Part II: The Fed releases rules on capital for GSIBs, includes extra requirements for securities financing trades

This is part II of our post on the Fed’s new capital rules. We look at the calculation methodology and some observations about the rules. 

How is the SFT calculation done?

“…A GSIB’s short-term wholesale funding score would be based on the GSIB’s average use of short-term wholesale funding sources over a calendar year. The proposed components of short-term wholesale funding would be weighted to account for the varying degrees of risk associated with different sources of short-term wholesale funding, and would then be divided by the GSIB’s average total risk-weighted assets over the same calendar year. A GSIB would then apply a fixed conversion factor to the measure of short-term wholesale funding to normalize the value of short-term wholesale funding relative to the other systemic indicators. This amount would constitute the GSIB’s short-term wholesale funding score..”

“…A GSIB’s short-term wholesale funding amount would include the following:

  • All funds that the GSIB must pay under each secured funding transaction, other than an operational deposit, with a remaining maturity of one year or less;
  • All funds that the GSIB must pay under each unsecured wholesale funding transaction, other than an operational deposit, with a remaining maturity of one year or less;
  • The fair market value of all assets that the GSIB must return in connection with transactions where it has provided a non-cash asset of a given liquidity category to a counterparty in exchange for non-cash assets of a higher liquidity category, and the GSIB and the counterparty agreed to return the assets to each other at a future date (covered asset exchange);
  • The fair market value of all assets that the GSIB must return under transactions where it has borrowed or otherwise obtained a security which it has sold (short positions); and
  • All brokered deposits and all brokered sweep deposits held at the GSIB provided by a retail customer or counterparty…”

The definitions use the LCR rules, including differentiating assets by liquidity.

“…The proposal would align the definition of a “secured funding transaction” with the definition of that term in the LCR rule. As such, it would include repurchase transactions, securities lending transactions, secured funding from a Federal Reserve Bank or other foreign central bank, Federal Home Loan Bank advances, secured deposits, loans of collateral to effect customer short positions, and other secured wholesale funding arrangements…”

Secured funding trades (e.g. repos, sec lending) are weighted within the calculation based on their tenor and collateral type. A secured funding trade using Level 1 liquid assets that has a remaining maturity of 30 days or less has a 25% weighting. 31 to 90 days: 10%. Over 91 days: 0%. The same trade on a level 2A liquid asset has a higher weighting (50% for 30 days or less, 25% for 31~90 days remaining, 10% for 91-180 days, 0% for 181 to 365 days. 2B liquid assets are higher still (75%, 50%, 25%, and 10% respectively).

What is interesting is a specific mention for collateral upgrade unwinds. If a dealer has a future obligation to return Level 1 assets and receive level 2A assets, those future incoming 2A assets are included in the secured asset funding 2A bucket. We expect these trades would be executed in order to fund collateral transformation deals. Say an insurance company swaps their corporate bonds for US Treasuries in order to fund a derivatives initial margin requirement, the bank will have to turn around and lend out the corporates and borrow HQLA to get square, creating a future obligation based on when those trades mature. The bank might have netted the collateral transformation trades from their balance sheet under Fin 41. But under this rule, the unwind liability will get added in. This extra cost will inevitably flow back to the pricing of the original collateral transformation deal.

What is the timing of the rules? There is a phase in starting Jan. 2016, becoming fully effective Jan. 2019.

Unlike some daily calculations mandated by Dodd-Frank and Basel, the funding numbers are determined by averages calculated over the prior year. That allows for seasonal swings to be smoothed out.

The elephant in the SFT room is foreign competition. Will other central banks take up similar provisions and what will their capital numbers (and appetite for SFT) do as a result? There is precedent for asking banks to exceed Basel capital requirements – Switzerland being the most prominent example – but global coordination is rare when there is a competitive advantage on the table. The large domestic operations of foreign banks are subject to US regulatory regimes and we wonder how this will impact their SFT operations.

At the end of the day, these rules resolve a lot of regulatory uncertainty. But they will also put pressure on keeping SFT businesses within the GSIBs from making capital buffer matters worse.

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