PASLA/RMA CONFERENCE
Global Legal and Regulatory Issues
and Business Implications
Gregory J. Lyons
March 6, 2014
Indemnified Securities Lending
What Frameworks Are Relevant?
Basel
Committee
Dodd-Frank
Lender
Disclosure
Lenders
Capital SCCL
Lending Limits
FBO Rules
Future Capital
US/Foreign
Agent Banks
B/D
Borrowers
Structure
MMFs
Financial Stability
Oversight Counsel/SEC
Collateral Requirements
Financial Stability
Board
2
Where We Are – Where We’re Going (Maybe)
Proposed Market Risk Rules
FSB Recommendations
US Capital Finalized
BD Net Capital Finalized
MMF Proposal
Derivatives Regulation
US Capital Effective
Liquidity Coverage Ratio (LCR) “Ramifications” Begin in Earnest 2014
Volcker Finalized
Today
2014
FBO Finalized
Supplementary Big Bank Rules Proposed
FTT Clarity?
Leverage Ratio
Some “Big Bank”
Rules Effective
Mid-2014
End 2014
SCCL Finalized
Supplementary Big Bank Rules Finalized
MMF Finalized?
3
What We Will Cover Today
I.
Permissibility & Structure
- Volcker
-Shadow Banking
-Disclosure and Investor Protection
II.
Capital & Liquidity
- US/Int’l Capital Rules
- LCR & NSFR
III. Exposure Limits
IV. FBO Rules
V. Financial Transaction Tax
4
I. Permissibility & Structure
5
Volcker Rule and Global Perspective
6
Scope and Coverage
• Applies to “banking entities”
– Essentially, all FDIC-insured depository institutions (“IDIs”)
(certain IDIs limited to trust and fiduciary activities are
exempt) and affiliates
– Foreign banking entities with a U.S. banking presence also
are captured, but they have greater flexibility with respect to
activities engaged in outside the United States
• Agencies have not yet determined how the Volcker Rule will
apply to systemically important nonbank financial
institutions
– The Dodd-Frank Act indicates that the Federal Reserve
“shall” adopt additional capital charges and quantitative
limits on the activities of nonbank SIFIs, subject to the
exemptions for permitted activities that apply to banking
entities
7
Scope and Coverage
Banking Entities (Consolidated Coverage)
BHC
3rd Party
50%
50%
RIA/BD
GP
JV
20%
Insured Bank
Covered
Fund
30%
20%
Company
50%
Company
3/5 Directors
Company
All 100% owned, except as noted
8
Compliance Timeline
April 1,
2014
June 30,
2014
Effective date of
final rule
Reporting of
quantitative
metrics ($50 bn
in trading assets
and liabilities)
July 21,
2015
Conformance
period ends
July 21,
2016-22?
Extension of
conformance
period(s)
Potential extension of conformance period
• Potentially two additional one-year “general” extensions
• Additional potential five-year extension for “illiquid” funds
(for obligations existing as of May 1, 2010)
9
Basic Prohibitions
• Under the Volcker Rule, banking entities generally may not:
– Engage in “proprietary trading”
– Sponsor, acquire or retain an ownership interest in or have
certain types of dealings with certain private funds
10
Proprietary Trading
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Proprietary Trading – Fundamentals
The Prohibition
• A banking entity generally may not trade any “financial
instrument” as “principal” for its “trading account” (see next
slide for explicitly excluded transactions)
Financial
Instrument
Trading Account
• Includes: Securities, derivatives, commodities futures and
options on the foregoing
• Includes: FX swaps and forwards
• Excludes: Loans, spot FX, physical commodities
• Short-term trading (60-day rebuttable presumption)
• Trading in market-risk capital rule covered positions and
trading positions
• Trading as a dealer, swap dealer or security-based swap
dealer
12
Proprietary Trading – Fundamentals
Excluded Transactions
• Repos and reverse repos
• Securities lending 
• Liquidity management (limited to securities transactions and subject to conditions)
• Trading by a clearing member of a derivatives clearing organization or clearing
agency
• Covering short sales and similar existing obligations
• Acting solely as agent, broker or custodian (including on behalf of affiliates)
• Satisfying judicial and similar proceedings
• Satisfying a delivery obligation for delivery, clearing or settlement on behalf of
customers
• Acting as trustee for deferred compensation, pension and similar employee plans
Note: No general exclusion for asset-liability management
13
Covered Funds
Defining Covered Funds
• Certain Funds Exempt from the Definition of an Investment Company
Issuer that would be an investment company under the Investment
Company Act but for section 3(c)(1) or 3(c)(7) of the Act
– Section 3(c)(1) excludes issuers with 100 or fewer beneficial owners
– Section 3(c)(7) excludes issuers whose securities are owned exclusively
by “qualified purchasers”
– An issuer relying on either Section 3(c)(1) or 3(c)(7) may not make a
public offering
• Commodity Pools with Similar Characteristics
Commodity pools for which:
– The CPO has claimed an exemption under CFTC Rule 4.7
– The CPO is registered with the CFTC as a CPO in connection with the
pool; substantially all the units of the pool are owned by qualified eligible
persons; and units of the pool have not been publicly offered
14
Covered Funds
The Special Status of Foreign Covered Funds
Volcker Rule Applies
Foreign fund that:
1)
U.S. Banking
Entities
2)
3)
4)
is organized or established
outside the United States and
has no ownership interests
offered or sold in the United
States;
is engaged primarily in
investing in securities for resale
or other disposition or
otherwise trading securities;
has as its sponsor the U.S.
banking entity or has issued an
ownership interest owned by
the U.S. banking entity; and
if offered in the U.S., would rely
on Section 3(c)(1) or 3(c)(7)
Foreign Banking
Entities
Volcker Rule
Doesn’t Apply
15
Covered Funds
Exclusions Denied
• Commenters requested that many other types of entities be excluded from
the definition of “covered fund”
FMUs
Cash Collateral Pools
Not Excluded as
Covered Funds
Pass-Through REITs
Muni Tender Option Bond Vehicles
Venture Capital Funds
Credit Funds
ESCs
• The agencies suggest that some of these entities may be able to rely on
exemptions from the Investment Company Act other than section 3(c)(1)/(7)
and, thus, may be able to avoid the “covered fund” definition
16
EU Banking Structural Reforms
17
The Proposed Regulation
• The reforms introduced by a proposed Regulation will address
concerns that certain banks (particularly large banking groups)
have become too complex to manage, monitor and supervise,
as well as too difficult to resolve should they fail.
• The European Commission believes that an EU-wide initiative
on structural reforms is necessary to achieve the ‘single
rulebook’, in line with the CRD IV.
• The proposed Regulation will introduce two significant reforms:
– The prohibition on proprietary trading (as of 1 January 2017); and
– The separation of trading activities (as of 1 July 2018).
18
The Proposed Regulation (continued)
• The proposed regulation will apply to the following EU credit
institutions, parent undertakings and certain other branches and
subsidiaries:
– Global systemically important institutions, as defined by the CRD IV
Directive; and
– Entities that for three consecutive years have total assets amounting to at
least €30bn and trading assets of at least €70bn or 10% of their total
assets.
• The Regulation will not apply to firms excluded from the scope of
the CRD IV Directive or the CRR (e.g. credit unions in the UK).
19
The Prohibition on Proprietary Trading
• The proposed Regulation prohibits certain entities from
engaging in 'proprietary trading‘.
– Prohibited is the use of own capital or borrowed money to participate in the
acquisition or disposal of any financial instrument or commodity for the
sole purpose of making a profit for own account.
– Trading in government bonds of EU member states is permitted.
• The Regulation also prohibits investing in hedge funds or entities
that engage in proprietary trading or that sponsor hedge funds.
– Excluded from this prohibition are unleveraged and closed-ended funds
(e.g. private equity, VC and social entrepreneurship funds).
20
The Separation of Trading Activities
• The Regulation proposes to protect vulnerable retail clients by
granting national competent authorities the discretion to
separate a credit institution's trading activities from its retail
activities.
• If a credit institution's trading activities pose a threat to financial
stability the competent authority may prohibit the performance of
such activities.
• Alternatively, trading activities may be performed by another
entity in the same banking group provided it is legally,
operationally and economically separate from the credit
institution.
21
The Definition of Trading Activities
• Trading activities are not directly defined by the proposed
Regulation.
• Instead, trading activities are stated to exclude (amongst
others):
– Lending, including consumer credit, credit agreements relating to
immovable property and financing of commercial transactions.
– Financial leasing.
– Money broking, safekeeping and administration of securities.
– Issuing electronic money and other means of payment, e.g. travellers’
cheques.
– Safe custody services.
22
Covered Funds
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Covered Funds
The Basic Prohibitions
• A banking entity
– may not, as principal, directly or indirectly, acquire or retain
any ownership interest in or sponsor a covered fund
– may not enter into “covered transactions” (as defined in
Section 23A of the Federal Reserve Act) with a covered
fund for which the banking entity, directly or indirectly,
serves as investment manager, investment adviser or
sponsor
24
Shadow Banking
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FSB Shadow Banking Initiative: Five Workstreams
1. Banks’ interactions with shadow banking entities
2. Money market funds
3. Other shadow banking entities
4. Securitization
5. Securities lending and repos
26
FSB Shadow Banking Initiative: Timeline
• Nov. 2012
– Proposals issued for public comment
• End 2012 / Early 2013
– Quantitative impact assessment
• Sept. 2013 G20 Summit
– Provide final set of recommendations
27
FSB Shadow Banking Initiative on Securities Lending
and Repos
• FSB April 2012 Interim Report on Securities Lending:
– Discusses market regulation, transparency and other issues
– Comment period closed May 25, 2012
• Generally involves interaction of Bank
BD
Less regulated
institutions
28
Securities Lending: FSB Areas of Concern
• Report states focus from a shadow banking system on
1
2
3
4
Maturity & Liquidity
Transformation
Maturity Transformation
and Leverage
Chain Transactions
Collateral
downgrades/upgrades
(Short term liabilities
vs. long term assets)
(Possible through
leveraged investment
fund financing)
Short sale cash
(Often used by banks
to obtain repo
financing)
Securities borrowing collateral
Reinvested cash collateral into
longer term assets
further lengthens
Cash collateral to riskier
investments
(AIG)
29
Financial Stability Issues
1. Lack of Transparency (due to bilateral nature)
–
–
–
–
Macro-level market data
Micro-level (institution-specific) market data
Corporate (balance sheet disclosure)
Risk reporting (e.g., re-hypothecation) by intermediaries to clients
2. Procyclicality of system leverage/interconnectedness
– Varies depending on:
a)
Value of collateral
–
b)
Size of haircuts
–
c)
Collateral “velocity” (rate reused)
3. Other Risks of Reuse of Collateral
– Interconnectedness
– Leverage
30
Financial Stability Issues (cont.)
4. Fire-Sale of Collateral Assets
– Particularly with counterparties with large collateral pools
5. Agent Lender Practices
Indemnity
– Lender
Agent Bank
Borrower
– Indemnity eliminates lender concern of borrower risk
6. Cash Collateral Reinvestment
– AIG-Lending as short term funding for investment
– Collateral Pools may promote rapid withdrawal
7. Cash Collateral Valuation Rigor
– MBS collapse
31
Shadow Banking Risks in Sec. Finance:
FSB Finalizes Policy Recommendations
• Background
– FSB issued final recommendations in August 2013:
Policy Framework for Addressing Shadow Banking Risks in
Securities Lending and Repos
• Final Recommendations address:
– Financial stability risks in securities lending and repo
markets
– Policy recommendations related to:
» enhanced transparency
» regulation of securities financing activities
» improvements to market structure
– New proposals re: minimum haircuts for non-cleared
securities finance transactions
32
Final FSB Recommendations
• Enhanced transparency
–
–
–
–
–
Regulatory collection of “granular” data on securities lending / repo exposures
Collect trade-level (flow) data and “snapshots” of sec/lending repo markets
Global standards and processes for data collection/aggregation
Improved public disclosures for securities finance activities
Review reporting requirements for fund managers to end investors
• Regulation
– Minimum standards for cash collateral reinvestment
– Minimum standards for collateral valuation and management
– Prudential limits on, and disclosure requirements for, re-hypothecation
• Market structure
– Evaluation of costs/benefits of central clearing in securities lending markets
– Low priority for changing insolvency treatment of securities finance transactions
33
Minimum Haircuts for Non-Cleared SFTs
• Key Aspects of FSB Proposal (comments due Nov. 28, 2013)
– Minimum standards for haircut calculation methodologies
– Minimum standards for portfolio margin calculations
– Numerical Floors
34
Shadow Banking Risks
FRB Governor Stein Speech
• November 7, 2013 Speech, “The Fire-Sales Problem and
Securities Financing Transactions”
– “Securities financing transactions . . . are particularly
deserving of policy attention.”
– Because of the “significant social costs, the goal of
regulatory policy should be to get private actors to
internalize these costs.”
– The “sensible path forward might involve some mix
of . . . capital surcharges, modifications to the liquidity
regulation framework, and universal margin
requirements.”
Watch macroprudential, as well as
microprudential, regulation
35
Disclosure and Investor Protection
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New Standards and Examination Priorities
• In January 2014, SEC announced a sweep regarding securities
lending practices, focused on fee splits between lenders and
agents
• At the end of 2013, FINRA finalized a new rules that, among
other things, requires broker-dealers to:
– provide disclosure to customers about risks of securities
lending
– obtain consent from customer to lend customer securities
held on margin
– make a “reasonableness” determination before borrowing
fully paid or excess margin securities from a customer
37
II. Capital and Liquidity
38
Final U.S. Capital Rules
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Applicability of Final Rules
The Final Rules do not
apply to
foreign parent.
Dodd-Frank
Foreign Prudential
Rules?
Foreign Parent
U.S. Holding Company
The Final Rules
apply to U.S.
banks, thrifts,
and to top tier BHCs
and SLHCs.
U.S. Bank
SR 01-1 applies until
no later than July 21,
2015 for wellmanaged, wellcapitalized foreign
FHCs. Exemption for
certain SLHCs.
Broker-Dealer
(Indirectly)
40
General Effect of Final Rules
Capital Requirements = Capital (Narrowed)
(Increased)
Risk-Weighted
Assets (Risk
weights increased)
41
Capital Ratios
End-State Ratios With Supplementary Leverage Ratio Proposal
Capital Conservation Buffer:
Additional buffer to avoid limitations on capital distributions &
discretionary bonuses. Progressive limitations for banks with
capital levels below buffer.
Countercyclical Buffer: Starts at 0 but could be as high as 2.5%
upon agency discretion (e.g., during period of excessive credit
growth). Applies only to Advanced Approaches Banks before
Capital Conservation Buffer.
G-SIB Surcharge: Applies only to designated banks.
1% - 2.5%
G-SIB
Surcharge
0% - 2.5%
Countercyclical
Buffer
2.5%
4.5%
Common
Equity Tier
1 Capital
Capital
Conservation
Buffer
Supplementary Leverage Ratio: Tier 1 capital to total
leverage exposure must be > 3%. Applies only to
Advanced Approaches institutions. Incorporates certain offbalance sheet assets in denominator (e.g., guarantees,
financial standby letters of credit, forward agreements).
1% - 2.5%
G-SIB
Surcharge
0% - 2.5%
Countercyclical
Buffer
Capital
Conservation
Buffer
1% - 2.5%
G-SIB
Surcharge
0% - 2.5%
Countercyclical
Buffer
2.5%
2.5%
Capital
Conservation
Buffer
2.0%
Additional
Tier 1
1.5%
1.5%
4.5%
Tier 1
Capital
8.5% Total
4.5%
Total Capital
10.5% Total
Tier 2
Additional
Tier 1
4%
Leverage Ratio
1%
IDI
2%
BHC
3%
Supplementary
Leverage Ratio
with Add-On
7% Total
42
Standardized Approach
(Effective January 1, 2015)
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Comparison Snapshot
Commercial Loans
Loan Type
Current Risk Weight
New Risk
Weight
Corporate exposures
100%
100%
Qualifying Broker-Dealer
20%
100%
Assets not assigned to a
risk weight category
100%
100%
44
Comparison Snapshot
Foreign Debt
New Risk
Weight
(%)
Current Risk Weight
Generally
Sovereign CRC
0% for direct and unconditional claims on
OECD governments
20% for conditional claims on OECD
governments
100% for claims on non-OECD governments
that entail some degree of transfer risk
0-1
0
2
20
3
50
4-6
100
7
150
OECD Member with No CRC
0
Non-OECD Member
with No CRC
100
Sovereign Default
150
45
Forthcoming Changes: Advanced Approaches Banks
• Governor Tarullo: More “complementary” burdens on the horizon
– Requirement to maintain certain levels of holding company equity and debt
– The G-SIB Capital surcharges contemplated by the Basel Committee (the
Basel Committee published a revised methodology for these surcharges
on July 3, 2013)
– Additional measures for risks related to short-term wholesale funding,
including additional capital requirements for banks dependent on such
funding
46
The CRD IV Directive
• The Directive addresses EU-specific issues that do not directly
relate to the Basel III reforms.
• The Directive contains provisions on issues where the degree of
prescription is lower and links with national law are particularly
important.
• Member states were required to transpose the Directive into
national legislation and regulation by 31 December 2013.
47
The CRD IV Directive (continued…)
• The Directive implements additional EU-specific reforms in the
following areas:
– Remuneration – a 1:1 ratio is imposed on certain bankers' salary relative
to variable pay, which can rise to 1:2 with explicit shareholder approval.
Firms are also required to disclose the number of individuals with a total
remuneration over a certain threshold.
– Corporate governance – measures are introduced to strengthen
processes related to the composition of boards and their role in risk
oversight and strategy, as well as strengthening the risk management
function within firms.
48
The CRD IV Directive (continued…)
– Sanctions – member states are required to apply administrative sanctions
and fines for violations of EU banking legislation.
– Reliance on external ratings – measures are introduced intended to the
reliance by credit institutions on external credit ratings.
49
(Supplemental) Leverage Ratio
50
BIS Final Leverage Ratio
• Published in January 2014
• Public disclosure begins January 1, 2015
• Final calibration by 2017
• Pillar 1 treatment by January 1, 2018
• Meant as a simple, non-risk-based “backstop measure” to the
risk-based framework.
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BIS Final Leverage Ratio
Capital Measure & Ratio
Tier 1 Capital
Exposure Measure
≥
3%
• BIS will continue to collect info on CET1 and total capital as
numerator
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BIS Final Leverage Ratio
Exposure Measure
On-Balance Sheet Exposures
+
Derivative Exposures
+
Securities Finance Transaction (“SFT”) Exposures
+
Off-Balance Sheet (“OBS”) Exposures
Exposure Measure
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BIS Final Leverage Ratio
On-Balance Sheet Exposure
• Generally must include all on-balance sheet exposures
– Except derivatives and SFT specifically covered
• Liability items may not be deducted
– E.g., gains/losses on fair value liabilities
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BIS Final Leverage Ratio
Derivatives Exposures
• Generally, exposure = Replacement Cost (“RC”) + PFE add-on
– Special treatment if subject to bi-lateral netting K.
» Net RC
• Collateral received generally cannot be netted against exposure
• Collateral provided requires gross up if reduced asset value
• Cash variation margin may be treated as pre-payment under
certain circumstances (and reduce RC)
– Enhancement from proposal
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BIS Final Leverage Ratio
SFTs – As Principal
• If acting as principal
–
–
–
–
Exposure measure = Gross + CCR
Exposure = Gross SFT (with no accounting netting)
Exclude SFT securities received, if treated as asset
Cash payables/receivables may be netted
» Final settlement date same, and set off enforceable
• Counterparty Credit Risk (“CCR”) Exposure
– If MNA, securities + cash lent minus same borrowed
– If no MNA, each transaction is own netting set
• Note: Netting ↑ over proposal
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BIS Final Leverage Ratio
SFTs – As Agent
• Key point – where bank does not control/own the underlying
cash or security, that resource cannot be leveraged
• So long as typical indemnity, CCR is the only exposure
– If greater indemnity, a further exposure equal to the full
amount of the security or cash lent must be included in
exposure
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BIS Final Leverage Ratio
OBS
• Includes – commitments, direct credit substitutes,
acceptances, and standby letters of credit
• Converted with credit conversion factor (“CCF”):
– Non-securitization commitments
» Unconditionally cancellable – 10%
» < 1 yr – 20%
» > 1 yr – 50%
– DCS/Acceptances – 100%
– Securitization Exposures – 100%
» Except liquidity facilities – 50%
• Note – Proposal used uniform 100% CCF
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U.S. Supplementary Leverage Ratio Proposal
• On July 9, 2013, FRB, FDIC and OCC issued proposed rule to require higher
leverage capital requirements for U.S. banking organizations identified as GSIBs by the Financial Stability Board.
– Applies to BHCs with > $700B total consolidated assets OR > $10 trillion
assets under custody
• Proposed rule would increase Supplementary Leverage Ratio
– BHC Level: 3%  5% (2% increase)
– IDI Level: 3%  6% (3% increase)
• 2% increase at BHC level functions as buffer (similar to capital conservation
buffer)
– Progressively more stringent limits on BHC capital distributions and
discretionary bonus payments if BHC goes below 2%
59
Liquidity Coverage Ratio
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Overview
• Proposed by the Federal Reserve Board, OCC and FDIC
• Comment period ends January 1, 2014
• Imposes a minimum quantitative liquidity standard on large and
internationally active U.S. banks
• Requires banks to hold enough High Quality Liquid Assets
(“HQLA”) to cover daily “Net Total Cash Outflows”
• “Super-equivalent” to the 2013 Basel III LCR
– Phases in over 2 years instead of 4
– More stringent standards for HQLA
– More stringent treatment of outflows to address maturity
mismatch
61
Applicability
• BHCs and SLHCs with
– $250 billion in total consolidated assets; or
– $10 billion in on-balance sheet foreign exposures
• Depository institution subsidiaries of the above with $10 billion or
more in total consolidated assets
• Nonbank SIFIs designated by FSOC
but not…….
• Nonbank SIFIs and SLHCs with substantial insurance activities
or SLHCs with significant commercial activities
62
LCR Formula
HQLA
Level 1 up to 100%
Level 2 up to 40%
Level 2A
Level 2B up to 15%
≥1
LCR =
Total Net Cash outflows =
Maximum net cumulative
daily outflows over the next
30 calendar days
63
HQLA and Total Net Cash Outflows
• HQLA
– Divided into Level 1, Level 2A and Level 2B assets
– Level 1: Central Bank Reserves, US Government and Agency Debt
and certain sovereign and multilateral development bank debt
– Level 2A (15% haircut): GSE debt, certain multilateral development
bank debt
– Level 2B (50% haircut): Investment grade corporate debt and
certain publicly traded common equity securities
• Total Net Cash Outflows
– “Total Net Cash Outflows” on the calculation date is the largest of
the cumulative net outflows for the next 30 days
» More stringent than the Basel III LCR
– The “largest” requirement is meant to address maturity
mismatches within the 30 day window
64
Calculating Cumulative Outflows/Inflows
• Calculation of cumulative outflows/inflows over 30 day window required on
daily basis
• Cumulative Outflows
– “Frontloads” some outflows relating to: retail cash, commitment
facilities, structured transactions, collateral outflow and derivatives
– Cumulative treatment for outflows relating to: certain brokered
deposits, wholesale funding, debt securities, secured funding and
asset exchanges and foreign central bank borrowing
• Cumulative Inflows
– Cumulative treatment for all categories of inflows
– Categories of inflows include: retail cash, unsecured wholesale cash,
securities cash, secured lending and asset exchange cash
– Excludes certain categories of inflows, including those with no
contractual maturity date
65
Cumulative Outflows
30-Day Maximum
300
250
200
150
100
50
0
1
2
3
4
5
6
7
8
9
10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30
66
Cumulative Inflows
600
500
400
Excess over Maximum Inflow
300
Cumulative Inflows Under LCR
Maximum Inflows
200
100
0
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30
Day
67
Basel Committee
NSFR Proposal
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BIS Net Stable Funding Ratio (“NSFR”) Proposal
Overview
• Published in January, 2014
• Requires “stable funding profile in relation to…assets and offbalance sheet liabilities.”
– Longer time horizon than LCR
• Expected to become minimum standard by 2018
• Comments due by April 11, 2014
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BIS NSFR Proposal
Ratio and Approach
Available amount of stable funding (“ASF”)
Required amount of stable funding (“RSF)
≥
100%
• Designed to reflect stability of liabilities across 2 dimensions:
1) Funding tenor – Generally, long term deemed more
stable
2) Funding type/Counterparty – Retail generally more stable
than wholesale
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BIS NSFR Proposal
ASF Determination
Summary of Liability Categories and associated ASF factors
ASF factor
Components of ASF category
100%
• Total regulatory capital
• Other capital instruments and liabilities with effective residual maturity of one year or more
95%
• Stable non-maturity (demand) deposits and term deposits with residual maturity of less than
one year provided by retail and SME customers
50%
• Funding with residual maturity of less than one year provided by non-financial corporate
customers
• Operational deposits
• Funding with residual maturity of less than one year from sovereigns, public sector entities
(PSEs), and multilateral and national development banks
• Other funding with residual maturity of not less than six months and less than one year not
included in the above categories, including funding provided by central banks and financial
institutions
0%
• All other liabilities and equity not included in above categories, including liabilities without a
stated maturity.
• Derivatives payable net of derivatives receivable if payables are greater than receivables
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BIS NSFR Proposal
RSF Determination – On-Balance Sheet
Summary of asset categories and associated RSF factors
RSF factor
Components of RSF category
0%
• Coins and banknotes
• All central bank reserves
• Unencumbered loans to banks subject to prudential supervision with residual maturities of less than six months
5%
•
Unencumbered Level 1 assets, excluding coins, banknotes and central bank reserves
15%
•
Unencumbered Level 2A assets
50%
•
•
•
•
•
Unencumbered Level 2B assets
HQLA encumbered for a period of six months or more and less than one year
Loans to banks subject to prudential supervision with residual maturities six months or more and less than one year
Deposits held at other financial institutions for operational purposes
All other assets not included in the above categories with residual maturity of less than one year
•
Unencumbered residential mortgages with a residual maturity of one year or more and with a risk weight of less than
or equal to 35%
Other unencumbered performing loans with risk weights grater than 35% under the Standardised Approach and
residual maturities of one year or more, excluding loans to financial institutions
65%
•
•
85%
100%
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•
•
•
•
•
Other unencumbered performing loans with risk weights greater than 35% under the Standardised Approach and
residual maturities of one year or more, excluding loans to financial institutions
Unencumbered securities that are not in default and do not qualify as HQLA including exchange-traded equities
Physical traded commodities, including gold
All assets that are encumbered for a period of one year or more
Derivatives receivable net of derivatives payable if receivables are greater than payables
All other assets not included in the above categories, including non-performing loans, loans to financial institutions
with a residual maturity of one year or more, non-exchange-traded equities, fixed assets, pension assets,
intangibles, deferred tax assets, retained interest, insurance assets, subsidiary interests, and defaulted securities
72
BIS NSFR Proposal
RSF Determination – Off-Balance Sheet
Summary of off-balance sheet categories and associated RSF factors
RSF factor
RSF category
5% of
currently
undrawn
portion
Irrevocable and conditionally revocable credit and liquidity facilities to any client
National
supervisors
can specify
the RSF
factors based
on their
national
circumstances
.
Other contingent funding obligations, including products and instruments such as:
• Unconditionally revocable credit and liquidity facilities;
• Trade finance-related obligations (including guarantees and letters of credit);
• Guarantees and letters of credit unrelated to trade finance obligations; and
• Non-contractual obligations such as
‒ potential requests for debt repurchases of the bank’s own debt or that of related conduits,
securities investment vehicles and other such financing facilities;
‒ Structured products where customers anticipate ready marketability, such as adjustable
rate notes and variable rate demand notes (VRDNs); and
‒ Managed funds that are marketed with the objective of maintaining a stable value.
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BIS NSFR Proposal
Certain Key Changes from 2010 Proposal
Available Stable Funding (ASF)
Recognition of operational deposits
Clarification of secured funding treatment
Higher ASF factors for stable non-maturity deposits and term deposits
Additional granularity for liabilities with residual maturities of less than one year
Required Stable Funding (RSF)
Greater consistency with LCR HQLA definitions
Lower RSF factors for unencumbered loans to retail and small business customers
Higher RSF factors for loans to non-bank financial institutions and non-HQLA securities
Additional granularity and lower RSF factors for certain other non-HQLA
Higher RSF for HQLAs encumbered for a period of six months or more and less than one year
Higher RSF factor for interbank lending for a period of six months or more and less than one year
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III. Exposure Limits
75
Basel Committee Limits on Large Exposures
Comment Period Ended – June 28, 2013
Intended Full Implementation –
January 1, 2019
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Single-Counterparty Exposure Limits: Basel
Framework – Counterparties/Limits
• Places limits on consolidated exposure to counterparties – daily
limit / monthly compliance reports
• General limit of 25% of banking group’s CET 1 or Tier 1 Capital
and of exposure to any single counterparty (and affiliates)
– E.g., December 31, 2012 – Bank Tier 1 capital =
$150 B
– Bank standard exposure limit $37.5 B
• More stringent limit of 10% - 15% of “net” credit exposure of GSIBs to other G-SIBs
– Bank current exposure limit = $15 B
• Note – US proposal based on capital stock and surplus
77
“Counterparties” Limit
• Exposures to a counterparty aggregated across the covered
company and all its subsidiaries
– “Subsidiary” broadly defined as directly or indirectly
“controlled”
(50% of any class of voting securities) by covered company
(systems issue)
» 25% voting or equity in US proposal
• “Counterparty” includes:
– Company and all its subsidiaries collectively
– Unlike U.S. proposal, sovereigns excluded
78
Gross Credit Exposure; Haircuts
• Gross credit exposure. Gross credit exposure calculation varies by
transaction
– “Haircut Approach” – Securities lending and repo
• Collateral haircuts (E.g., U.S. proposal)
– Sovereign debt: 0.005 to 0.06 depending on maturity, OECD
Country Risk Classification
– Bank eligible corporate and muni bonds: 0.02 to 0.12 depending on
residual maturity
– Main index equities: 0.15
– Other publicly traded equities: 0.25
– Mutual funds: Highest applicable haircut
– Cash collateral “held on deposit”: 0
• Substitution of credit provider also permitted
79
Single-Counterparty Exposure Limits:
Framework – Calculation
• Aggregate net credit exposure
– The sum of the following calculation for all transactions
between a BHC and a counterparty and its affiliates:
– Gross credit exposure for the transaction (calculated using
any applicable haircuts)
» Less market value of eligible collateral (reduced by
applicable collateral haircut);
» Less value of any eligible guarantee;
» Less value of derivatives / other hedges
– BUT: any adjusted value of collateral, guarantee, derivatives,
etc. is shifted to count toward the credit exposure limit of the
issuer / guarantor / etc.
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Single-Counterparty Credit Limits – U.S. Examples
The following examples show counterparty credit exposures
calculated for repurchase and reverse repurchase transactions:
Principal Reverse Repo – Fixed Income Collateral
BHC transfers $100 in cash to Broker Dealer. Broker Dealer
provides $102 in 10-year sovereign bond collateral (OECD
country 0-1).
Credit Exposure to Broker Dealer
– BHC Gross Exposure = $100
– BHC Net Exposure = $100 – $102*96%= $2.08
Credit Exposure to Foreign Sovereign
– BHC Gross Exposure = $100 – $2.08 = $97.92
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Single-Counterparty Credit Limits –
U.S. Examples (cont’d)
Indemnified Reverse Repo – Equity Collateral
BHC acts as an agent for Mutual Fund as part of a securities
lending arrangement and transfers $100 in cash to Broker
Dealer. Broker Dealer provides $105 in main index equity
collateral.
• Credit Exposure to Broker Dealer
– BHC Gross Exposure = $100
– BHC Net Exposure = $100 – $105*85% = $10.75
• Credit Exposure to Equity issuer
– BHC Gross Exposure = $100 – $10.75 = $89.25
82
Single-Counterparty Credit Limits –
U.S. Examples (cont’d)
Tri-Party Repo
BHC transfers $105 in main index equity securities to BNY
Mellon as intermediary for Broker Dealer.
BNY Mellon holds $100 in cash provided by Broker Dealer as
custodian for BHC.
• BHC Credit Exposure to Broker Dealer
– BHC Gross Exposure = $105+$15.75= $120.75
– BHC Net Exposure = $120.75 – $100 = $20.75 (eligible cash
collateral includes cash held on deposit by a third-party
custodian)
83
IV. Foreign Banking Organization Rule
84
FRB FBO Proposed Prudential Rules
• Reference Date – July 1, 2014
• Compliance Date – July 1, 2015
• But – per Michael Gibson (FRB BS&R
Director) 3/28/13
- Not finalized before U.S. regulation
- Compliance date may be delayed
85
FBO Proposed Prudential Rules
Data Points
Morgan Stanley/Oliver Wyman Report (April 11, 2013)
• Global “Balkanization” reduces RoE by 2-3 %
– Need to duplicate infracture at local levels
• US is a key global profit and growth driver
– Americas in 2012
» Represented 47% of global revenues
» Represented 55 – 60 % of global profits
86
FBO > U.S. $50B Global;
Combined U.S. Presence > U.S. $50B
FBO Focus
Certify/demonstrate to FRB meet BIII .212(c)
Provide FRB relevant capital ratios with FRY-7Q .212(c)
Based on
FRY-7Q
Risk Mgmt
FBO
Risk Mgmt
– See IHC, may
be at FBO if
has US Ops
other than
through the
FHC
Either comply with and
provide FRB info regarding
req’d home county stress
tests, or hold assets equal to
108% of liabilities of US
branch and agency network
and engage in US non-IHC
sub operation stress tests
.263
Stress
Testing
Capital
– US Liquidity Risk Cttee .222
– Annual review /approval of liquidity risk tolerance for US .222
– Consistent with enterprise-wide
– Consider capital/risk profile/complexity/size/activities
– US Chief Risk Officer .222
– Review liquidity rules with each new US business line/product
– Annual review of significant US products/business lines
– Annual review/approval of contingency funding plan [.228]
– Quarterly
– Cash flow projection review [.225]
– Review liquidity stress testing practices [.226]
– Review liquidity stress testing results [.226]
– Approve size/composition of liquidity buffer [.227]
– Review specific limits [.229]
– Review sufficiency of liquidity risk management info
– Review liquidity risk policies established by US operation management
.223
– Regularly report to US Risk Cttee
– Independent liquidity risk function .224
– At least annually review US liquidity risk mgmt
– Report issues for corrective action
Net credit exposure of US ops may not exceed 25% of FBO’s cap and surplus .242
– Lower limit if FBO exceeds $500 B global assets
– Generally like US SCCL, except treats home country sovereigns like US gov’ts
Liquidity
SCCL
87
V. Financial Transaction Tax
88
Difference between the Proposed EU FTT Directive, Existing French
FTT Law and the Italian Law Decree for FTT
France
Italy
EU FTT - Proposed
Who pays it?
Purchaser
Purchaser
Purchaser and Seller
On what?
French Co’s
1bn euro cap
Italian Co’s
500m euro cap
Equities and debt securities
issued within the 11 PMS
ADR?
Yes
Yes
No (Anti-avoidance point)
Rate?
0.2%
0.12% - 0.10%
0.22% - 0.20%
0.10% on both (min)
Trade netting?
Yes
Yes
No
Issuer based?
Yes
Yes
Yes (this is new)
Establishment?
No
No
Yes
Pass porting and
Authorization?
No
No
Yes
Temporary transfers
exempt?
Yes
Yes
No
Market maker relief?
Yes
Yes
No
89
On 28th September 2011, the Commission tabled a proposal for a Council
Directive on a common system of financial transaction tax (FTT). On 14th
February 2013, an amended Directive was issued under the enhanced
cooperation process.
Given the extremely high mobility of most of the transactions to be potentially
taxed, it was and still is important to avoid distortions caused by tax rules
conceived by Member States acting unilaterally……France and Italy have already
done so and Spain and Portugal were in the process of doing so.
What is enhanced cooperation?
It allows for countries of the European Union to work more closely together whilst
the legal framework of the Union – the EC Treaty.
Requires the minimum of 9 Member States which combined have more that 75%
of the EU Population.
The 11 Member States involved are Belgium, Germany, Estonia, Greece, Spain,
France, Italy, Austria, Portugal, Slovenia and Slovakia. Other Member States can
join. However, should the Member State number fall below 9 jurisdictions then
enhanced cooperation falls down?
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Article 4* Establishment – What the Legal Opinion
Covered.
For the purposes of this Directive, a financial institution shall be deemed to be established in the
territory of a participating Member State where any of the following conditions is fulfilled:
(a)it has been authorised by the authorities of that Member State to act as such, in respect of
transactions covered by that authorisation;
(b)it is authorised or otherwise entitled to operate, from abroad, as a financial institution in regard to
the territory of that Member State, in respect of transactions covered by such authorisation or
entitlement;
(c)it has its registered seat within that Member State;
(d)its permanent address or, if no permanent address can be ascertained, its usual residence is
located in the Member State;
(e)it has a branch within that Member State, in respect of transactions carried out by that branch;
(f)
it is party, acting either for its own account or for the account of another person, or is
acting in the name of a party to the transaction, to a financial transaction with another financial
institution established in that Member State pursuant to points (a),(b), (c), (d) or (e), or with a party
established in the territory of that Member State and which is not a financial institution
The 11 Participating Member States (“PMS”).
Belgium, Germany, Estonia, Greece, Spain, France, Italy, Austria, Portugal, Slovenia, Slovakia
* Source: CNS – Consultation Procedure 2013/045 - “Implementing enhanced cooperation in the area of financial transaction tax (FTT)”
http://www.europarl.europa.eu/oeil/popups/ficheprocedure.do?lang=en&reference=2013/0045(CNS)
91
Article 4*
Establishment
Deemed establishment
Issuance
Don’t know
Group
PMS
FI
Parent
UK
FI
NPMS
FI
UK
FI
NPMS
FI
Branch
NPMS
Sub
PMS
France
FI with authorisation/pass-porting Art 4 (1)(a)(b) = still in scope
FI that is established Art 4 (1)(c)(d)(e) = still in scope
FI within Art 4 (1)(f) = subject of the opinion
French
equities
Dutch equities
Euronext
(Paris Bourse)
HK
FI
Non-participating Member State (“NPMS”)
Participating member State (“PMS”)
Financial institution (“FI”)
HK
FI
* Source: CNS – Consultation Procedure 2013/045 - “Implementing enhanced cooperation in the area of financial transaction tax (FTT)”
http://www.europarl.europa.eu/oeil/popups/ficheprocedure.do?lang=en&reference=2013/0045(CNS)
92
Article 10* Joint and Several Liability – Practical and Technical Overview
Redistribution Based upon Issuance – under Negotiation at Present.
Key point 1:
Deemed established in both
Italy and France (Article 4 (1)(f) – subject of the legal opinion
PMS
(Italian)
FI
Sale of German
equities
Key point 2:
Article 10(4)
Italy can hold the
Italian FI joint and severally
liable for the payment of the
Tax should US FI not agree to pay.
US
FI
Physically
Settled (German equity)
forward
Key point 3:
Deemed established under the
issuance principle (Article 4) in Germany
on the physical receipt.
UK
FI
Sale of Belgian
equities
PMS
(French)
FI
Key point 5:
Collection and payment.
Article 11 provides for each PMS
to lay down reporting, registration
and accounting obligations
Key point 4:
Redistribution – Issuance.
Using a pure issuance model
both Germany and Belgium would
be due the tax.
Source: CNS – Consultation Procedure 2013/045 - “Implementing enhanced cooperation in the area of financial transaction tax (FTT)”
http://www.europarl.europa.eu/oeil/popups/ficheprocedure.do?lang=en&reference=2013/0045(CNS)
93
ISLA Submission to Treasury 21st March 2013 –
Subsequently Sent to the EC
Article 4
For the purposes of this Directive, a financial institution shall be deemed to be established in the territory of a participating Member State
where any of the following conditions is fulfilled:
(a) the FI has been authorised by the authorities of that Member State to act as such, in respect of transactions covered by that
authorisation
(b) it is authorised or otherwise entitled to operate, from abroad, as financial institution in regard to the territory of that Member State, in
respect of transactions covered by such authorisation or entitlement
UK Bank
Loan of
Hong Kong
equities
US Bank
UK Bank has a
regulatory authorisation
to act in a participating
Member State in relation
to a securities lending or
repo transaction
Participating
Member State
Despite the fact that UK Bank has undertaken a stock loan transaction over HK equities with a US Bank, the present
drafting of conditions (a) and (b) within Article 4 does not allow one to wholly conclude that such a transaction should
remain entirely outside the scope of the Directive irrespective of the fact that neither party to the stock loan
transaction or the underlying security itself are established or have been issued within a participating Member State.
Under the present drafting, it would appear that in effect, UK Bank shall remain “established” within the participating
Member State for the purposes of the transaction therefore subjecting it to FTT under the Directive.
Clearer guidance around the proper intent of Article 4 is required.
94
Temporary Transfers…What We May Be Up Against?
Room Document 2 - 22nd May 2012
“Contrary to what numerous stakeholders claim, there are issues of financial stability around the use of such instrument – FSB interim report April 2012”
1.Lack of transparency
2.SF markets can influence leverage, complexity and level of risk taking
3.Collateral re-use could reinforce (2) and may have other destabilising effects
4.Potential risk from the fire-sale of collateral assets following a default
5.Potential risk arising from agent lender indemnities to their clients in the event borrower defaults
6.Non-bank type lenders reinvesting cash collateral can effectively perform “bank like” activities that involve maturity, liquidity transformation and leverage
7.Insufficient rigour in collateral valuation and management practices
It could be that the “one transaction” relief is all we get?
Latest:
•Speculation about a 1bp rate and the issuance principle taking precedence
•Merkel statement on FTT
•EC Council legal services opinion begins to undermine Article 4
•French FTT not being collected.
* Securities Lending and Repos: Market Overview and Financial Stability Issues. Interim Report of the FSB Work stream on Securities Lending and Repos
http://www.financialstabilityboard.org/publications/r_120427.pdf
95
Gregory J. Lyons
Ph# - 212-909-6566
Email - gjlyons@debevoise.com
96