The rules fall under three categories: systems and control requirements, to come into force by the end of 2009; regulatory reporting requirements to be implemented sometime in 2010; and strict quantitative requirements to be phased in gradually once the recession has ended.
Although the implementation date is not yet decided, it is the quantitative rules, and specifically the requirement to hold a liquid assets buffer, that has been of most concern to market participants. While few dispute the need to hold liquid assets as a safeguard against future crises, the FSA has stipulated any buffer should be composed of high-quality government bonds issued by countries in the European Economic Area, Canada, Japan, Switzerland and the US, or central bank reserves from the same countries.
But banks have argued the stipulation is too narrow and they can obtain ample liquidity from assets other than government bonds and central bank reserves. "We've queried the fairly restrictive definition of securities in the buffer because we consider diversification to be an important part of prudent liquidity risk management, both in funding sources and in standardised liquidity buffers," said Macer Gifford, head of asset-liability management and regional markets at Standard Chartered in Singapore.
But the FSA wants to be certain UK banks hold adequate liquidity and is reluctant to adjust the buffer requirements. "The question we asked is, what assets are liquid in the market and have retained liquidity despite the credit crunch? The answer is high-quality government debt. Claims other assets are equally liquid largely depend on firms being able to turn them into liquidity by accessing central banks, but a firm can instantly become illiquid if the central bank has doubts about its viability," said Paul Sharma, director of wholesale prudential policy at the FSA in London.
Another area of contention has been the effect of the rules on cross-border institutions. If the FSA doesn't grant waivers to small UK-based branches of overseas banks, there could be an exit of such firms from London as they seek to avoid having to hold liquidity in a branch or subsidiary. "If the UK liquidity regime requires a London-based branch of a Swedish bank to have a local treasury with competent people, resources and systems, and to be self-sufficient with its liquidity, I don't think the bank would be interested in staying in London - it would be too costly," said Lars Söderlind, senior adviser on market and liquidity risk at Stockholm-based regulator Finansinspektionen.
Such considerations will depend on how stringent the FSA is in granting waivers to branches and subsidiaries of overseas institutions - a factor that in turn will depend on the liquidity framework of the firm in question and the rules enacted by its home state regulator. Following a year-long consultation with market participants, the FSA intends to finalise its requirements by the end of this year. Until then, lobbying by industry associations and banks on the most contentious areas is likely to continue.