds and large agricultural and energy traders.

Clearing Broker

Simon Puleston Jones, FIA’s head of Europe, said traditional buyers of derivatives need to maintain access to many banks that are members of clearinghouses.

“From time to time, clearing brokers do go into default, and so not only do we need to ensure there is access to clearing, but we need to ensure that in the event one of the clearing brokers falls over, that there is another clearing broker standing to ensure that post-default porting is viable,” Puleston Jones said at the same industry conference in London.

Andrews said the leverage rule could make it more difficult to transfer client accounts between banks at times of stress because fewer lenders would be willing to take on the additional risk and cost. That view was echoed this week by Timothy Massad, chairman of the U.S. Commodity Futures Trading Commission, the top U.S. derivatives regulator.

Conflicting Rules

The comments show regulators’ growing willingness to revise conflicting rules put in place following the 2008 credit crisis that the industry argues that could harm the economy. Global regulators moved after the crisis to have more derivatives traded at central clearinghouses as a way to prevent risk from spreading through the financial system. Meanwhile, they put in tougher capital rules, including the leverage ratio, to ensure banks can withstand shocks.

The Basel Committee, which publishes global rules that are then implemented by national regulators, has asked for feedback and data showing the impact of the leverage rule by July 6, and could move to change it.

Not everyone thinks that’s a good idea.

Thomas Hoenig, vice chairman of the U.S. Federal Deposit Insurance Corp., is among those who say industry lobbying threatens to undermine the leverage ratio as a simple measure of capital to total assets.

‘Fewer Assets’

“Such proposed changes would confound the purpose and obscure the conclusions of the leverage ratio,” Hoenig said in a speech last month. If the change results in banks reporting fewer assets, “capital levels would trend down and would again, over time, compromise the strength of the industry, expose the public to loss, and undermine the stability of the economy.”

Despite such concerns, regulators began to warm to the idea last year, starting in the U.S., where the CFTC’s Massad said a change is necessary. The Bank of England then said it supported allowing collateral to offset, or reduce, a bank’s exposure to cleared trades under the leverage rule.

Mark Carney, the BOE governor, told members of the European Parliament late last year that the regulation “should be top of the list” of issues that should be reviewed when Europe moves to adopt its own version of the Basel rule.

“There are few unintended consequences of regulation at the international level,” Carney said. “This is one that does need to be considered and we will be considering it through the appropriate Basel processes but obviously at the European level irrespective of that we need to take heed of it.”

‘Overly Burdensome’

Hill, the EU commissioner for financial services, said in May that policy makers must ensure that capital and leverage rules “are not overly burdensome, that they don’t weigh too heavily on those that provide clearing services and don’t undermine sensible business planning and risk management.”

Kay Swinburne, a British member of the EU assembly, raised the possibility that Europe could shift the policy on its own without a change at the global level.

“Nothing is set in stone,” Swinburne said this week. “If it’s demonstrated that there is harm being done to the concept of central clearing because of the U.S. experience, then Europe doesn’t have to follow.”

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