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Wednesday, 26 September 2018

DERIVATIVES: Capital treatment for exposure to CCPs still too harsh - dealers

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  • Bank for International Settlements in Basel

The Basel Committee on Banking Supervision’s latest proposals on capitalisation of bank exposures to central counterparties will still lump banks with unnecessarily high capital charges that could ultimately disincentivise central clearing, dealers argued.

The Committee released its second consultation on exposures to CCPs on November 2, after complaints that the initial proposals released in December for calculating the capital framework were inappropriate and overly punitive. Market participants say the latest proposals are an improvement, but the capital treatment is still too harsh.

“There’s no doubt that the incentives in one part of the system to increase the use of clearing are misaligned with the incentives to regulate CCPs,” said one head of client clearing at a major institution. “If Basel introduces the current capital methodology, people will be less incentivised than they should be to clear trades, which is a bad thing. Banks will comply with it, but it clearly won’t promote clearing.”

Many of the original concerns over the capital charges focused on the risk methodology put forward by the Committee, which is based on the gross notional of derivatives trades within the clearing houses, and therefore does not fully take into account the multilateral meeting benefits that CCPs provide, some argue. The Committee sought to address these comments by adjusting the amount of netting in the risk methodology from 0.6 to 0.7.

“In general, we welcome some of the changes that Basel has made. The change in the formula should reduce the total capital requirement for clearing transactions by roughly a quarter,” said one Basel III specialist at a major bank.

“But it is still not ideally what we want. We believe it is appropriate to hold capital against these exposures, but if you do it excessively then it kills the system. Really, we want for CCPS to be able to develop their own risk models and use them to determine regulatory capital,” he added.

Elsewhere, banks are pleased the Committee has opted to relax the rules on risk-weightings for client positions that are not fully insulated from the bankruptcy of both the client’s clearing bank and from other customers at that clearing bank. As long as the client’s position meets other requirements for segregation and continuity of accounts, these exposures will now attract a 4% risk-weighting.

This could be a significant boon, as a punitive risk-weighting against such positions would have made it harder for dealers to offer guaranteed portability for clients. Guaranteed portability – whereby a clearing bank offers to unconditionally take on a client’s position if its other clearing bank defaults – has been a hot topic among dealers and clients alike, and is seen by many to be essential if clearing is to work in practice.

“This risk-weighting is a new element and clearly positive, providing a strong incentive for banks to clear as many positions as possible,” said the Basel III expert.

The proposals will be out for consultation until November 25, and the Committee intends to publish the final rules by about the end of this year. The rules should be implemented by January 2012.

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