The Futures Industry Association (FIA) has filed a response to the Basel Committee on Banking Supervision urging the adoption of FIA’s suggested modification to the leverage ratio and to recognise the exposure-reducing nature of client collateral in order to align regulatory incentives.
Central clearing of derivatives was a key pillar of the G20 countries response to the post-2008 financial crisis reforms to reduce systemic risk in the financial system, however FIA argues that to date, the leverage ratio’s failure to recognise collateral has had a direct negative impact on the ability of banks to provide clearing services to customers.
“FIA supports strong capital standards, but we have consistently emphasised with policymakers and through data, that the leverage ratio has a direct negative impact on the ability of banks to provide clearing services to customers,” says FIA president and CEO Walt Lukken. “The financial crisis dramatically proved the value of central clearing, and as a result, policymakers made mandatory clearing a reality. Unfortunately, the application of certain capital charges works against that mandate by creating economic disincentives for client clearing.”
FIA cites the Financial Stability Board’s own findings in its Derivatives Assessment Team report, which says, “the treatment of initial margin in the leverage ratio can be a disincentive for client clearing service providers to offer or expand client clearing.”
FIA’s response points out that clearing has not decreased systemic risk to the extent it should, because there are fewer clearing members available to take on a book of positions from a failing clearing member as a result of the leverage ratio. This problem is exacerbated during times of market stress, it adds.
“FIA strongly supports the adoption of a limited and targeted revision to the leverage ratio denominator to allow cash and non-cash forms of initial margin and variation margin to offset a clearing member bank’s potential future exposure and replacement cost in a client cleared derivative transaction, as proposed in Option Three of the Consultation,” says Lukken. “Recognition of the exposure-reducing effect of initial margin within the leverage ratio is critical for the long-term health of the cleared derivatives ecosystem.”