Basel III Liquidity Framework

Transcription

1 Basel Committee Publishes Final Document on Net Stable Funding Ratio SUMMARY On October 31, 2014, the Basel Committee on Banking Supervision (the Basel Committee ), published a final document presenting the net stable funding ratio ( NSFR ), one of the key standards proposed by the Basel Committee to strengthen liquidity risk management as part of the Basel III framework (the Final NSFR ). 1 The NSFR is designed to promote more medium- and long-term funding of the assets and activities of banks over a one-year time horizon, thus complementing the Basel III liquidity coverage ratio ( LCR ), the standard intended to address short-term liquidity risk management over a 30-day stressed horizon. The NSFR is supposed to take effect as a binding requirement on January 1, Originally proposed in 2009, the Basel Committee presented a revised NSFR framework for comment in a consultative document in January 2014 (the 2014 NSFR Proposal ). 2 Although the Final NSFR is largely consistent with the 2014 NSFR Proposal, it contains a number of changes and clarifications to that proposal, including: The treatment and calculation of derivate exposures have been revised and clarified. The list of assets requiring stable funding has been expanded to include assets posted as initial margin for derivative contracts, as well as a specified proportion of derivative liabilities. Certain short-term exposures to banks and other financial institutions have been assigned higher funding requirements. The Final NSFR introduces the concept that certain asset and liability items are interdependent and permits national supervisors, subject to certain enumerated conditions, to treat such items as neutral for purposes of the NSFR. New York Washington, D.C. Los Angeles Palo Alto London Paris Frankfurt Tokyo Hong Kong Beijing Melbourne Sydney

2 Like all Basel Committee standards, national supervisors must subsequently implement the NSFR in their respective jurisdictions. The U.S. federal banking agencies (the Agencies ) have not yet publicly addressed the application of the NSFR to U.S. banking organizations, including which U.S. banking organizations will be made subject to the NSFR. It remains to be seen whether the Agencies will implement a more stringent version of the NSFR in the U.S. than the internationally agreed-upon Final NSFR so-called super-equivalence in Agency parlance as was the case with the Agencies implementation of the LCR. 3 BACKGROUND OF THE NSFR The NSFR is defined as the ratio of a subject institution s available amount of stable funding divided by its required amount of stable funding. The standard requires that the ratio be no lower than 100%. The NSFR is designed to ensure that a subject institution s assets and off-balance sheet activities are funded with at least a minimum amount of stable liabilities in relation to their liquidity risk profiles over a one-year horizon. Generally described, the numerator in the ratio available stable funding ( ASF ) is calculated by applying to designated items on the right side of the balance sheet (that is, items that are sources of funding) a factor called an ASF factor ranging from 100% to 0% depending upon the particular equity or liability component, with the factor reflecting stability of funding. Similarly, the denominator of the ratio the required stable funding ( RSF ) is calculated by applying to each asset on the left side of the balance sheet and certain off-balance sheet commitments (that is, items requiring funding) a specific required stable funding factor called an RSF factor ranging from 100% to 0% reflecting the amount of the particular item that supervisors believe should be supported with stable funding. DISCUSSION HIGHLIGHTS OF THE FINAL NSFR Highlights of the Final NSFR are described below with respect to each of the ASF and the RSF, as well as certain other matters addressed in the guidance, including, where applicable, certain noteworthy differences from the 2014 NSFR Proposal. I. AVAILABLE STABLE FUNDING 1. General Considerations Maturity Dates: Consistent with the 2014 NSFR Proposal, the Final NSFR provides that, in determining the maturity of an equity or liability instrument, investors with a call option would be assumed to exercise such option at the earliest possible date. However, in the case of funding with options exercisable at the bank s discretion, the Final NSFR appears to somewhat relax the initially proposed assumption that a bank s option is deemed exercised at the earliest possible date in most circumstances, instead providing that supervisors take into account reputational factors that may limit a bank s ability not to exercise the option (that is, where the market expects liabilities to be redeemed before their legal final maturity date, banks and supervisors would need to assume such behavior for the purpose of the NSFR and include these liabilities in the corresponding ASF category). -2-

3 Calculation of Derivative Liabilities: As noted above, the Final NSFR clarifies the calculation methodology for derivative liabilities. Such liabilities would be required to be calculated first based on the replacement cost for derivative contracts (obtained by marking to market) where the contract has a negative value. When an eligible bilateral netting contract is in place that meets certain conditions specified in prior Basel Committee guidance, the replacement cost for the set of derivative exposures covered by the contract would be the net replacement cost. Moreover, in calculating NSFR derivative liabilities, collateral posted in the form of variation margin in connection with derivative contracts, regardless of the asset type, would be deducted from the negative replacement cost amount. 2. ASF Factors The Final NSFR largely leaves as proposed the liabilities and capital instruments receiving a 100% ASF factor and the liabilities receiving ASF factors of 95%, 90% and 50%, but makes certain changes to the liabilities receiving an ASF factor of 0% as described below. The components that would comprise each ASF factor are as follows: 100% ASF Factor: These liabilities and capital instruments would comprise: (a) the total amount of regulatory capital (before the application of capital deductions), excluding the proportion of Tier 2 instruments with residual maturity of less than one year; (b) the total amount of any capital instrument not included in (a) that has an effective residual maturity of one year or more, but excluding any instruments with explicit or embedded options that, if exercised, would reduce the expected maturity to less than one year; and (c) the total amount of secured and unsecured borrowings and liabilities (including term deposits) with effective residual maturities of one year or more. Cash flows falling below the one-year horizon, but arising from liabilities with a final maturity greater than one year, do not qualify for the 100% ASF factor. 95% ASF Factor: These liabilities would comprise stable non-maturity (demand) deposits and/or term deposits with residual maturities of less than one year provided by retail and small business customers based on the relevant definitions in the LCR. 4 90% ASF Factor: These liabilities would comprise less stable non-maturity (demand) deposits and/or term deposits with residual maturities of less than one year provided by retail and small business customers based on the relevant definitions in the LCR. 50% ASF Factor: These liabilities would comprise (a) funding (secured and unsecured) with a residual maturity of less than one year provided by non-financial corporate customers; (b) operational deposits; (c) funding with residual maturity of less than one year from sovereigns, public sector entities ( PSEs ), and multilateral and national development banks; and (d) other funding (secured and unsecured) not included in the categories above with residual maturity from six months to less than one year, including funding from central banks and financial institutions. 0% Factor: Consistent with the 2014 NSFR Proposal, the Final NSFR would apply 0% to all other liabilities and equity categories not included in the buckets above and certain other liabilities without a stated maturity. The treatment of derivatives for purposes of the ASF factor is modified to conform to the revised formulation described above. The Final NSFR removes the previous payables/receivables concept and instead provides that, if net derivative liabilities (calculated based on replacement cost net of collateral, if relevant) are greater than net derivative assets (as calculated pursuant to the procedure described below), a 0% ASF factor would apply to net derivative liabilities. (Alternatively, as noted below, if net derivative assets are greater than net derivative liabilities, a 100% RSF factor would apply to net derivative assets.) Finally, the Final NSFR also adds to the 0% bucket trade date payables arising from the purchases of financial instruments, foreign currencies and commodities that are expected (even if they have failed) to settle within the standard settlement period for the transaction. -3-

4 II. REQUIRED STABLE FUNDING 1. General Considerations Maturity Dates: In keeping with the approach to maturity dates of the liability components of ASF, the RSF rules assume that investors will exercise any option they have to extend maturity for assets and, for assets with options exercisable at the bank s discretion, supervisors are directed to take into account reputational factors that may limit a bank s ability not to exercise the option. Encumbered Assets: The Final NSFR largely maintains the RSF treatment of encumbered assets as previously proposed (that is, assets encumbered for one year or more would receive a 100% RSF factor; assets encumbered for a period of between six months and less than one year that would, if unencumbered, receive an RSF factor lower than or equal to 50% would receive a 50% RSF factor; assets encumbered for between six months and less than one year that would, if unencumbered, receive an RSF factor higher than 50% would retain that higher RSF factor; and assets having less than six months remaining in the encumbrance period would receive the same RSF factor as an equivalent asset that is unencumbered). However, where the 2014 NSFR Proposal had simply provided that assets encumbered for central bank liquidity operations may receive the same RSF factor as a similar asset that is unencumbered, the final standard states that supervisors should discuss and agree on the appropriate RSF factor for such assets with the relevant central bank and notes that this must not be lower than the RSF factor applied to the equivalent asset that is unencumbered, thereby implying that the applicable RSF factor may be higher. Secured Financing Transactions: The treatment of secured funding arrangements remains largely as proposed, including the guidance that banks should generally exclude from their assets securities which they have borrowed in securities financing transactions (such as reverse repos and collateral swaps) where they do not have beneficial ownership, but include securities they have lent in transactions where they do retain beneficial ownership. The Final NSFR clarifies that securities financing transactions with a single counterparty would be allowed to be measured net when calculating the NSFR, provided that the netting conditions set out in the Basel III leverage ratio framework and disclosure requirements are satisfied. 5 Calculation of Derivative Assets: The calculation methodology for derivative assets in the Final NSFR is equivalent to that used for derivative liabilities and is first based on the replacement cost for derivative contracts (obtained by marking to market) where the contract has a positive value. Further, collateral received in connection with derivative contracts may not offset the positive replacement cost amount, irrespective of the relevant accounting treatment, unless it is received in the form of cash variation margin and meets the conditions specified in the Basel III leverage ratio framework and disclosure requirements. Any remaining balance sheet liability associated with either variation margin received that does not meet the specified criteria or initial margin received may not offset derivative assets and should be assigned a 0% ASF factor. Off-Balance Sheet ( OBS ) Exposures: The Final NSFR repeats the previously proposed guidance regarding OBS exposures and would assign an RSF factor of 5% to the currently undrawn portion of irrevocable and conditionally revocable credit and liquidity facilities to any client, while permitting national supervisors to specify their own RSF factors for a range of other contingent funding obligations. 2. RSF Factors Although the Basel Committee has generally retained the previously proposed scheme for the denominator of the NSFR, it has revised certain of the components of the RSF and their corresponding RSF factors as set forth below. The final RSF factors and their components are as follows: 0% RSF factor: The Basel Committee has removed from this category unencumbered loans to banks with residual maturities of six months or less, leaving only claims on central banks with such a -4-

5 maturity. Separately, while the Final NSFR continues the inclusion of coins, banknotes and central bank reserves, it adds in regard to the latter that supervisors may agree with the relevant central bank on the RSF factor to be assigned to required central bank reserves if they exist on a longer-term horizon and therefore require associated stable funding, thus allowing the possibility that such reserves may be accorded an RSF factor higher than 0%. Further, this category would now include trade date receivables arising from sales of financial instruments, foreign currencies and commodities that are on the same settlement timeline as the trade date payables assigned to the 0% ASF factor. 5% RSF factor: The assets that would be included in this category remain unchanged (unencumbered Level 1 assets (as defined in the LCR), subject to certain exclusions and inclusions as previously proposed. 10% RSF factor: The 10% RSF factor is a new weighting and would apply solely to a subset of the short-term, unencumbered loans to financial institutions that previously would have been assigned a 0% RSF factor, namely, those loans secured against Level 1 LCR assets where the bank has the ability to freely rehypothecate the collateral for the life of the loan. 15% RSF factor: This factor previously would apply only to unencumbered Level 2A (as defined in the LCR) assets but has been expanded to also apply to all short-term unencumbered loans to financial institutions which do not qualify for the 10% RSF factor. 50% RSF factor: The assets subject to a 50% RSF weighting remain largely the same as proposed, including (a) unencumbered Level 2B assets (as defined in the LCR), (b) any high quality liquid assets ( HQLA ) (as defined in the LCR) that are encumbered for a period of between six months and less than one year, (c) all loans to financial institutions and central banks with residual maturity of between six months and less than one year, (d) deposits held at other financial institutions for operational purposes, that are subject to the 50% ASF factor, and (e) all other non-hqla not included in the above categories that have a residual maturity of less than one year. 65% RSF factor: This factor would apply to the same group of assets as proposed, including unencumbered residential mortgages and other unencumbered loans not included in the above categories (excluding loans to financial institutions), in each case having a residual maturity of one year or more and qualifying for a 35% or lower risk weight under the Basel II standardized approach for credit risk. 85% RSF factor: The initially proposed components in this bucket remain generally unchanged and would include (a) other unencumbered performing loans having a residual maturity of one year or more but not qualifying for a 35% or lower risk weight under the Basel II standardized approach for credit risk, (b) certain unencumbered securities with a remaining maturity of one year and exchangetraded equities, and (c) physically traded commodities (including gold). Most significantly, a new group of assets has been added to this bucket, comprising cash, securities and other assets posted as initial margin for derivative contracts and cash or other assets provided to contribute to the default fund of a central counterparty. The Basel Committee indicates that, in light of the ongoing implementation of regulatory requirements related to the margining and settlement of derivatives, it will continue to evaluate the treatment of margining in the NSFR and will conduct quantitative analysis and consider alternative approaches, if necessary and appropriate. 100% RSF factor: This category would apply to all assets that are encumbered for a period of one year or more as well as all other assets not included in the above categories, including nonperforming loans, loans to financial institutions with a residual maturity of one year or more, nonexchange-traded equities, fixed assets, items deducted from regulatory capital, retained interest, insurance assets, subsidiary interests and defaulted securities. Additionally, as noted above in the discussion of the 0% ASF factor, under the revised formulation on derivatives, if net derivative assets are greater than net derivative liabilities, a 100% RSF factor applies to net derivative assets. Significantly, a new group of assets has been added to this category, comprising 20% of derivative liabilities (that is, negative replacement cost amounts), to be calculated in accordance with the methodology described above. -5-

6 III. INTERDEPENDENT ASSETS AND LIABILITIES The Final NSFR introduces a concept regarding interdependent assets and liabilities, which gives national supervisors discretion to determine whether certain asset and liability items, on the basis of contractual arrangements, are interdependent such that the liability cannot fall due while the asset remains on the balance sheet, the principal payment flows from the asset cannot be used for something other than repaying the liability, and the liability cannot be used to fund other assets. For interdependent items, supervisors may adjust RSF and ASF factors so that they are both 0%, subject to the following criteria: The individual interdependent asset and liability items must be clearly identifiable. The maturity and principal amount of both the liability and its interdependent asset should be the same. The bank is acting solely as a pass-through unit to channel the funding received (the interdependent liability) into the corresponding interdependent asset. The counterparties for each pair of interdependent liabilities and assets should not be the same. The Final NSFR directs supervisors, however, to consider whether perverse incentives or unintended consequences are being created before exercising such discretion. Additionally, it requires that instances where this exceptional treatment would apply be transparent, explicit and clearly outlined in the regulations of each jurisdiction. However, this discussion does not include any specific examples of interdependent assets and liabilities, and appears to leave room for discretion by national supervisors in this area. * * * Copyright Sullivan & Cromwell LLP

7 ENDNOTES Basel Committee, Basel III: the net stable funding ratio (Oct. 2014). Basel Committee, Basel III: The Net Stable Funding Ratio Consultative Document (Jan. 2014). See also Basel Committee, International framework for liquidity risk measurement, standards and monitoring Consultative Document (December 2009). For additional information regarding the Basel Committee s original proposal of the NSFR, see our memorandum to clients titled Bank Capital and Liquidity Requirements: Basel Committee Issues Proposals to Strengthen Bank Capital and Liquidity Regulation, dated December 28, For additional information regarding the Agencies implementation of the LCR in the U.S., see our memorandum to clients titled : Federal Reserve Approves Final Rule Implementing Basel III Liquidity Coverage Ratio for Large U.S. Banks, dated September 9, See Basel Committee, Basel III: The Liquidity Coverage Ratio and liquidity risk monitoring tools (Jan. 2013). For additional information regarding the LCR, see our memorandum to clients titled : Basel Committee Publishes Changes to the Liquidity Coverage Ratio, dated January 15, See Basel Committee, Basel III leverage ratio framework and disclosure requirements (Jan. 2014). -7-

8 ABOUT SULLIVAN & CROMWELL LLP Sullivan & Cromwell LLP is a global law firm that advises on major domestic and cross-border M&A, finance, corporate and real estate transactions, significant litigation and corporate investigations, and complex restructuring, regulatory, tax and estate planning matters. Founded in 1879, Sullivan & Cromwell LLP has more than 800 lawyers on four continents, with four offices in the United States, including its headquarters in New York, three offices in Europe, two in Australia and three in Asia. CONTACTING SULLIVAN & CROMWELL LLP This publication is provided by Sullivan & Cromwell LLP as a service to clients and colleagues. The information contained in this publication should not be construed as legal advice. Questions regarding the matters discussed in this publication may be directed to any of our lawyers listed below, or to any other Sullivan & Cromwell LLP lawyer with whom you have consulted in the past on similar matters. If you have not received this publication directly from us, you may obtain a copy of any past or future related publications from Nathalie-Claire Chiavaroli ( ; chiavarolin@sullcrom.com) in our New York office. CONTACTS New York Whitney A. Chatterjee chatterjeew@sullcrom.com H. Rodgin Cohen cohenhr@sullcrom.com Elizabeth T. Davy davye@sullcrom.com Mitchell S. Eitel eitelm@sullcrom.com Michael T. Escue escuem@sullcrom.com Jared M. Fishman fishmanj@sullcrom.com C. Andrew Gerlach gerlacha@sullcrom.com Andrew R. Gladin gladina@sullcrom.com Wendy M. Goldberg goldbergw@sullcrom.com Erik D. Lindauer lindauere@sullcrom.com Jiang Liu liujia@sullcrom.com Mark J. Menting mentingm@sullcrom.com Camille L. Orme ormec@sullcrom.com Rebecca J. Simmons simmonsr@sullcrom.com Donald J. Toumey toumeyd@sullcrom.com Marc Trevino trevinom@sullcrom.com Mark J. Welshimer welshimerm@sullcrom.com Michael M. Wiseman wisemanm@sullcrom.com Washington, D.C. Eric J. Kadel Jr kadelej@sullcrom.com -8-

9 William F. Kroener III J. Virgil Mattingly Jennifer L. Sutton Andrea R. Tokheim Samuel R. Woodall III Los Angeles Patrick S. Brown London Mark J. Welshimer Tokyo Keiji Hatano SC1: