March 6, 2015
Bloomberg Brief
Financial Regulation
14
COMMENTARY ANALYSIS BY CADY NORTH & MATTHEW DEBRABANT, BLOOMBERG ENTERPRISE SOLUTIONS
Leveling High-Quality Liquid Assets Under Basel III Proves Difficult for Banks
As banks start daily reporting under the Basel
Committee on Banking Supervision's liquidity
coverage ratio, compliance is proving to be more
difficult than originally thought, according to
Bloomberg Enterprise Solutions's Cady North and
Matthew Debrabant. They say banks must first
spend time organizing their market and internal
data and, for global firms, international differences
must still be solved before the longer-term net
stable funding ratio is introduced later this year.
This January marked the roll out of the
liquidity coverage ratio, or LCR, under the
new Basel III framework. The full
requirements for daily reporting and
holding 100 percent of high-quality liquid
assets, or HQLAs, to cover 30-day
stressed outflows will be phased-in during
the next few years according to various
country standards. Early reports from
around the world showed that banks have
improved their liquid positions. In the
U.S., for instance, the Federal Reserve
noted last fall that the liquidity
requirement would be manageable
because about 70 percent of institutions
already met the standard.
However, after just a few months into
the reporting, compliance is proving to be
a bit more difficult than previously
imagined. The security-level analysis
required, the various interpretations of
global jurisdictions and the daily reporting
requirement are creating headaches for
bank compliance teams around the world.
Banks are starting to find out that the
analysis they’ve done on a certain
security they hold may not match the
analysis that another bank has done. This
will undoubtedly create a red flag for
regulators. In the U.S., the Federal
Reserve is demanding that U.S. filers
report (under FR2052a) using enough
granularity that the regulators can
recreate their LCR calculations and
double check the banks’ work. Strict
requirements to document compliance
efforts are also time consuming.
Security-Level Analysis
One of the biggest headaches banks
are running into is the requirement to
perform a security-level analysis to
determine whether an asset is
HQLA-eligible and then dropping it into
the right eligibility bucket with the
corresponding haircuts. For instance, it’s
not enough to flag all securities that are
backed by U.S. government-sponsored
entities as level 2A assets. In the U.S.,
filers have to do some additional analysis
to determine whether the asset is “liquid
and readily marketable." To be fully
compliant, banks have to have a process
in place to measure whether there’s more
than two committed market makers in the
secondary market, have a large number
of non-market maker buyers and sellers
"Since these rules are
global, it will only be
through additional
guidance or
enforcement actions
that differing
interpretations will be
resolved."
and provide the relevant pricing and
volume analysis.
For 2A and 2B assets banks also have
to access historical price information to
find out when and to what degree the last
price drop on the security occurred. This
is reasonably achievable for equities, but
much more difficult for mortgages and
government bonds as it takes staff time
and data reporting power to do the
analysis in an accurate way.
Interpretation Problems
Unfortunately for global firms, leveling
an HQLA in one country doesn’t mean
that you’ve found the right level and
haircut for another country. For instance,
in the U.S. only GSE-backed residential
mortgage-backed securities, or RMBS,
are allowed as HQLA, while in the
European Union, private label RMBS are
allowed in some cases. Because of these
jurisdictional differences, when in doubt
banks tend to rely on the interpretation
methods they feel most comfortable with
at the home country level.
Another interpretation problems occurs
when banks try to level regional and local
government bonds. In the U.S.,
municipals are not HQLA-eligible, though
regulators are reviewing this status. In the
EU and other jurisdictions, they may be
eligible depending on the origin and risk
weight. Different interpretations on the
eligibility and level of regional and local
governments by banks will yield very
different results.
Since these rules are global, it will only
be through additional guidance or
enforcement actions that differing
interpretations will be resolved.
Daily Reporting
As daily reporting is phased in,
conducting the leveling, liquidity, and
price drop analysis manually will not be
tenable. Banks must spend time
organizing their market and internal data,
so that they can measure these detailed
bits of information in an automated way.
Further, for globally active firms, banks
need to make sure they stay apprised of
regulatory differences across country
lines as well as ongoing changes in
guidance
Hopefully, banks will be able to sort out
these compliance problems before the
longer-term net stable funding ratio, or
NSFR, is introduced later this year. The
goals of the LCR and NSFR are to create
a common standard and raise the quality
of liquidity risk measurement across the
globe. In practice from a compliance
perspective, it’s more difficult to achieve
such a common standard.
(Cady North is a regulatory specialist and Matthew
Debrabant is a product manager with Bloomberg
Enterprise Solutions.)