We鈥檝e been here Basel IV
16 February 2016
Basel III is still a work in progress, and Basel IV might be just around the corner
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Basel III鈥檚 overhaul of liquidity standards is still being felt on both sides of the securities financing transaction, with prime brokers and agent lenders having to adjust their business models to address the direct and indirect impacts of the sweeping regulation.
An Alternative Investment Management Association (AIMA) and S3 Partners joint survey found in January that the majority of responding hedge fund managers had revised their relationships with prime brokers in order to better tackle new regulatory challenges.
Basel III has already caused 75 percent of the survey鈥檚 respondents to rethink how they do business with their prime brokers and more than 67 percent have had to cut the levels of cash kept on their prime brokers鈥� balance sheets. The survey also found that most alternative asset managers either maintained or increased the number of prime brokers over the last two years鈥攚ith four becoming the average.
It was also revealed that only 20 percent of managers have a clear understanding of how their prime brokers calculate their worth in terms of the revenue they provide relative to balance sheet impact. Fewer still have the data necessary to calculate this themselves.
On the other side of the transaction, Kristin Missil, head of financial analysis and reporting for global securities lending at Northern Trust, sees similar pressures on the mainstay between agent lenders and beneficial owners that is indemnification.
She says: 鈥淩egulatory capital and large exposures will most
affect agent lenders directly. The current US capital rules are punitive for indemnified lending transactions. Indirectly, the business is affected by changes in demand due to a much broader set of regulations applicable to principals of the transactions, specifically, the borrowers.鈥�
The Basel Committee on Banking Supervision鈥檚 regulatory work is far from done, with 2019 set as the completion date for implementation of the liquidity standards. Missil adds: 鈥淭he year 2019 is not necessarily viewed as the only finish line. Our expectation is that the regulatory environment will continue to evolve and the banks will respond to the requirements as necessary.鈥�
鈥淭here are key aspects of regulations that are already effective and impacting agent lenders, such as regulatory capital, but other rules, like the treatment of securities lending transactions within large exposure, have not been finalised at the Basel level. Local regulators are still working to issue rules on the implementation of Basel standards within their jurisdiction that could have an effect on securities lending transactions.鈥�
鈥淓ven rules that have been finalised may be re-evaluated as appropriate, as evidenced by the recent Basel proposal on revisions to the standardised approach in December of last year.鈥�
The trilogy becomes a quadrilogy
Jonathan Berryman, senior vice president of risk strategy at FIS, warned in a recent whitepaper, Basel IV: Coming If You鈥檙e Ready or Not, that the Basel regulators are far from done with their rulemaking. 鈥淭he ink may barely be dry on Basel III, but the Basel Committee on Banking Supervision seems intent on making fundamental changes to standard risk weights across the majority of risk types.鈥�
鈥淎nalysed separately, each revision could be seen as an incremental shift, just the start of the journey towards a new Basel Accord. When viewed in combination, however, a bigger picture starts to emerge鈥攂uilding a clear and compelling case for the imminent coming of Basel IV.鈥�
There are as many as seven different pieces of rulemaking under consultation or due to be implemented in the next few years, across credit, market, operational and counterparty credit risk, as well as interest rate risk in the banking book and capital floors, that could be fairly described as the next coming of Basel.
Berryman comments: 鈥淣early every element of the risk-weighted asset (RWA) calculation is going to change in the next two to three years. The icing on the cake is the capital floors, which have the potential to fundamentally change the philosophy of RWA鈥攑articularly in the larger banks where the RWA calculation (since Basel II) has moved towards a risk-sensitive, internal management view of the risk, rather than a regulatory prescribed formulaic one-size-fits-all view.鈥�
Missil concludes: 鈥淪ome key rules affecting securities lending transactions have not yet been finalised, such that the requirements for implementation are not yet defined. We continue to partner with our custody bank peers and other agent lenders in the Risk Management Association on this topic. The organisations are actively engaged with government agencies on regulatory developments to provide relevant context and input to inform final rulemaking.鈥�
鈥淚n addition to managing purely the compliance aspect of regulations, a real issue is how organisations adjust their business models in response to the changing regulatory landscape.鈥�
鈥淭he cumulative effects (including both the intended and unintended consequences) of the new rules are far from being understood.鈥�
An Alternative Investment Management Association (AIMA) and S3 Partners joint survey found in January that the majority of responding hedge fund managers had revised their relationships with prime brokers in order to better tackle new regulatory challenges.
Basel III has already caused 75 percent of the survey鈥檚 respondents to rethink how they do business with their prime brokers and more than 67 percent have had to cut the levels of cash kept on their prime brokers鈥� balance sheets. The survey also found that most alternative asset managers either maintained or increased the number of prime brokers over the last two years鈥攚ith four becoming the average.
It was also revealed that only 20 percent of managers have a clear understanding of how their prime brokers calculate their worth in terms of the revenue they provide relative to balance sheet impact. Fewer still have the data necessary to calculate this themselves.
On the other side of the transaction, Kristin Missil, head of financial analysis and reporting for global securities lending at Northern Trust, sees similar pressures on the mainstay between agent lenders and beneficial owners that is indemnification.
She says: 鈥淩egulatory capital and large exposures will most
affect agent lenders directly. The current US capital rules are punitive for indemnified lending transactions. Indirectly, the business is affected by changes in demand due to a much broader set of regulations applicable to principals of the transactions, specifically, the borrowers.鈥�
The Basel Committee on Banking Supervision鈥檚 regulatory work is far from done, with 2019 set as the completion date for implementation of the liquidity standards. Missil adds: 鈥淭he year 2019 is not necessarily viewed as the only finish line. Our expectation is that the regulatory environment will continue to evolve and the banks will respond to the requirements as necessary.鈥�
鈥淭here are key aspects of regulations that are already effective and impacting agent lenders, such as regulatory capital, but other rules, like the treatment of securities lending transactions within large exposure, have not been finalised at the Basel level. Local regulators are still working to issue rules on the implementation of Basel standards within their jurisdiction that could have an effect on securities lending transactions.鈥�
鈥淓ven rules that have been finalised may be re-evaluated as appropriate, as evidenced by the recent Basel proposal on revisions to the standardised approach in December of last year.鈥�
The trilogy becomes a quadrilogy
Jonathan Berryman, senior vice president of risk strategy at FIS, warned in a recent whitepaper, Basel IV: Coming If You鈥檙e Ready or Not, that the Basel regulators are far from done with their rulemaking. 鈥淭he ink may barely be dry on Basel III, but the Basel Committee on Banking Supervision seems intent on making fundamental changes to standard risk weights across the majority of risk types.鈥�
鈥淎nalysed separately, each revision could be seen as an incremental shift, just the start of the journey towards a new Basel Accord. When viewed in combination, however, a bigger picture starts to emerge鈥攂uilding a clear and compelling case for the imminent coming of Basel IV.鈥�
There are as many as seven different pieces of rulemaking under consultation or due to be implemented in the next few years, across credit, market, operational and counterparty credit risk, as well as interest rate risk in the banking book and capital floors, that could be fairly described as the next coming of Basel.
Berryman comments: 鈥淣early every element of the risk-weighted asset (RWA) calculation is going to change in the next two to three years. The icing on the cake is the capital floors, which have the potential to fundamentally change the philosophy of RWA鈥攑articularly in the larger banks where the RWA calculation (since Basel II) has moved towards a risk-sensitive, internal management view of the risk, rather than a regulatory prescribed formulaic one-size-fits-all view.鈥�
Missil concludes: 鈥淪ome key rules affecting securities lending transactions have not yet been finalised, such that the requirements for implementation are not yet defined. We continue to partner with our custody bank peers and other agent lenders in the Risk Management Association on this topic. The organisations are actively engaged with government agencies on regulatory developments to provide relevant context and input to inform final rulemaking.鈥�
鈥淚n addition to managing purely the compliance aspect of regulations, a real issue is how organisations adjust their business models in response to the changing regulatory landscape.鈥�
鈥淭he cumulative effects (including both the intended and unintended consequences) of the new rules are far from being understood.鈥�
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