Basel III: Getting Down to Details

Terry Flanagan

The ongoing phase-in of Basel III for U.S. banks will impact the structure of global financial markets in 2015 and beyond.

“Basel III comes up in almost every conversation we have,” said Kevin McPartland, head of market structure research at Greenwich Associates. “We look at every market around the world: corporate bonds, treasuries, swaps, equities, you name it. This is the one topic that seems to really cut across all of those.”

In September 2014, U.S. prudential regulators issued a final rule that implements a quantitative liquidity requirement consistent with the liquidity coverage ratio (LCR) established by the Basel Committee on Banking Supervision.

The final rule creates a quantitative liquidity requirement, the LCR, for covered companies. The LCR is the ratio of a company’s high-quality liquid asset (HQLA) amount to its projected net cash outflows over a 30-day period. When fully implemented, the final rule requires a covered company to maintain an LCR of at least 100%.

Kevin McPartland, Greenwich Associates

Kevin McPartland, Greenwich Associates

Basel III is being phased in over a four-year period, through 2019. “We have the global oversight, but there will be regional implementation as well, which further complicates things,” McPartland said. “It’s going to be a long-running process just because it is so big and complicated. You’re certainly seeing the major banks already adjusting their businesses in anticipation and ensuring that they’re ready for the changes that are to come.”

Even in less capital-intensive businesses like equities, the effects of Basel III can be seen in the amount of capital commitment provided by banks, as client ‘tiering’ has ramped up over the last couple of years. “It’s a topic that really cuts to the core of the sell-side business model,” McPartland said.

For OTC derivatives, the imposition of Basel III on top of the already onerous clearing mandates of Dodd-Frank and Emir are putting pressure on futures commission merchants.

“Those businesses have already had a tough time being profitable after those clearing mandates have kicked in and, as the Basel III implementation rolls on, it’s only going to get harder and harder for those businesses to make money with the current fee structure that they have out in front of the buy side,” said McPartland. “It’s a service that the market needs, but you can’t expect the FCMs to continue to provide it at a loss. It’s not going to be viable over the long run.”

According to a survey by Sapient Global Markets that examines industry attitudes towards changes in derivatives clearing, 81% of respondents cited their greatest concerns as being the uncertainty caused by regulations, the cost of compliance associated with new clearing mandates and implementing new technology.

“Regulation is placing tremendous pressure on the clearing community, with conversations inevitability focused on the costs involved and how to potentially alleviate them,” said Jim Bennett, managing director at Sapient. “As a result, the industry is on the brink of transformation, as firms search for new ways to differentiate their clearing offerings while ‘commoditizing’ the processes that either fail to offer competitive advantage or require decoupling due to regulatory requirements.”

In fixed income, some of the world’s largest banks shifted strategies, scaled back or even dropped some fixed-income products entirely, due to regulation. Strategy changes and the uneven implementation schedule of the Basel III capital rules by regulators in different regions has had a huge influence on competitive positioning, market share and profitability of the world’s largest fixed-income dealers.

“It’s changing the economics of many of the business lines,” said McPartland. “Holdings of corporate bonds have dropped because banks have less capital that they can commit overall, and are therefore less willing to commit it to facilitate corporate bond trading.”

Featured image via Mavar/Dollar Photo Club

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