Liquidity Management Under Basel III Impact study for European banks operating in the US A comparison of European and US regulations June 2015
Daniel H. Connor
Shane C. Williams
Aurelien Borde
Partner
Partner
Senior Manager
Tel: (862) 596-0649 Mail: daniel.connor@sia-partners.com
Tel: (917) 701-7700 Mail: shane.williams@sia-partners.com
Tel: (917) 935-8855 Mail: aurelien.borde@sia-partners.com
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Introduction
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Introduction Liquidity Management Under Basel III – A Comparison of European and US Regulations In December 2010, the Basel Committee on Banking Supervision (BCBS) finalized the Basel III requirements, which included three main components: the Capital Requirements, the Leverage Ratio and the Liquidity Requirements. The Liquidity Requirements introduced the Liquidity Coverage Ratio (LCR) and the Net Stable Funding Ratio (NSFR). As of March 2015, the Capital Requirements in both the US and EU have been implemented and are currently in their phase-in periods. The implementation of the leverage ratio requirement began in January 2013 with bank-level reporting to supervisors and, since January 2015, public disclosure is now required from institutions. Final adjustments to the definition and calibration of the leverage ratio are expected to be completed by 2017, with a Pillar 1 treatment targeted for January 2018. The current document focuses on the current status of the third Basel III component, the Liquidity Requirements, and highlights the differences between the European and American requirements. While the European Union issued its final rule on LCR in June 2013, the US banking agencies issued a final rule in September 2014. In their current state, the US liquidity requirements have been set to tighter calculation levels than the European requirements on both the numerator and the denominator of LCR. Moreover, while both regulations were effective as soon as January 2015, the US phase-in period will be 1 year shorter than the European’s: banking organizations will have to meet a minimum 100% LCR ratio by January 2017 in the US and by January 2018 in the EU. In October 2014, the BCBS published a final version of its NSFR metric. It is still expected to be enforced by January 2018 even though it is yet to be translated by the regulators on both sides of the Atlantic. In the US, banking organizations should expect a proposal by mid-2015 and final rule by 2015 year-end, whereas in the EU they should expect a final rule by as far as 2016 year-end. CONFIDENTIAL © Sia Partners
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2
Update on the Situation
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Update on the Situation Overview of Basel III implementation in Europe and United States The recent financial crisis demonstrated significant weaknesses in the liquidity positions of banking organizations. As a consequence, in September 2008, the Basel Committee on Banking Supervision (BCBS) issued its “Principles for Sound Liquidity Management and Supervision” stating new qualitative standards for liquidity risk management. In addition to these principles, the BCBS also established in December 2010 quantitative standards for liquidity in its “Basel III: International framework for liquidity risk measurement, standards and monitoring,” which introduced a liquidity coverage ratio (LCR) and a net stable funding ratio (NSFR). After a comment and observation period, the LCR definition was finalized by the BCBS in January 2013 as part of the Basel III liquidity framework. Since January 2015, internationally active banking organizations are required to meet the LCR requirements beginning with an initial phase-in period. In October 2014, the BCBS published a final version of its definition of the NSFR. The NSFR is still expected to be enforced in January 2018, even though it hasn’t yet been translated by regulators. - In Europe In June 2013, the European Union (EU) published Regulation No 575/2013 (CRR) and Directive 2013/36/EU (CRD IV) which seeks to apply the Basel III framework and incorporate the LCR requirements within the EU. The effective date for LCR was January 1, 2015, under a three-year phase-in period. - In the United States In October 2013 the US Federal Reserve issued a proposal, Regulation WW, to implement a LCR. After comments and a few modifications, the final rule was issued in September 2014. The LCR designed by the Fed is more stringent than the BCBS and EU LCR frameworks in several significant aspects. Its effective date was January 1, 2015, beginning a two-year phase-in period. CONFIDENTIAL © Sia Partners
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Update on the Situation Synthetic comparison of European and American regulations • •
•
LCR •
•
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Scope of application The scope of banking organizations subject to LCR is wider in Europe than in the US. General approach The European regulation defines a single LCR calculation option for all internationally active banking organizations, while the US regulation requires compliance under one of the two LCR calculation options: a “Full” version for large, internationally active banking organizations, and a “modified” version for other large bank holding companies and savings and loan holding companies (depository institution holding companies). Definition of the numerator: High Quality Liquid Assets (HQLA) The US approach is more rigorous than Europe’s. Indeed securities issued or guaranteed by PSEs, covered bonds and other securities issued by financial institutions, and RMBS are not recognized as HQLA at all. Moreover, only certain corporate debt securities may qualify as Level 2B (and not Level 2A) assets. More generally, it has to be noted that whereas the EU LCR relies on external credit ratings to define certain HQLAs, the US LCR doesn’t (in application of the Dodd Frank Act which prohibits references to external credit ratings in federal regulations). Definition of the denominator (net cash outflows) The general US definition is more stringent than Basel’s or Europe’s. Indeed, the net cumulative cash outflow over the entire 30-day period is complemented in the US regulation definition by a maturity mismatch add-on. Cash flow categories use definitions and parameters that are different from the EU LCR framework (e.g. special treatment for brokered deposits) but cash flow rates are broadly similar. Planning The US phase-in period is shorter than Europe’s. Under the U.S. LCR proposal, banking organizations are required to maintain a minimum LCR of 100% as soon as January 1, 2017. This is two years ahead of the Basel Committee’s compliance timeline and one year ahead of the EU’s CRD IV compliance timeline. 6
Update on the Situation Synthetic comparison of European and American regulations
• • •
NSFR •
• •
Liquidity circulation and consolidation •
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The Basel Committee has issued it’s final version of the NSFR in October 2014. On both sides of the Atlantic, the NSFR is still expected to be enforced by January 2018. In Europe, the NSFR has been defined in the CRD IV text but only as a non-binding metric. Under Article 510 CRR, the EBA has to submit by end 2015 a comprehensive report on stable sources of funding and asses the impact on business and the risk profile of banks. Subsequently, by end 2016, the Commission is expected to submit a legislative proposal to the Parliament and the Council. In the US, banking organizations should expect the agencies to make a proposal by mid-2015 and to published a final rule by 2015 year-end.
The US regulation is more stringent than the European regulation on liquidity circulation and LCR consolidation rules. Indeed, both regulations require unencumbered assets (i.e. legally and practically readily available at any time to be liquidated) with the specific constraint that assets held in third countries where there are transfer restrictions or which are denominated in non-convertible currencies shall be considered available only to the extent that they correspond to outflows in the third country or currency in question. However the US regulation has an even more local approach and considers the group architecture. Certain subsidiary’s HQLAs can not count towards parent’s HQLAs due to broader restrictions (such as sections 23A and 23B of the Federal Reserve Act and Regulation W).
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Update on the Situation Which organizations are affected by the US LCR ? •
The US agencies have proposed two versions of the LCR depending on the type and size of financial organization: • Required to comply with the “Full” US LCR
•
Required to comply with the “Modified” US LCR
•
U.S. bank holding companies (BHC) and savings and loan holding companies (SLHC) with $50 billion or more in total consolidated assets and that are not Insurance underwriting companies (IUC) or Holding with 25% or more of its total assets in IUC or Grandfathered unitary SLHCs deriving 50% or more of its total assets or total revenues from activities not financial in nature.
• •
Depository institution subsidiaries of the above-mentioned BHCs and SLHCs Bridge financial company or its subsidiary, a new depository institution or a bridge depository institution (as those terms are used in the resolution context), Non-bank financial institutions that have been designated by the Financial Stability Oversight Council as "systemically important" (SIFIs) (a separate rule is expected), A foreign banking organization (FBO) not otherwise subject to the U.S. LCR (see next page), Other organizations not mentioned above.
Not required to comply
•
• • •
•
US banking organizations with $250 billion or more in total assets or $10 billion or more in onbalance sheet foreign exposure, Consolidated U.S. depository institution subsidiary, of an advanced approaches banking organization, with $10 billion or more in total consolidated assets, Any other banking organization whose primary federal banking regulator determines that it is appropriate that it becomes subject to the U.S. LCR framework.
For banking organizations that are subject to the final rule as of September 30, 2014, the effective date is January 1, 2015. After this date, a banking organization that meets the applicability threshold for the full LCR must comply beginning on April 1 of the following year ; whereas if it meets the applicability threshold for the modified LCR it must comply beginning on the first day of the following quarter.
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Update on the Situation Impact on European Banking Organizations •
The Regulation WW (September 2014) does not apply to Foreign Banking Organizations (FBO) or Intermediate Holding Company (IHC) that are required to be created under Regulation YY (implementation of Dodd Frank Act section 165 “Enhanced supervision and prudential standards for nonbank financial companies supervised by the Board of Governors and certain bank holding companies”). • However, the Federal Reserves mentioned that “the Board intends through future separate rulemakings to implement the quantitative liquidity standards included in the Basel III Accord for the U.S. operations of some or all foreign banking organizations with $50 billion or more in combined U.S. assets, consistent with the international timeline.” Given the spirit of this regulation, there is a high probability that Large FBOs required to create a separately capitalized toptier U.S. intermediate holding company (IHC) will have to comply with a specific US LCR (on its IHC consolidated perimeter). To be noted that under Regulation YY, Large FBOs and their IHC are subject to a qualitative liquidity framework and should maintain a 14-day, resp. 30-day, liquidity buffer (effective July 1, 2016).
Foreign Bank Organization (FBO)
Foreign commercial company
US commercial subsidiary CONFIDENTIAL © Sia Partners
Intermediate Holding Company (IHC)
US Bank
If ≥ $10 billion
US Broker Dealer
US Branch and agency network
US non financial company
Probably subject to specific LCR requirements
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Liquidity Management – Key Indicators
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Liquidity Management - Key Indicators Regulation : Liquidity Coverage Ratio (LCR) – US definition Goal
Disclosure requirements
• The Liquidity Coverage Ratio (LCR) helps to assess the institution ability to face a 30-day
• Frequency: • Each business day (full LCR) • Last business day of the month (modified LCR) • Application date: • 01/01/2015 (full LCR) • 01/01/2016 (modified LCR) • Remark: there is a transition period to the daily
liquidity shortage. • Specifically, it ensures that institutions have sufficient liquid and high quality assets to face a significant liquidity crisis for a month.
Definition • The Full LCR is calculated by dividing HQLA’s by the net cumulative cash outflow within a 30-
day stress period plus an add-on. It must be higher than 100%. The add-on is defined as the difference between the positive largest daily net cumulative maturity outflow and the positive net cumulative maturity outflow on the last day of the stress period. • The modified LCR applies a 70% ratio to the net cumulative cash outflow, which doesn’t take into account the maturity mismatch add-on. withdraw % (def. 100%)
Total liquid assets
Level 1 Securities issued or guaranteed by a US GSE Securities issued or guaranteed by sovereigns or MDB assigned a 20% riskweight under Basel III STD Corporate debt security that is Investment grade and proven to be a reliable source of liquidity Publicly traded common equity share in the Russell 1000 index or included in Level 2B of a foreign jurisdiction and proven to be a reliable source of liquidity
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50 %
50 %
3%
Non-stable retail deposits
10 % 10 to 40 %
Net derivatives cash outflows
100 %
Structured transaction outflow
100 %
Mortgage commitment outflow
10 %
Other commitment outflow
Implementation timetable • Progressive schedule:
0 to 100 %
80%
Collateral valuation and condition changes 20 to 100 %
85 % 85 %
Stable retail deposits
Retail bokered deposits
Outflows
Unencumbered cash and central bank 100 % reserves Securities issued or guaranteed by the 100 % US Treasury or a US government agency Securities issued or guaranteed by sovereigns assigned a 0% risk-weight under Basel III STD or hold to meet its 100 % net cash outflows in the jurisdiction of the sovereign entity.
90%
100%
100%
100%
2017
2018
2019
Collateral substitution and asset exchange 0 to 100 % Limit 40%
Level 2A Level 2B
Unsecured wholesale funding
5 to 100 %
Debt security
3 to 5%
Secured funding Limit 15%
! : Limits should be meet before and after unwinding all asset-based transactions
! : Total cash inflows are subject to an aggregate cap of 75% of total expected cash outflows.
0 to 100 % renewal % (def. 100%)
Inflows
High quality liquid assets buffer
Weight (% of fair value)
LCR calculation • Until 30/06/2015 for BHC and SLHC with ≥ $700 billion in total consolidated assets or ≥ $10 trillion in assets under custody (and their consolidated depository institution subsidiary with ≥ $10 billion in total consolidated assets) • Until 30/06/2016 for the others.
Net derivatives cash inflows
50 %
Retail cash inflows
50 %
Unsecured wholesale inflow Non HQLA securities Secured lending and Asset exchange
50 to 100 % 100 % 0 to 100 %
Observation 2013
2014
2015
2016
NB: This planning is two years ahead of the BCBS’s timeline and one year ahead of the EU’s timeline (CRD IV). 11
Liquidity Management - Key Indicators Regulation : Net Stable Funding Ratio (NSFR) – BCBS definition Goal
Disclosure requirements
• The Net Stable Funding Ratio (NSFR) aims to ensure that the institution does not finance its
• The BCBS has published a final version of its
activities with too many short-term resources... • Specifically, it ensures that the institution has sufficient stable resources (i.e. with a high maturity) to refinance its assets over the medium / long term.
NSFR in October 2014. • The NSFR is still in an international observation period. • The US agencies anticipate that they would issue a proposed rulemaking implementing the NSFR by mid 2015 and a final rule by 2015 year end.
Definition • NSFR is calculated by dividing available stable sources of funding (ASF) by the required stable
funding (RSF). The result must be higher than100%. RSF Factor
100 %
95 %
90 %
50 %
0%
Required Stable Funding
Available Stable funding
ASF Factor • Total regulatory capital (excl. Tier 2 instruments with residual maturity ≤ 1Y) and other capital instruments and liabilities with effective residual maturity ≥ 1Y • Stable non-maturity deposits and term deposits with residual maturity ≤ 1Y provided by retail and SME customers • Less stable non-maturity deposits and term deposits with residual maturity ≤ 1Y provided by retail and SME customers • Funding with residual maturity ≤ 1Y provided by non-financial corporate customers ; • Operational deposits ; • Funding with residual maturity ≤ 1Y from sovereigns, PSEs, and MDB; • Other funding with residual maturity ≥ 6M and ≤ 1Y not included in the above categories • All other liabilities and equity not included in the above categories, including liabilities without a stated maturity (with a specific treatment for deferred tax liabilities and minority interests) • Net NSFR derivative liabilities • “Trade date” payables
• Coins and banknotes, central bank reserves ; • All claims on central banks with residual maturities ≤ 6M ; • “Trade date” receivables
0%
• Unencumbered Level 1 assets, excluding above
5%
Implementation timetable
10 %
• Schedule is for the moment undetermined:
• Unencumbered loans to financial institutions with residual maturities ≤ 6M secured against re-usable Level 1 assets • All other unencumbered loans to financial institution swith residual maturities ≤ 6M ; • Unencumbered Level 2A assets • Unencumbered Level 2B assets ; • HQLA encumbered for a period ≥ 6M and ≤ 1Y ; • Loans to financial institutions and central banks with residual maturities ≥ 6M and ≤ 1Y ; • Deposits held at other financial institutions for operational purposes ; • All other assets, excluding above, with residual maturities ≤ 1Y • Other unencumbered, excl. loans to financial • Institutions, with a residual maturity ≥ 1Y and with a riskweight ≤ 35% under the Standardized Approach • Cash, securities or other assets posted as initial margin for derivative contracts and cash or other assets provided to contribute to the default fund of a CCP ; • Other unencumbered loans with a risk-weight ≥ 35% and a residual maturity ≥ 1Y, excluding loans to financial institutions ; • Unencumbered securities (not in default) ; • Physical traded commodities (incl. gold) • All other assets and net derivatives receivables
NB: in RSF, other off-balance sheet items are let to national supervisors’ discretion.
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• Irrevocable and conditionally revocable credit and liquidity facilities (undrawn portion)
15 %
?%
?%
50 %
Observation 65 %
2013
2014
2015
2016
2017
2018
2019
85 %
100 % 5%
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EU & US LCR Gap Analysis
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Gap analysis between US and EU LCR Focus on the numerator (High Quality Liquid Assets) • The following chart provides a general overview of the main differences in the definition of the numerator of the US and EU: EU • Only one LCR is defined, based on a 30-day stress period. • Limits enforced on Level 2 and level 2B HQLAs proportions
General
should take into account the unwinding of asset-based transactions maturing within this 30-day stress period. • The definition of certain HQLAs relies on external credit ratings. • Includes securities issued or guaranteed by public sector
• Securities issued or guaranteed by public sector entities
Level 1
• Includes securities issued or guaranteed by public sector
entities (PSEs) assigned a 20% risk-weight under Basel II. • Includes corporate debt securities (including commercial
paper) and covered bonds rated ≥ AA-. • Includes RMBS rated ≥ AA (not self-issued). • Includes corporate debt securities (including commercial
Level 2B
• Two versions of the LCR are defined (Full vs. Modified).
Both are based on a 30-day stress period (like EU LCR). • Limits are enforced taking both adjusted and unadjusted (unwinding / no unwinding) amounts. • The definition of HQLAs does not rely on external credit ratings (prohibited by Dodd-Frank).
entities (PSEs) assigned a 0% risk-weight under Basel II.
Level 2A
US
paper) rated between A+ and BBB-.
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(PSEs) are not included. The Board might be considering issuing a separate proposal that would permit certain highly liquid state and municipal securities to qualify as HQLA.
• Securities issued or guaranteed by public sector entities
(PSEs) are not included. • Covered bonds and corporate debt securities are not
included. • RMBS are not included. • Only publicly traded common equity share in the Russell
1000 index or included in Level 2B of a foreign jurisdiction and proven to be a reliable source of liquidity are included.
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Gap analysis between US and EU LCR Focus on the denominator (Total Net Cash Outflows) • The following chart provides a general overview of the main differences in the definition of the denominator of the US and EU: EU • Only one LCR is defined, based on a 30-day stress period. • The total net cash outflows amount is computed as the
total net disbursements of cash flows over the 30-day liquidity stress period.
General
• Deposits are first segmented on the type of product. Term
Outflows
deposits characterized by notices of withdrawal of 30 days or dissuasive penalties for the retail market will have a 0% outflow rate, whereas other term deposits and sight accounts will be treated based on the relation with the client and guarantees. • Unsecured wholesale cash inflows from financial
Inflows
institutions rate are based on the relation with the client (operational transactions will have a 0% inflow rate, whereas non operational transactions will have a 100% rate).
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US • Two versions of the LCR are defined (Full vs. Modified).
The total net cash outflows amount is computed as the total net disbursements of cash flows over the 30-day liquidity stress period (like EU LCR), however • The Modified LCR applies a 70% ratio to the end result. • The Full LCR adds a maturity mismatch add-on (defined as the difference between the positive largest daily net cumulative maturity outflow and the positive net cumulative maturity outflow on the last day of the stress period.) to the end result. • Deposits are first segmented by type of counterparty.
They will be treated based on the relation with the client and guarantees. For retail deposits, a significant distinction is made for brokered deposits.
• Unsecured wholesale cash inflows from financial
institutions (regulated financial companies, investment companies, non-regulated funds, pension funds, investment advisers, or central banks) will have a 100% weight. 15
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