FIA Global sent a letter to the Basel Committee on Banking Supervision this week urging the committee to consider how segregated margin is treated in the leverage calculations that determine bank capital requirements. FIA Global was joined on the letter by two other global trade associations—the World Federation of Exchanges and CCP12—as well as four global central clearing parties in their own rights: ICE, CME Group, LCH Clearnet Group, and Eurex Group.
The letter addresses the Basel III leverage ratio framework, which was designed to capture the total exposure a banking organization has to its customers and counterparties. Accurately capturing this exposure is critical to establishing appropriate capital requirements to mitigate risk.
“It’s troubling that the Basel III leverage ratio fails to treat segregated margin appropriately,” Walt Lukken, President and CEO of FIA said. “Segregated margin plainly reduces the exposure of centrally cleared derivatives transactions. This letter explains why the leverage ratio should be calculated in a way that accounts for that exposure reduction. But more importantly, we explain that a failure to clarify the leverage ratio calculation will have serious consequences for central clearing and the businesses that use these tools to hedge risk.”
The letter explains that if the exposure-reducing effect of segregated margin isn’t included in leverage ratio calculations, the amount of capital required for central clearing will substantially increase:
“Such a significant increase in required capital will also significantly increase costs for end users, including pension funds and businesses across a wide variety of industries that rely on derivatives for risk management purposes, including agricultural businesses and manufacturers. Further, banks may be less likely to take on new clients for derivatives clearing. As a result, market participants may be less likely to use cleared derivatives for hedging and other risk management purposes.
“In addition, the liquidity and portability of cleared derivatives markets could be significantly impaired, which would substantially increase systemic risk.”
The letter identifies three potential avenues for revising the leverage ratio: an interpretive FAQ, amending the text of the leverage ratio standard, and adopting a modified calculation methodology that recognizes the benefit of collateral.
“If the leverage ratio calculation stands as-is, we will likely see fewer banks offering central clearing services and fewer opportunities for end-users to hedge risks,” Lukken said. “That result is not only undesirable, but it is also completely contrary to the G20’s intentions to promote central clearing.”
