Regulators urged to change leverage ratios
The Basel bank leverage ratio should be reconsidered to encourage more competition in clearing according to consultancy Tabb Group.
The Basel Committee on Banking Supervision calculates leverage ratios by including client margins held by banks as part of their risks, which increases the capital required to perform client clearing. Critics have argued that client margins should not be counted in the leverage ratio as they are in strictly segregated accounts and either cash or highly liquid securities such as US treasuries.
Radi Khasawneh, a senior research analyst said in a new Tabb Perspective note, “Central Clearing Landscape: Concentric Circles,” that a change in the bank leverage ratios could make clearing more competitive.
He cited the market for clearing US dollar interest rate swaps where interdealer brokers are taking advantage of the price difference for clearing which has emerged this year between the London Stock Exchange’s LCH.Clearnet and the CME.
Khasawneh said: “Differences between the cost of clearing at the main clearing houses can create a redirection of flow – in the future this could be to a new entrant or expanded offering from other venues. This would be a positive for all as more options would exist.”
Scott O’Malia, chief executive of Isda, posted on the derivatives trade organisation’s blog this month that the Basel bank leverage ratio should exclude client margins when determining exposures from client clearing. Isda was also one of the signatories, alongside a group of exchanges and clearing houses, of a letter to the Financial Times this month asking for changes to the leverage ratio calculations.
O’Malia said that as a former commissioner of the Commodity Futures Trading Commission he could attest to the strict rules that regulators had put in place to protect client collateral across many jurisdictions.
He wrote: “Properly segregated client cash collateral is not a source of leverage and risk exposure. In fact, it does the opposite: it acts to reduce the exposure related to a bank’s clearing business by covering any losses that may be left by a defaulting client. This exposure-reducing effect is not recognized by the leverage ratio.”
He warned that firms would exit client clearing if the capital constraints were too high, which is at odds with the regulators encouraging over-the-counter derivatives to move into central clearing. For example, in May this year Nomura became the latest brokers to pull out of offering OTC swap clearing services to US and European clients.
“We believe further data analysis on this topic is necessary to fully understand the impact,” added O’Malia. “We would therefore encourage the Basel Committee to re-open its leverage ratio rules and reconsider this issue.”
Bloomberg reported today that regulators including the Federal Reserve, the European Central Bank and the Bank of England, plan to discuss excluding collateral posted by clients in the leverage ratio at a private meeting this week citing two people with knowledge of the talks.