Fed, Goldman: wide use of SA-CCR creates problems

New international standards for the measurement of counterparty exposure may have become a victim of their own success, needing closer examination before they are injected into other parts of the regulatory framework.

After the standards were published by the Basel Committee on Banking Supervision in 2014, they were built into three other parts of the prudential framework – including the leverage ratio, as a more risk-sensitive way to calculate capital for cleared exposures. Now, regulators say the standards are so important (and already overdue) they need to be implemented quickly, while banks say they can’t be rushed due to the extent of their impact.

“This is a rule that, on one hand, is incredibly helpful as we think about the clearing business – but as it’s been rolled out into more aspects of the framework and become more integral to everything we do, it has become obvious there are pieces that do need some attention in terms of calibration,” said Jim Mannoia, a managing director in regulatory policy at Goldman Sachs, speaking at the International Swaps and Derivatives Association’s AGM last week.

Also speaking at the event, David Lynch, a deputy associate director with the Federal Reserve, acknowledged the standardised approach to counterparty credit risk (SA-CCR) has “really permeated a lot of different parts of the Basel framework and I think that’s an element that perhaps could use a little bit of thinking”.

But he also stressed the counterparty rules were now holding up other parts of the overall framework.

“How can you go and do the leverage ratio if you haven’t implemented SA-CCR? How can you do the large exposures rule if you haven’t implemented SA-CCR? How do you implement the capital floors if you haven’t done that? All those issues come up, so it becomes a sequencing issue and it is now becoming pretty apparent that that’s got to occur pretty soon,” he said.

SA-CCR is designed to reflect the amount of exposure a counterparty has at the point of a default, and replaces the current exposure method (CEM) and the standardised method – two regulator-set approaches that were criticised for being too blunt. Both, for example, failed to treat margined and non-margined trades differently. The replacement was intended to be more risk-sensitive.

The idea is that we are going to follow up very quickly and implement SA-CCR to get that risk-sensitivity in there

David Lynch, Federal Reserve

It was quickly mooted for a role in the leverage ratio, where the CEM helps calculate derivatives exposure, and was later picked up for use within the large exposures regime, where it represents exposure-at-default. Last year’s hard-fought agreement to floor banks’ modelled capital requirements at 72.5% of the standardised total means it also has a role to play in setting firm-wide capital levels.

National regulators may face pressure from the Basel Committee if they fail to move ahead with the rule, which was scheduled to become effective in January, 2017. In an April report studying implementation of various rules among its 28 member jurisdictions, the committee found only six in which SA-CCR adoption was complete – Argentina, Indonesia, Japan, Saudi Arabia, Singapore and Switzerland. In the European Union, the European Commission adopted a proposed regulation that includes SA-CCR, but the package is still subject to heated debate in the Parliament and Council of the EU.

The US is graded as “adoption not started”, but speaking at the Isda event, Lynch said that should change soon, because of the pressure being placed on clearing businesses by the leverage ratio and its 30-year-old risk measure, the CEM.

“We subjected cleared trades to the capital requirements using CEM, but we hadn’t implemented the more risk-sensitive SA-CCR framework yet, and that really has had quite an impact on the cleared markets. The idea is that we are going to follow up very quickly and implement SA-CCR to get that risk-sensitivity in there,” he said.

But Goldman’s Mannoia argued more analysis is needed, arguing the rule as it stands could produce unintended consequences. As an example, he pointed to the interaction between SA-CCR and the gradual roll-out of new margining requirements for non-cleared derivatives. This has involved introducing new agreements – known as credit support annexes (CSAs) – to exchange variation margin and initial margin for many bilateral relationships. In some cases, this falls foul of a SA-CCR bar on netting across multiple collateral agreements.

“In the evolution of the margining rules, you end up with contracts where you actually have multiple CSAs in a netting set and all of a sudden, despite increased risk-sensitivity in general, you actually end up with a framework where in certain cases you have higher risk-weighted assets. It feels like an unintended consequence,” he said.

Mannoia added: “That speaks to the need for a long time to think about all the component parts” of the Basel framework that will use SA-CCR.

Editing by Philip Alexander