Implementing a UK leverage ratio framework

A response to the Prudential Regulation Authority s consultation Implementing a UK leverage ratio framework by the British Bankers Association October 2015 Introduction The BBA is pleased to respond to the PRA s consultation paper CP 24/15 Implementing a UK leverage ratio framework 1. The BBA is the leading association for UK banking and financial services representing members on the full range of UK and international banking issues. It represents over 200 banking members active in the UK, which are headquartered in 50 countries and have operations in 180 countries worldwide. Eighty per cent of global systemically important banks are members of the BBA. As the representative of the world s largest international banking cluster the BBA is the voice of UK banking. All the major banking groups in the UK are members of our association as are large international EU banks, US and Canadian banks operating in the UK as well as a range of other banks from Asia, including China, the Middle East, Africa and South America. The integrated nature of banking means that our members are engaged in activities ranging widely across the financial spectrum from deposit taking and other more conventional forms of retail and commercial banking to products and services as diverse as trade and project finance, primary and secondary securities trading, insurance, investment banking and wealth management. Our members manage more than 7 trillion in UK banking assets, employ nearly half a million individuals nationally, contribute over 60 billion to the UK economy each year and lend over 150 billion to UK businesses. Members include banks headquartered in the UK, as well as UK subsidiaries of EU and 3rd country banks all of which will be impacted by the PRA s proposals on the leverage ratio, either now or in 2017, depending on the outcome of the Financial Policy Committee s (FPC) 2017 review. In responding to the consultation paper we provide some high level comments before referencing particular elements of the draft supervisory statement. Key messages Super-equivalence to reporting and disclosure of risk-based capital ratios and to other countries regimes The proposed reporting and disclosure of the Leverage Ratio, reflecting daily positions through the use of average, high and low values, goes well beyond the reporting and disclosure requirements for 1 http://www.bankofengland.co.uk/pra/documents/publications/cp/2015/cp2415.pdf

2 the principal risk-based capital ratios, including the key Common Equity Tier 1 capital ratio, where only period end positions are disclosed. The daily averaging requirement is not something that has previously been envisaged within the Basel framework or the CRR. Consequently we believe that it is highly likely that such a requirement would be super-equivalent not only to the reporting and disclosure of the risk-based ratios but also to the practices implemented across the EU and elsewhere, potentially creating confusion in the market and placing an additional administrative burden on those in-scope UK regulated firms which would not be borne by their overseas competitors. We do not believe that this super-equivalence is merited for the Leverage Ratio, which has been conceived by the Basel Committee as a simple, transparent, non-risk based measure designed to complement the risk-based capital ratios. The inherent lack of risk sensitivity in the Leverage Ratio limits its appropriateness in reflecting the capital adequacy of a firm based on its underlying risk profile. Consequently the Leverage Ratio needs to be considered alongside risk-based capital ratios to present a view of the capital adequacy of a firm and should be reported and disclosed in a way that is consistent with risk-based capital ratios. More generally, the European Commission has implemented the January 2015 Leverage Ratio delegated act and the EBA has issued prescribed reporting (COREP) and disclosure (Pillar 3) templates to ensure comparability and consistency of approach across firms, as well as to create a level playing field for institutions that are established in the EU and operate internationally. This is also to help to avoid misleading market participants as to the leverage of institutions. We believe the proposed UK Leverage Ratio framework will not only diverge from this but it will also go against the fundamental aims of the European authorities. We strongly recommend that the UK follow the European Leverage Ratio framework and await the finalisation of possible binding Leverage Ratio requirements set in Europe and their associated reporting and disclosure requirements. Potential benefits of super-equivalent reporting and disclosure requirements The consultation paper outlines two benefits of the proposed Leverage Ratio framework reporting and disclosure requirement to address the so called window dressing by : reducing operational risk from a large number of transactions involved in short-term balance sheet management trades; and, reducing volatility in short-term interbank markets around period end dates. However no quantitative evidence was provided in support of these purported benefits. As noted in the consultation paper, the calculation of a daily Leverage Ratio has significant practical challenges, particularly for banking book assets and off balance sheet items. The necessary processes and controls (including those for items subject to estimation) are expected to be particularly burdensome for firms. In regard to the issue of window dressing :

3 Firstly, we do not believe that the PRA needs to implement additional regulation to guard against deliberate window dressing since the FSMA already makes it an offence to provide, knowingly or recklessly, information which is misleading. Secondly, it should also be borne in mind that it may be the case that a quarter end position does not reflect the typical "average" position during the reporting period simply due to the regular short term business cycle. It is perfectly reasonable that reported figures would reflect this, sometimes being higher than average, sometimes lower. However, where quarterly window dressing is suspected, the PRA should be able to identify it from existing monthly returns (e.g. the Capital+ Return) or can require monthly or more frequent reporting on a firm specific basis where the PRA felt this was justified. Importantly, this would avoid requiring all those firms that do not undertake any window dressing from having to undertake the additional burdensome reporting. Conversely, if the additional blanket requirement for reporting based on daily calculations were to be introduced then there would be no value or benefit for those firms that do not engage in window dressing, if any do, or for the PRA. Consequently, in view of this, it would seem more appropriate for the PRA to address concerns over window dressing through more targeted controls focussing perhaps on money market and repo transactions directly, which are the principal transaction types we believe could cause window dressing, rather than by introducing an unwieldy Leverage Ratio-based reporting approach. More generally, on the basis of proportionality, information provided in the COREP templates should be sufficient for the PRA's oversight of the leverage position of smaller firms. Perhaps if a firm's ratio fell to a level approaching the minimum ratio then more detailed reporting could be required at that point? Multiple Leverage Ratio Metrics and Approaches As noted in the consultation paper, the proposed disclosure requirements will result in a multitude of Leverage Ratio metrics being disclosed, with both period end and average metrics required and UK and EU versions. Such a range of metrics are likely to lead to confusion and a lack of clarity for investors and other end users, even if differences between the many results are explained and reconciled. Such a situation manifested itself for UK firms disclosures of Leverage Ratio metrics at end 2013, where due to the evolving definition of the Leverage Ratio, firms felt it was necessary to outline results on a range of bases. We recommend that disclosures should only focus on period end CRD IV and UK metrics with appropriate commentary explaining the differences for clarity. Excessive Complexity of UK Framework As outlined in our September 2014 response to the FPC s review of the leverage ratio 2, we applauded the finalisation by the Basel Committee of its global standard for the leverage ratio and believe that the framework being introduced in the UK is an excessively complex framework through the use of variable buffers and excessive reporting, significantly undermining the key benefit of 2 https://www.bba.org.uk/policy/financial-and-risk-policy/prudential-capital-and-risk/leverage-ratio/bbaresponse-to-leverage-ratio-paper/

4 simplicity. This reduces the usefulness to investors of disclosed Leverage Ratio metrics and provides additional challenges to firm s capital planning. Among other things this additional complexity will make it more difficult for investors to assess and price UK Additional Tier 1 (AT1) securities compared to those issued elsewhere in the EU or in the US, materially reducing investor appetite for equity and AT1 securities issued by UK firms. It will also complicate the determination of the levels of loss absorbing capacity required under FSB TLAC standards and MREL. The consultation paper s proposed reporting and disclosure requirement will require the creation of additional system solutions that will be expensive for firms to implement even where a best estimates approach is applied. Inappropriate Implementation Timing The EU is expected to finalise and implement a binding Pillar 1 Leverage ratio framework in 2017/2018. The timing of the proposed full implementation of the UK-specific reporting and disclosure requirements outlined in the consultation paper in 2017 does not seem to be an appropriate, given the potential changes to the UK Leverage Ratio framework that could be required at a similar time for consistency with the EU framework. We strongly recommend that the UK follow the European leverage ratio framework and not introduce significant changes to the UK framework in the period leading up to the finalisation and introduction of binding leverage ratio requirements in the EU. Comment on proposed handbook text Appendix 1- Leverage ratio 1.1 We understand that as currently drafted the handbook text applies at the consolidated level (or individually where a firm is not part of a consolidation group. We assume that if and when the Capital Requirement Regulations (CRR) are amended to include a leverage ratio requirement that it will apply at a solo level and that such a solo requirement will not be applied by the PRA any earlier than the date specified in CRR. Appendix 2 - Reporting 3.1 We believe the PRA should not implement any additional reporting beyond COREP at this stage. However, if the PRA were to introduce additional UK specific reporting templates as set out in the consultation paper (which we would oppose) then we propose that the transitional requirements be extended until both Basel and the European Commission have finalised their approach to the Leverage Ratio and related reporting requirements. Firms do not wish to waste internal and external IT resource at a time when it continues to be scarce. While the introduction of FSA084 is more aligned to COREP the introduction of FSA083 would be a material change for firms. Requiring UK banks to move to FSA083 before the

5 international and regional requirements have been finalised could potentially require them to make two changes to Leverage Ratio reporting methodology within a short period of time. This would be overly burdensome for firms. Appendix 3 - Disclosure 3.3 Appendix 3 would require quarterly disclosure of the countercyclical leverage ratio buffer whereas Pillar 3 only requires the disclosure of the countercyclical capital buffer (upon which the countercyclical leverage ratio buffer is based) on an annual basis. This seems superequivalent, for a complementary measure, to the risk based capital regime. We recognise that the EBA guidelines recommend quarterly disclosure of leverage measures however the PRA requirements would effectively make this compulsory, which we do not support. 3.6 Our members have devoted a lot of attention to educating investors about the Leverage Ratio. Were such a requirement made mandatory, our firms feel it is unnecessarily burdensome to require UK firms to have to disclose additional information to enable users to understand the reason for any differences between ratios derived under the UK framework and the CRR Leverage Ratio. If a new Leverage Ratio is set in the UK this should be clearly defined in the PRA Rulebook. As the EU Leverage Ratio is clearly defined in the delegated act this should be sufficient for market participants to understand the differences in how both ratios are defined. Therefore a quarterly requirement to explain the differences between such ratios seems unnecessary and should not be made mandatory. Appendix 6 draft leverage ratio reporting template We are grateful that the PRA reporting templates are closely aligned to the EBA guidelines but recommend that FSA 084 - transitional reporting - should be changed to align with current COREP requirements which will change, as we have noted above, from reporting based on the arithmetic mean of end-month Leverage Ratio data to a point-in-time end-quarter leverage ratio at the end of 2015. Average and Daily Leverage Ratio reporting and disclosure We note that post-transition firms will be required to report quarter average, high and low figures for on-balance sheet exposures. As outlined above in the Key Messages, we consider this is excessive for a metric that is designed to be complementary to risk-based metrics, which do not have such onerous reporting or disclosure requirements. For averaging purposes it will be necessary to consider the treatment of unverified profits. Under the CRR unverified profits cannot be included in CET1 capital. For current quarter end reporting/disclosure purposes firms typically undertake profit verification exercises with external auditors, providing the necessary waiver and supplementary analysis documentation to the PRA, in order to enable inclusion of profits accumulated over the reporting period. Under the consultation paper proposals the Tier 1 capital base for the purposes of the average Leverage Ratio is to be calculated as the average of the month-end levels over the quarter, thereby including intra-quarter

6 Tier 1 capital bases that are not individually subject to profit verification. We therefore suggest that unverified profits be allowed to be included in the Month 1 and Month 2 Tier 1 capital bases for the purposes of the average Leverage Ratio calculation, net of any foreseeable dividends, in order that the framework fits into the current quarterly profit verification cycle, or, alternatively, that only period end Tier 1 capital levels are used for ratio calculations. Also, it does not appear to be entirely clear from the consultation paper what Tier 1 capital should be used for the calculation of the daily high and low Leverage Ratios. Is it the PRA s intention to use the average Tier 1 capital for the quarter (average of the 3 month-ends) for all daily Leverage Ratios, or to use the Tier 1 capital base applicable on that individual day (either the previous month-end level or the subsequent month-end level)? A further complication in relation to daily averaging relates to those areas of the statutory balance sheet where accounting information on a daily basis is neither readily available nor usable without further work, for instance converting management information into statutory accounting information. We anticipate that most firms will be able to make use of daily data captured via treasury and trading and liquidity activities without too much additional work but that other balance sheet assets, such as the stock of loans that a bank holds (e.g. mortgage portfolios), would require a different approach that could incur additional cost to collate and refine. We would therefore appreciate further discussion with the PRA in order to establish some high level principles on the application of a best estimates approach when determining daily averages in relation to these balance sheet assets, including around the conversion of what is effectively management information into an IFRS-like balance sheet number. We seek clarification on the application of the daily averaging requirement to the derivatives and securities financing transactions measures of the Leverage Ratio. In both cases the on balance sheet values are adjusted to reflect regulatory measures, conditions and restrictions under the CRR delegated act rules, including netting arrangements, collateral, net written credit protection and potential future exposure (derivatives measure) and counterparty credit risk (SFT measure). The rules also require certain other adjustments to balance sheet assets. We believe that daily averaging should only apply to the statutory accounting on balance sheet assets and not to the regulatory adjustments applied to these assets in accordance with the CRR requirements. Application of daily averaging to the regulatory adjustments over and above the statutory on balance sheet assets would create an unnecessary, additional burden for firms and incur additional cost to operationalise. Settlement balances, which can be very volatile, are also a cause for concern as banks subject to IFRS record significantly higher exposure values than firms operating under the US GAAP brokerdealer exemption for regular way trades, as settlement balances are generally presented on a gross basis. We are aware that this is an issue that the Basel Committee is considering and trust that the FSA 083 template will be amended when it has reached a final determination. Responsible executive Simon Hills Executive Director British Bankers Association +44 (0) 207 216 8861 simon.hills@bba.org.uk