Proposed European rules on banks' exposures to central counterparties (CCPs) have been criticised by the Investment Management Association (IMA), the UK buy-side trade body, as potentially punitive to long-only investors.
Banks are likely to pass the suggested capital charge for CCP exposures onto the long-term savings industry which “would suffer the burden, whilst also offering the least likely possibility of default,” wrote Jane Lowe, the IMA's director of markets, in a submission to the European Commission (EC).
In a recent consultation document, the EC proposed that banks' trading exposures to CCPs – including posted collateral, mark-to-market and potential future exposures –involve counterparty credit risk and therefore should be subject to a capital charge. For qualifying CCPs, the capital charge should be equal to the product of the exposure at default of the trade exposures multiplied by a 2% risk weight. Exposure to non-qualifying CCPs should be treated as bilateral and therefore capitalised more strictly. The consultation period on the proposal closed on 9 March.
“Banks will pass on the effective cost of the additional capital charge proposed for qualifying CCPs,” said Lowe. “We would therefore not support the imposition of a further capital weighting either at all or in the manner suggested.” Lowe added the paper's approach to capitalising bilateral exposures was too rigid. “What should be considered are not just the collateral quality and whether it is sufficiently bankruptcy remote, but also the credit profile of the underlying client,” she said.
The IMA's response raised similar concerns about contributions to default funds, warning that costs to banks would be passed onto the client in a way that reflects the risk profile of the product not the end-user. “This effectively discriminates against… pension funds and by extension [it] favours clients representing much higher default risk,” Lowe concluded.
The sell-side warned that if too high a margin were set for members of CCPs it would likely be applied to clients and would consequently “result in a system-wide liquidity drain, with many clients required to clear but having difficulty in the funding the required margin.” A joint response by the Association for Financial Markets in Europe, British Bankers' Association and International Swaps and Derivatives Association, argued that high margins would also disincentivise firms from using central clearing where it was not mandatory.
The consultation was supplementary to another feedback exercise conducted from February to April 2010, also on focused on possible changes to the Capital Requirements Directive (CRD). The CRD reflects the Basel Committee capital adequacy ratio rules, and is the legislation that European banks must base their own capital requirements upon.
The EC's proposals broadly follow the preliminary guidelines set out in a consultative document published by the Basel Committee on 20 December 2010, which is currently preparing an impact assessment.
Within its consultation the committee proposed a two-tier system when determining the necessary level of capitalisation of a bank’s exposure to a CCP, differentiating between “qualifying” and “non-qualifying” CCPs. To be “qualified” a CCP would have to either calculate or provide the data to calculate capitalisation needed for members and it must comply with recommendations for CCPs made by industry standards bodies, the Committee on Payment and Settlement Systems and the Committee of the International Organisation of Securities Commissions.
The EC services plans to take account of the outcome of its own consultation, the outcome of the Basel consultation and the Basel Committee’s impact assessment results, expected in Q1 2011, as well as any other progress made in discussions on the international stage when finalising its legislative proposal due before summer 2011.