Two influential regulatory officials have indicated that they share the widespread concerns within the derivatives industry regarding the impact of Basel III capital requirements on clearing firms. Although they expressed these views as individuals, their comments suggest that banking regulators are recognizing that the treatment of cleared derivatives under Basel III should be reviewed.
In an article published on April 20, Benoît Cœuré, the chairman of the Committee on Payments and Market Infrastructures, a key standard-setting body at the international level, encouraged banking regulators to consider the impact of the Basel III capital standards on derivatives clearing. He warned that the reduction in the number of clearing members could have implications for systemic risk.
“The prospective further concentration of client clearing business in a smaller number of clearing members would further increase the respective financial risk concentration and could limit the ability to port client positions and collateral in case of member default, heightening potential systemic spillover risks,” wrote Cœuré, who is also a member of the European Central Bank’s governing board.
Also on April 20, Federal Reserve Governor Jerome Powell discussed the unintended consequences of including initial margin in the leverage ratio. Speaking at an event in Washington, D.C., Powell noted that regulators want to see the adoption of clearing, but the leverage ratio makes it more expensive. “We are undermining the clearing mandate and the ability of smaller clients to get their products centrally cleared. I think we need to look again at the calibration of the leverage ratio in the U.S.,” said Powell.
Market participants have been warning for some time that the capital requirements stemming from the leverage ratio will harm the strength and stability of the cleared derivatives markets worldwide unless it is amended to recognize the exposure-reducing effect of the collateral that clearing banks collect from their clients.
Last November, a coalition of 15 industry bodies representing clearing members, asset managers, insurance companies, commodity end-users, hedge funds, derivatives exchanges and clearinghouses sent a joint letter outlining their concerns to Mark Carney, the chairman of the Financial Stability Board, Mario Draghi, the chairman of the Group of Governors and Heads of Supervision, and Stefan Ingves, chairman of the Basel Committee on Banking Supervision.
“We believe that the leverage ratio, as presently constructed, has certain unintended consequences that will make the financial system more fragile, severely undermine the global efforts to bring more derivatives in central clearing, and seriously impair the ability of end-users in the real economy to hedge their market risks,” the groups said in the letter.