Giancarlo: Save FCMs, Reform the SLR
Nearly half of all US futures commission merchants have left the business over the past 20 years, and if bank regulators do not change how they apply Basel III’s Supplemental Leverage Ratio to bank-owned FCMs the trend will only continue, according to Acting Commodity Futures Trading Commission Chairman Christopher Giancarlo.
The current picture only gets worse when only 19 of the remaining 55 FCMs hold customer funds, he said while addressing the International Swaps and Derivative Association’s 32nd annual meeting in Lisbon.
Global banks, such as Bank of New York Mellon, Deutsche Bank, Nomura, RBS and State Street, already have shuttered their swaps clearing businesses. As a knock-on effect, just three or four FCMs handle the clearing of approximately half of the cleared trades in some exchange-traded derivatives market.
“Such concentration can potentially impact market functioning and be a source of systemic risk,” said Giancarlo.
He traces the root of the problem to banking regulators who are applying the SLR’s capital charges in a manner in which the Basel Committee on Banking Supervision never intended and reflects a flawed understanding of central counterparty clearing.
“Swaps clearing was adopted in the 2009 Pittsburgh Accords and Dodd-Frank Act to move customer margin off the balance sheets of bank FCMs and into CCPs,” said Giancarlo. “Yet applying a capital charge against that customer margin continues to treat FCMs as having retained the exposure.”
This application of the SLR forces some of the largest bank-owned FCMs to put aside as much as 5% of their assets for loss absorption, he added.
Giancarlo suggests that SLR calculation should exclude customer cash collateral held at the CCP from the bank’s leverage calculation and that it should be taken into account when computing future exposures in a manner that is consistent with the BCBS standard approach to counterparty credit risk calculations.
The CFTC staff estimates that such changes could reduce capital costs for these clearing members as much as 70% while translating into a 1% capital reduction at the bank holding level.
“Assuming these savings are fully passed on to their customers, these reductions could translate into a three-fold increase in trading activity, especially hedge positions that are carried overnight,” said Giancarlo. “This dramatic reduction in costs on a service imperative to managing systemic risk in swaps is entirely worth the trade-off of a minuscule reduction in balance sheet protection. The financial system will be safer and more stable for it.”
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