Info Service on Finance and Development (Apr16/01)
12 April 2016
Third World Network
BCBS proposes revisions to Basel III leverage ratio framework
Published in SUNS #8216 dated 7 April 2016
Geneva, 6 Apr (Kanaga Raja) -- The Basel Committee on Banking Supervision
(BCBS) on Wednesday (6 April) released a consultative document, proposing
revisions to the design and calibration of the Basel III leverage
According to a BCBS press release, the Basel III framework, published
in January 2014, introduced a simple, transparent, non-risk-based
leverage ratio to act as a supplementary measure to the risk-based
The proposed changes to the framework are an important element of
the regulatory reform programme that the Basel Committee has committed
to finalise by end-2016, it said.
The proposed revisions to the Basel III leverage ratio framework encompass
* to measure derivative exposures, the Committee is proposing to use
a modified version of the standardised approach for measuring counterparty
credit risk exposures (SA-CCR) instead of the Current Exposure Method
* to ensure consistency across accounting standards, two options are
proposed for the treatment of regular-way purchases and sales of financial
* clarification of the treatment of provisions and prudential valuation
adjustments for less liquid positions, so as to avoid double-counting;
* alignment of the credit conversion factors for off-balance sheet
items with those proposed for the standardised approach to credit
risk under the risk-based framework.
The Committee has welcomed comments from the public on all aspects
of the proposals outlined in the document by 6 July 2016.
According to the BCBS document, titled "Revisions to the Basel
III leverage ratio framework", an underlying cause of the global
financial crisis was the build-up of excessive on- and off-balance
sheet leverage in the banking system.
In many cases, banks built up excessive leverage while apparently
maintaining strong risk-based capital ratios.
"At the height of the crisis, financial markets forced the banking
sector to reduce its leverage in a manner that amplified downward
pressures on asset prices. This deleveraging process exacerbated the
feedback loop between losses, falling bank capital and shrinking credit
The Basel III framework introduced a simple, transparent, non-risk-based
leverage ratio to act as a credible supplementary measure to the risk-based
The Basel III leverage ratio is intended to: restrict the build-up
of leverage in the banking sector to avoid destabilising deleveraging
processes that can damage the broader financial system and the economy;
and reinforce the risk-based requirements with a simple, non-risk-based
The Basel Committee is of the view that: a simple leverage ratio framework
is critical and complementary to the risk-based capital framework;
and a credible leverage ratio is one that ensures broad and adequate
capture of both the on- and off-balance sheet sources of banks' leverage.
According to the document, public disclosure of the Basel III leverage
ratio started becoming effective 1 January 2015 based on the standards
published in January 2014 (the Basel III leverage ratio framework).
In January 2016, the Group of Central Bank Governors and Heads of
Supervision (GHOS), the Committee's oversight body, discussed the
final design and calibration of the Basel III leverage ratio.
The GHOS agreed that the Basel III leverage ratio should be based
on a Tier 1 definition of capital and should comprise a minimum level
of 3%, and further discussed additional requirements for global systemically
The GHOS also agreed to finalise the calibration of the Basel III
leverage ratio in 2016 to allow sufficient time for it to be implemented
as a Pillar 1 measure by 1 January 2018, thereby confirming the timeline
set out in the Basel III framework.
The BCBS document proposes revisions to the design and calibration
of the Basel III leverage ratio framework.
On revisions to the treatment of derivative exposures, the BCBS document
said at present, the Basel III leverage ratio framework uses the Current
Exposure Method (CEM) to measure the replacement cost (RC) and the
potential future exposure (PFE) for derivative transactions, with
certain leverage ratio-specific modifications to limit the recognition
"This approach captures the exposure arising from the underlying
derivative contract and counterparty credit risk (CCR) exposure."
However, when the Basel III leverage ratio framework was published
2014, the Committee noted that it would consider replacing the Basel
III leverage ratio framework's use of the CEM with an alternative
approach adopted under the risk-based framework.
In March 2014, the Committee published ‘The standardised approach
for measuring counterparty credit risk exposures' (SA-CCR) to specify
the measurement of derivative exposures for risk-based capital purposes
in replacement of both the CEM and the Standardised Method (SM).
The Committee's main objectives in formulating the SA-CCR framework
* devise an approach to measuring the CCR exposure of derivatives
that is suitable to be applied to a wide variety of derivative transactions
(margined and un-margined, as well as bilaterally and centrally cleared);
* addresses known deficiencies of the CEM and the SM;
* draws on prudential approaches already available in the Basel framework;
* minimises discretion to be used by national supervisors and banks;
* improves the risk sensitivity of the risk-based capital framework
without creating undue complexity.
"The identified deficiencies of the CEM that necessitated the
development of the SA-CCR for the risk-based framework were that the
CEM did not differentiate between margined and un-margined transactions;
that the supervisory PFE add-on factors did not sufficiently capture
the level of volatilities as observed over recent stress periods;
and that the recognition of netting was too simplistic and not reflective
of economically meaningful relationships between derivative positions."
According to the document, the Basel III leverage ratio framework
lays out several general principles, among which is one that states
that "banks must not take account of physical or financial collateral,
guarantees or other credit risk mitigation techniques to reduce the
[leverage ratio] exposure measure".
In addition, policy options for the Basel III leverage ratio must
also be assessed in light of the rest of the Basel framework to ensure
as much overall consistency as possible.
In balancing those criteria, the Committee proposes to implement a
modified version of the SA-CCR to ensure consistency with these fundamental
principles of the Basel III leverage ratio framework, especially with
respect to not recognising collateral to reduce the leverage ratio
In particular, in the proposed modified version of the SA-CCR for
the Basel III leverage ratio exposure measure:
(i) as was the case with the application of the CEM in the Basel III
leverage ratio framework, the replacement cost (RC) component will
continue to be modified to restrict the recognition of collateral
by allowing only eligible cash variation margin (CVM) exchanged under
the specified conditions set out in paragraph 25 of the Basel III
leverage ratio framework as revised to act as an offset to the RC;
(ii) the PFE add-on component will be adjusted by setting the PFE
multiplier to 1 (one), thereby not recognising any collateral posted
by the counterparty (or any negative net market value of the derivative
However, the Basel Committee said, in line with the SA-CCR framework,
the effect of margining would continue to be reflected in the potential
shorter time horizon or margin period of risk (MPOR), ranging between
five and 20 days, depending on whether the transaction is margined
and centrally cleared as well as on the size of the netting as set
out in paragraph 164 of the SA-CCR framework.
The BCBS document noted that in a series of letters to the Committee,
market participants have communicated a concern related to the treatment
of initial margin (IM) posted by clients to banks serving on their
behalf as clearing members (CMs) for centrally cleared client derivative
transactions under the Basel III leverage ratio framework.
Market participants have stated that the current approach to capturing
the PFE of a transaction with a client is excessive because collateral
posted as IM by the client to the CM is not permitted to reduce the
CM's PFE (whereas such a reduction is permitted under both the CEM
and the SA-CCR as applied for risk-based capital purposes).
"Market participants have voiced concern that the Basel III leverage
ratio treatment of client IM has the potential to adversely impact
the ability of CMs to provide client clearing services, resulting
in a potential outcome of increased concentration in the availability
of client clearing, which could conflict with the G20 mandate to increase
the use of central counterparty (CCP) clearing for derivatives that
are sufficiently standardised and liquid as a means to mitigate systemic
risk in derivatives markets."
The Committee said it is carefully considering this concern, adding
that it is consulting on implementation of a modified version of the
SA-CCR that does not allow any offsetting of a CM's PFE with the IM
posted by its central clearing clients.
On the other hand, the maturity factor for client-cleared trades may
be adjusted in line with the SA-CCR to take into account the shorter
time horizons for margined trades, with the result that a five-day
MPOR would apply to centrally cleared derivative transactions subject
to daily margin agreements that CMs have with their clients.
"This approach can be viewed as internally consistent with the
Basel III leverage ratio framework's principles and at the same time
providing incentives to support the use of central clearing,"
In addition, in line with the risk-based framework, the Committee
proposes to allow client servicing banks within multi-level client
structures to exempt from their Basel III leverage ratio exposure
measure the trade exposures to their CMs provided that the banks do
not guarantee the performance of either their CMs or the qualifying
central counterparties (QCCPs).
The Committee said it has decided that further evidence and data on
the impact of the Basel III leverage ratio on client clearing and
on CMs' business models should be collected during the consultation
period, in light of the G20 mandate for central clearing.
The Committee will consider both the effects of the Basel III leverage
ratio on the client clearing business model and the need for banks
to have adequate capital to support their clearing activities in deciding
whether to expand upon the measures described above, which may include
permitting offsetting of a CM's PFE with the IM posted by clients
on whose behalf it clears derivative transactions.
It further noted that the term "currency of settlement"
in the criteria for eligible CVM in paragraph 25 (iii) in the January
2014 version of the Basel III leverage ratio framework has been cited
as unclear in the context of multi-currency derivative contracts (e.
g. foreign exchange swaps) and derivative contracts that are governed
by master netting agreements (MNAs) and credit support annexes (CSAs),
or by rules prescribed by CCPs.
Market participants have asked for clarification as to whether CVM
payments would reduce derivative exposure amounts for purposes of
the Basel III leverage ratio exposure measure when the payments are
made in a currency or currencies identified in the legal documentation
supporting a derivative transaction, such as a CSA or MNA.
In particular, banks may have numerous derivative contracts, which
may be specified in different currencies of settlement for contractual
payments with the same counterparty, which are governed by the same
The net amount under an MNA, determined utilising a spot FX conversion
rate and expressed in a single currency, typically forms the basis
for margin calls as well as for net settlement upon termination of
A single daily margin payment may be owed under an MNA with respect
to the net variation margin amount owed for all of the positions covered
by the MNA, after completion of the netting process described above.
This single net margin payment, or payments equivalent to it, will
be made in the currency or currencies identified in the CSA (or relevant
collateral agreement) to the MNA.
There are also cases where the currency (or currencies) of the cash
flows of individual derivative transactions is (are) different from
both the termination currency of the MNA and the currency (or currencies)
of the eligible collateral specified in the CSA (e. g. CVM is usually
paid in the currency specified in the CSA), said BCBS.
In the current proposal, the Committee retains the wording "currency
of settlement" to specify the eligibility of the currency in
which CVM payments are made.
With specific reference to issues arising from foreign exchange risk,
the Committee proposes that CVM be subject to an FX haircut where
the currency of the CVM does not match the termination currency of
the netting set (i. e. the currency in which the bank would submit
its claim upon a counterparty default).
In its assessment, the Committee said it will consider the appropriateness
of aligning the application of an FX haircut in the Basel III leverage
ratio framework with the treatment as applied in the SA-CCR under
the risk- based capital framework.
On revisions to the specific treatment for written credit derivatives,
the Basel Committee noted that a bank that writes a credit derivative
is exposed to the creditworthiness of the reference entity.
The Basel III leverage ratio framework treats written credit derivatives
consistently with cash instruments (e. g. loans, bonds) and requires
that the effective notional amount of written credit derivatives be
included in the Basel III leverage ratio exposure measure, in addition
to any associated CCR.
"The effective notional amount of written credit derivatives
may be reduced by any negative fair value of those instruments that
has reduced Tier 1 capital and by the effective notional amount of
credit protection purchased through credit derivatives on the same
reference name provided that the purchased credit derivatives meet
the criteria set out in paragraph 30 of the January 2014 Basel III
leverage ratio framework."
The Committee said it considers that a credit derivative purchased
from a counterparty that is connected with the reference obligation
or from a counterparty whose credit quality is highly correlated with
the value of the reference obligation may not provide effective protection
against the risks arising from a written credit derivative, and therefore
proposes to introduce an additional criterion to prevent the offsetting
eligibility of any protection subject to such wrong-way risk.
Additional revisions proposed by the Committee pertaining to written
credit derivatives include clarifications regarding the meaning of
the term "written credit derivative" and the option of partial
reduction of the PFE of written credit derivatives where the effective
notional (amount) is included in the Basel III leverage ratio exposure
On the treatment of regular-way purchases and sales of financial assets,
the Basel Committee acknowledged that the timing and method for recognising
regular-way purchases or sales of financial assets that have not yet
been settled differ across and within accounting frameworks.
Specifically, said BCBS, these trades may be accounted for either
on the trade date (trade date accounting) or on the settlement date
(settlement date accounting).
Furthermore, for trade date accounting, the offsetting of cash receivables
and payables associated with sales and purchases of financial assets,
respectively, is allowed under certain accounting frameworks, but
disallowed under others.
The Committee therefore proposes to clarify the calculation of regular-way
purchases and sales of financial assets for purposes of the Basel
III leverage ratio exposure measure to ensure that differences in
accounting frameworks do not affect the calculation among comparably
situated banks, and that the Basel III leverage ratio exposure measure
properly reflects the inherent leverage associated with these trades.
In this respect, the Committee notes that:
* in the case of financial asset purchases, a bank is exposed to the
risk of a change in the value of the purchased assets as of the trade
date, as well as to the cash or any other asset which will be the
source of payment for the purchase until the settlement date; and
* in the case of financial asset sales, a bank is exposed to the risk
that cash will not be delivered by the counter-party of the transaction
to the bank to settle the transaction.
"This view of exposure for Basel III leverage ratio purposes
is consistent in substance with a trade date approach to accounting
for regular-way purchases and sales of financial assets, as the additive
impact of the yet to be settled transaction (i. e. any associated
exposure to the purchased assets or to the purchasing counterparty)
is reflected on the bank's balance sheet from the time at which it
enters into a transaction until the time at which the transaction
In contrast, said BCBS, a settlement date accounting approach does
not reflect on the balance sheet the risks associated with the assets
purchased but not yet settled, nor with the cash receivables from
assets pending settlement.
The Committee said that it is also aware that, under certain accounting
frameworks, banks using trade date accounting that are active securities
market-makers are allowed to offset cash receivables for unsettled
regular- way sales of securities against cash payables for unsettled
regular-way purchases of securities, and that this offsetting is unconditional
(i. e. there are no restrictions on the counterparties, securities
settled, settlement systems, etc).
"Given the transient nature of these transactions, the volatility
in the amounts of securities that may be traded on a given day owing
to market factors outside a bank's control, and the practice of using
the cash received from securities sales to fund securities purchases,
typically from the same set of counterparties, the Committee understands
that this accounting treatment aims to minimise large day-to-day swings
in market-makers' balance sheets, thus supporting their intermediation
activity that provides liquidity to financial markets."
For these reasons, the Committee said it is considering two possible
options for the treatment for measuring regular-way purchases and
sales of financial assets for the purposes of the Basel III leverage
ratio to ensure consistent measure of these exposures across banks
regardless of the accounting framework used by a bank:
* Banks using settlement date accounting must treat unsettled financial
asset purchases as off-balance sheet (OBS) items subject to a 100%
credit conversion factor (CCF).
* Banks using trade date accounting must include the gross cash receivables
owed that are attributable to sales of financial assets that are pending
settlement. This implies that banks must reverse out any offsetting
between cash receivables for unsettled sales and cash payables for
unsettled purchases of financial assets that may be recognised under
the applicable accounting framework.
* In addition to the criteria included in Option A, banks using trade
date accounting may, subject to certain conditions, offset cash receivables
and cash payables, with an equivalent effect to be permitted for banks
using settlement date accounting.
The Committee has also proposed to revise the Basel III leverage ratio
framework to provide clarification on: (i) whether general provisions
may be deducted from the Basel III leverage ratio exposure measure;
(ii) whether specific and general provisions may be deducted from
OBS exposures and; (iii) the treatment of PVAs (prudent valuation
The Committee further intends to allow both general and specific provisions
that have decreased Tier 1 capital to reduce the Basel III leverage
ratio exposure measure.
Similarly, it proposes that OBS items may be reduced by the amount
of any associated specific and general provisions provided that they
have decreased Tier 1 capital.
"In calculating OBS exposures under the Basel III leverage ratio
framework, it is proposed that specific and general provisions be
deducted from OBS exposures after the application of the relevant
In addition, to be consistent with the treatment of other deductions,
the Committee proposes that PVAs for less liquid positions related
to on-balance sheet assets and that are deducted from Tier 1 capital
may also be deducted from the Basel III leverage ratio exposure measure.
On additional requirements for G-SIBs, the BCBS document noted that
at its January 2016 meeting, the GHOS discussed additional Basel III
leverage ratio requirements for G-SIBs, above the 3% minimum.
The Basel III framework has already introduced a higher risk-based
capital ratio requirement for G-SIBs, it said.
The Committee believes that one way to maintain the relative roles
of the risk-based ratio and the leverage ratio in the regulatory capital
framework would be to introduce a higher Basel III leverage ratio
requirement for G-SIBs.
"An additional leverage ratio requirement for G-SIBs could be
based on the same Tier 1 definition of capital by which the Basel
III leverage ratio minimum is measured."
The Committee said it seeks views on the relative merits of the following
characteristics that would need to be specified for an additional
* whether there should be a limit on Additional Tier 1 capital that
may be used to satisfy an additional requirement;
* whether an additional requirement should be fixed and applied uniformly
to all G-SIBs or should vary based on a scaling of the G-SIB's higher
loss absorbency requirement as applicable under the risk-based framework;
* whether an additional requirement should be in the form of a higher
minimum requirement or a buffer requirement.
"The latter could operate in a manner analogous to the Basel
III framework's risk-based capital ratio buffers (i. e. with restrictions
on capital distributions if a G-SIB operates below the leverage ratio
buffer) or as a buffer whereby supervisors would be expected to take
timely and appropriate action in the event of a breach to ensure that
the breach is temporary (i. e. without automatic restrictions on capital
The BCBS document also addressed other issues including revisions
to the credit conversion factors for off- balance sheet items, treatment
of cash pooling transactions, treatment of traditional securitisations,
treatment of securities financing transactions (SFTs), and disclosure
On the Basel III leverage ratio framework's treatment of cash pooling
transactions, i. e. a treasury product offered to large corporate
clients which allows corporate groups to combine the credit and debit
positions of various accounts into one account, the Committee said
that two different schemes can apply:
* Notional (or virtual) cash pooling combines the balances of several
accounts of the entities within a corporate group in order to limit
low balance or transaction fees without physical transfer of funds.
Instead, balances of different entities are set off within the group,
so that a bank charges interest on the group‘s net cash balance.
The Committee proposes that these balances be reported on a gross
basis in line with revisions to paragraph 13 (paragraph 11 as revised)
of the Basel III leverage ratio framework, which does not allow netting
of assets and liabilities nor the recognition of credit risk mitigation
* Physical cash pooling, which combines various accounts from entities
within a corporate group into a single master or concentration account
at the end of each period through physical transfer of funds, typically
by means of intra-day settlement.
The Committee proposes to allow banks to report those balances on
a net basis if the transfer of credit and debit balances into a single
account results in the balances being extinguished and transformed
into a single balance (i. e. a single claim on or a single liability
to a single legal entity on the basis of a single account) and the
bank cannot be held liable in case of non-performance of one or multiple
participants in the cash pool.
The proposal also requires such settlement to take place at least
on a daily basis in order to be recognised on a net basis for the
Basel III leverage ratio exposure measure, said BCBS. +