Regulatory consulting firm Promontory Financial Group has calculated that the capital required against agent lender guarantees is reduced by 97% if loan transactions are processed through a CCP.
Calculations by the group, which are contained in a white paper on the statutory capital rules affecting agent lenders and prime brokers in the securities lending business, also show that the Supplementary Leverage ratio requirement has no impact upon either the capital required or the savings arising from central clearing.
This research, produced for securities lending data provider SL-x, include the proposals issued on July 6, 2013 by the Federal Reserve and other U.S. banking supervisors.
The report holds the view that while the financial rules by these regulators and the Basel Committee of Banking Supervision (BCBS) may be uncertain, two outcomes are inevitable: the amount of capital that banking organizations will have to set aside to cover exposures in the stock lending market will generally increase; and securities lending transactions cleared by a Qualified CCP (QCCP) will receive favorable risk-based capital treatment relative to those transactions that are bilaterally settled.
The research finds that, in contrast to agent lenders, prime broker stock loan transactions are more complex. Promontory cautions that “PBs whose parent banks are not compliant with Bank Holding Company (BHC) leverage requirements may find themselves at a competitive disadvantage arising from their inability to take advantage of the QCCP’s low risk weighting that gives rise to the 95% capital savings mentioned above.” However, such banks may still benefit from central clearing, albeit in alternative ways. If final Basel Committee recommendations encourage and national regulators adopt rules that exempt centrally cleared exposures from leverage ratio calculations then the capital savings is much the same as in the agent lender case—96% of amounts otherwise required, says the research.
Alternatively, one might conclude that if the BHC leverage ratio “binds” the prime broker’s book of stock loan business then QCCP clearing of that book effectively “frees up” risk-weighted assets (RWA) for use elsewhere in the bank, says Promontory. In this case, while the bank may not save capital, per se, this RWA benefit implies that both profits and return on capital will increase as higher-yielding assets can be employed elsewhere. Promontory points out that the presence of both ratios encourages shifting the asset mix toward higher risk/higher return investments “to the point where both the risk-based and leverage-based requirements are met.”
The report says given that certain aspects of these rules concerning repo-style transactions including securities lending are still under discussion at the BCBS, it seems likely that the U.S. rules will be further clarified subsequent to future Basel Committee recommendations. Promontory says: “Although the rules are final, the Federal Reserve and other U.S. banking supervisors will likely modify the rules after international agreement is reached at the BCBS regarding capital issues and risk weights, particularly as they relate to the stock lending markets.”