The next proposed US rules: adjusting the denominator of the Leverage Ratio (Finadium subscribers only)

The battle over the US Supplementary Leverage Ratio is over; the final rule has passed. The next Notice of Proposed Rulemaking (NPR) from US regulators focuses on the total leverage exposure, which is the denominator of the Leverage Ratio. Here’s a quick review for securities finance professionals.

According to the most recent NPR, “Regulatory Capital Rules: Regulatory Capital, Proposed Revisions to the Supplementary Leverage Ratio,” total leverage exposure would now include:

“Adjustments to the on-balance sheet asset amounts for repo-style transactions (including securities lending, securities borrowing, repurchase and reverse repurchase transactions), including a requirement to include in total leverage exposure the gross value of receivables associated with repo-style transactions that do not meet specified conditions;

A measure of counterparty credit risk for repo-style transactions; and

The notional amount of all other off-balance sheet exposures (excluding off-
balance sheet exposures associated with securities lending, securities borrowing, reverse repurchase transactions, and derivatives) multiplied by the appropriate CCF under the standardized approach for risk-weighted assets… the minimum CCF that may be assigned to an off-balance sheet exposure is 10 percent.”

What are the conditions noted for repo-style transactions?

“(A) The offsetting transactions have the same explicit final settlement date under their governing agreements;

(B) The right to offset the amount owed to the counterparty with the amount owed by the counterparty is legally enforceable in the normal course of business and in the event of receivership, insolvency, liquidation, or similar proceeding; and

(C) Under the governing agreements, the counterparties intend to settle net, settle simultaneously, or settle according to a process that is the functional equivalent of net settlement. That is, the cash flows of the transactions are equivalent, in effect, to a single net amount on the settlement date. To achieve this result, both transactions must be settled through the same settlement system and the settlement arrangements must be supported by cash or intraday credit facilities intended to ensure that settlement of both transactions will occur by the end of the business day, and the settlement of the underlying securities does not interfere with the net cash settlement.”

The NPR does propose a solution for a double counting issue that had been vexing the industry around calculating exposure for cleared derivatives transactions: “The proposed rule also would clarify the calculation of total leverage exposure for a clearing member banking organization with regard to cleared derivative contracts that are intermediated on behalf of a clearing member client with a central counterparty (CCP) to ensure that the clearing member banking organization does not double count these exposures.”

There’s a lot to get at here and speculation on new impacts, if there really are any given expected changes to the behavior of market participants, seems premature. According to Fed Governor Daniel Tarullo, “the aggregate amount of tier 1 capital needed to meet the supplementary leverage ratio would increase modestly as a result of the proposal, though again with potentially different impacts on different firms.” The basic idea though of the NPR is to tweak the denominator to align better with Basel rules and also to create more incentives for banks to seek out ways to reduce perceived systematic risk on their own, now that the carrots are laid out in front of them.

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