Basel Committee consults on derivatives-related reforms to capital adequacy framework

Basel Committee consults on derivatives-related reforms to capital adequacy framework
BCBS, June 28, 2013

The Basel Committee today released two consultative papers on the treatment of derivatives-related transactions under the capital adequacy framework.

1  Capital treatment of bank exposures to central counterparties - consultative document
http://www.bis.org/publ/bcbs253.htm
PDF of full document: http://www.bis.org/publ/bcbs253.pdf

The Basel Committee on Banking Supervision, in cooperation with the Committee on Payment and Settlement Systems (CPSS) and the International Organization of Securities Commissions (IOSCO), is seeking views on potential changes to the capital treatment of banks' exposure to central counterparties (CCPs). The Basel Committee published an interim standard in July 2012 and noted at that time that additional work was needed to improve the capital framework. Introduction of the interim standard represented an important step towards ensuring appropriate measurement, monitoring and management of banks' exposures to CCPs, exposures which had previously attracted no regulatory capital charge.

The proposed changes to the interim standard seek to establish a capital treatment that ensures banks' exposures to central counterparties are adequately capitalised, while also preserving incentives for central clearing. They promote robust risk management by banks and CCPs, including by encouraging CCPs to satisfy the CPSS-IOSCO Principles for financial market infrastructures (PFMIs). The proposed changes respond to evidence that application of the interim rules could lead both to instances of very little capital being held against exposures to some CCPs, and potentially in certain cases, to capital charges that are higher than for bilateral (non-centrally-cleared) transactions. There was also concern that, in some cases, the interim capital treatment might not create the appropriate incentives for maintaining generous default funds. [my emphasis] These outcomes are potentially inconsistent with the Committee's objectives and the changes set out in the consultative paper seek to address those concerns. 

In parallel to this consultation, the Committee will also conduct a quantitative impact study. Any amendments to the proposed standard will be based on feedback on this consultative document, evidence from the quantitative impact study that will be conducted alongside this consultation, and further consultation with CPSS and IOSCO. The Committee is not proposing any change to the capital treatment of exposures to non-qualifying CCPs. Nor does this consultative paper consider any changes to the rules on capital treatment of clearing member exposures to clients. 

2  The non-internal model method for capitalising counterparty credit risk exposures - consultative document
http://www.bis.org/publ/bcbs254.htm
PDF of full document: http://www.bis.org/publ/bcbs254.pdf

The Basel Committee's consultative paper The non-internal model method for capitalising counterparty credit risk exposures outlines a proposal to improve the methodology for assessing the counterparty credit risk associated with derivative transactions. The proposal would, when finalised, replace the capital framework's existing methods - the Current Exposure Method and the Standardised Method. It improves on the risk sensitivity of the Current Exposure Method by differentiating between margined and unmargined trades. The proposed non-internal model method updates supervisory factors to reflect the level of volatilities observed over the recent stress period and provides a more meaningful recognition of netting benefits. At the same time, the proposed method is suitable for a wide variety of derivatives transactions, reduces the scope for discretion by banks and avoids undue complexity.

The Basel Committee will conduct a quantitative impact study in order to inform the final formulation of the non-internal model method and to assess the difference in exposure and overall capital requirements under this proposal as compared to other measures of counterparty credit risk under the Basel framework. In addition to replacing the Current Exposure Method and the Standardised Method, the  non-internal model method may also be used with respect to the leverage ratio, large exposures, and exposures to central counterparties (CCPs).