DERIVATIVES-CFTC's Giancarlo urges bank capital rethink
Acting CFTC chairman Christopher Giancarlo has called on global regulators to recalibrate bank capital requirements to restore liquidity to markets in a bid to avoid ‘flash’ trading events.
Speaking at ISDA’s annual general meeting in Lisbon, Giancarlo warned that stringent Basel III demands have sapped capital from trading activities, leading to reduced market liquidity that may have been the trigger for more than a dozen major flash trading events since the passage of Dodd-Frank.
“Recurring liquidity flash events are not a fair price to pay for enhanced bank stability,” Giancarlo told delegates.
“The time has come for regulators on both sides of the Atlantic to recalibrate bank capital requirements to better balance systemic risk concerns with healthy economic growth and prosperity,” he said.
Giancarlo called for customer cash collateral held in clearinghouses to be excluded from a clearing member’s leverage calculation under the supplementary leverage ratio. He also called for customer collateral to be taken into account when calculating potential future exposure under the Basel Committee’s standardised approach to counterparty credit risk.
“Applying the SLR to clearing customer margin reflects a flawed understanding of central counterparty clearing,” he said.
The SLR requires large US banks to put aside around 5% of assets for loss absorption purposes. Current rules mean that capital is also charged against customer margin held against swaps in clearinghouses, which many see as a barrier to providing a service that is intended to steer risk away from balance sheets.
The onerous treatment has caused many futures commission merchants to cease operations. At the start of this year, the number of registered FCMs stood at 55 – down from over 100 in 2002. Just 19 of those FCMs currently hold customer funds for swaps clearing, causing extreme concentration in the business following the departure of large banks such as Bank of New York-Mellon, Nomura, RBS and State Street, while Deutsche Bank recently shut its US swaps clearing operations.
“A consolidated FCM industry could pose difficulties in transferring customer positions and margin to other FCMs in times of stress or an FCM default,” said Giancarlo. “In certain exchange-traded derivatives markets, three to four firms clear nearly half of the trades. Such concentration can potentially impact market functioning and be a source of systemic risk.”
According to Giancarlo, his suggested changes to the SLR rules could reduce capital costs for clearing members by as much as 70%, translating into a 1% capital reduction at bank holding company level. He also believes that the reductions could translate into a three-fold increase in trading activity – particularly in hedge positions that are carried overnight.
“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,” Giancarlo said. “The financial system will be safer and more stable for it.”
The derivatives regulator also warned that cross-border regulatory coordination was critical in avoiding fragmentation of the global marketplace.
“The CFTC should operate on the basis of comity, not uniformity, with overseas regulators,” Giancarlo said. “The CFTC should move to a flexible, outcomes-based approach for cross-border equivalence and substituted compliance.”
Giancarlo welcomed the opportunity to discuss the CFTC’s experience of CCP supervision with officials in Europe as they debate the location of euro derivatives clearing following the UK’s departure from the European Union in 2019.
He said that the key regulatory policy decision must be made with care by European officials as they weigh up perceived benefits of relocation to facilitate central bank support, against the higher costs to the European financial system associated with the loss of netting euro-denominated risk exposures.
“Given the closeness of the US and European derivatives markets, what Europe chooses to do on the supervision of CCPs undoubtedly will inform the evolution of US regulatory policy for cross-border swaps clearing,” he said.