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International regulators concede capital rules are too complex.
August 12
Fifth in a nine-part
Since the financial crisis, global regulators have been pushing to have as many over-the-counter derivative products as possible cleared with central counterparties, to improve transparency and minimize
As a result, volumes and revenues have significantly increased at these clearing houses. The regulators' intentions are good, but in my experience, anytime business surges at any institution, risk managers and supervisors should be paying much more attention to the firm's increased
CCPs, especially, have a lot of
Fortunately, the Basel Committee recognizes this danger. In a recent consultative document, the committee is signaling to banks that even if there are higher safeguards and default funds maintained by qualified
The new guidelines also encourage QCCPs to improve their default funds and their risk management. Together with recent
In July 2012, the Basel committee had released interim
In recognition of these findings, the new July 2013 guidelines focus on three areas related to transactions with QCCPs.
Two guidelines are for banks. First, the Basel committee proposes a new methodology to calculating a bank's capital for its trade exposures to a QCCP. Previously, the committee had recommended a mere 2% of the relevant risk-weighted assets. If the new guidelines were accepted, the risk weight applied to trade exposures would depend on the level of prefunded default resources available to the QCCP. If QCCPs want to attract banks as customers, they will have to really focus on their default resources; otherwise banks will have to allocate more in capital. With the new methodology, banks are likely to have to allocate 5% to 20% of RWAs depending on the QCCP's resources. While banks will not like the new guidelines, it should make them think more carefully about the amount and type of hedging or speculative derivatives transactions that they want to put on and will make them look for the QCCPs with the best safeguards.
Secondly, the new guidelines focus on new calculations for QCCP bank clearing members to use for prefunded default fund contributions. In my view and that of many financial derivatives markets reform advocates, the contributions required by the interim rules were not robust enough to absorb losses during market stress. The proposed method for QCCPs to calculate the default fund would better position the default funds to absorb losses, so that high credit quality members do not get hurt by a drawdown of the funds.
Thirdly, not only are banks required to improve their methodologies to calculate capital for transactions with QCCPs, but the guidelines also encourage QCCPs to have robust default funds. The Basel guidelines can be very useful if bank regulators use them to provide an incentive for, or at least not discourage, contributions to default funds to be prefunded, rather than commitments to pay after the fact. The creation of a default fund should not create new risk for the financial system in the form of hidden liabilities that surface when a trading partner falters. Rather, a default fund should serve to mutualize and distribute a risk that would otherwise fall on creditworthy members' trade exposure claims on the CCP.
Importantly, the proposed guidelines demonstrate the Basel Committee is aware that just insisting on additional capital is not enough. The Basel Committee is emphasizing that it wants improved risk management practices by banks and CCPs. For the QCCPs, there are established CPSS-IOSCO
While the proposed guidelines can be very useful in improving banks capital against QCCPs, as I have written in these
Next: Capital requirements for banks'
Mayra Rodríguez Valladares is managing principal at