The Bank of England has urged European policymakers to review the treatment of derivatives trades in the leverage ratio calculation used to determine the amount of capital required for banks. The central bank warned that the current framework could make central clearing costly and said it supported allowing clients initial margin to offset potential future exposure on centrally cleared client transactions.
“The leverage ratio is a simple measure and there should be a high bar to making adjustments to it,” the Bank of England wrote in its official response to the European Commission's "call for evidence" on financial reform. “Nonetheless, we should also be aware of the potential for unintended consequences, including for market liquidity.”
The central bank noted that while the leverage ratio does not normally allow collateral to reduce exposures, it supports an exception to allow initial margin to reduce leverage exposures for centrally cleared client trades “to ensure continuity and affordability of client clearing services." The central bank noted that many small financial firms that typically use derivatives for hedging purposes "are encountering difficulties gaining access to clearing, with many clearing providers unwilling to take on their business due to the low value of transactions these firms undertake, in conjunction with the operational costs of on-boarding and continuing to serve clients’ clearing activity.”
“The Bank therefore thinks that the leverage treatment of derivatives exposures for centrally-cleared client transactions within the leverage ratio exposure measure needs to be reviewed."
