Giancarlo: SLR change would cut clearing capital by 70%

Isda AGM: netting of clearing collateral would boost activity without weakening banks, claims CFTC chair

Chris Giancarlo - CFTC
Christopher Giancarlo: capital cut would translate into trading boost

Reform of the US supplementary leverage ratio (SLR) could boost trading activity without weakening the banking industry, according to Christopher Giancarlo, who is awaiting confirmation as chairman of the US Commodity Futures Trading Commission (CFTC).

Citing CFTC analysis, Giancarlo claimed changes to the controversial rule, which is seen as a particular burden for clearing businesses, could deliver a 70% capital cut to bank’s clearing units, with only a 1% drop in capital at the bank holding company level. If the savings were fully passed on to customers, the CFTC believes it could generate a threefold increase in trading activity.

“This dramatic reduction in costs on a service imperative to managing systemic risk in swaps is entirely worth the trade-off of a miniscule reduction in balance sheet protection,” said Giancarlo, who was speaking at the annual meeting of the International Swaps and Derivatives Association in Lisbon today (May 10).

The ratio sets bank capital as a proportion of a crude exposure measure, hitting clearing in particular because cash collateral posted to an intermediary bank by its clients is counted towards the bank’s own exposure total. Banks and regulators alike have argued this is restricting access to cleared markets.

Giancarlo argued the low profit margins inherent in the client clearing business model made it difficult for these units – known in the US as futures commission merchants (FCMs) – to exist outside bank holding companies, making it essential for banks to be able to provide clearing services in a way that is economically viable. Giancarlo said the number of CFTC-registered FCMs had declined from 100 in 2002 to just 55 at the start of this year, of which only 19 were holding customer funds for swaps clearing.

“A consolidated FCM industry could pose difficulties in transferring customer positions and margin to other FCMs in times of stress or an FCM default. In certain exchange-traded derivatives markets, three to four firms clear nearly half of the trades cleared. Such concentration can potentially impact market functioning and be a source of systemic risk,” said Giancarlo.

He backed the call by his predecessor, Timothy Massad, to remove client collateral held at central clearing counterparties (CCPs) from the leverage ratio exposure measure, and instead allow banks to net this collateral against their swaps counterparty exposure to their clients. European policy-makers are already planning to make this change and have urged the Basel Committee on Banking Supervision to follow suit at a global level.

The US SLR of 5% is a more demanding threshold than Europe’s 3% leverage ratio. The US Federal Deposit Insurance Corporation (FDIC), however, has so far resisted reform on the basis that any changes would leave bank balance sheets less resilient to shocks. Unlike the CFTC, the FDIC is represented on the Basel Committee.

At the Isda AGM, Giancarlo sought to counter the FDIC’s concerns with hard evidence, saying the proposed reforms to the SLR would dramatically reduce the capital that banks need to hold against clearing services without weakening their balance sheets.

These reductions could translate into a three-fold increase in trading activity, especially hedge positions that are carried overnight
Christopher Giancarlo, CFTC

“By CFTC estimates, this potential reduction in capital costs for these clearing members could be as high as 70%, but these will translate into a small 1% capital reduction at the bank holding company level. Assuming these savings are fully passed on to their customers, these reductions could translate into a three-fold increase in trading activity, especially hedge positions that are carried overnight,” said Giancarlo.

Both the CFTC and the FDIC are present on the US Financial Stability Oversight Council (FSOC), and both are part of a review of financial regulation being undertaken by Treasury Secretary Steven Mnuchin. An initial report for this review is due on June 3, and Giancarlo’s contribution may well be relatively detailed, as he has already been a commissioner at the CFTC since August 2013. By contrast, Keith Noreika only joined the Office of the Comptroller of the Currency (OCC) as acting chairman at the beginning of May.

FDIC chairman Martin Gruenberg, appointed by former president Barack Obama, remains in office until November 2017.


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