Basel IV might not be dead, but it’s looking pretty sickly.
Output floors for bank capital models are the centrepiece of the initiative — they concern credit risk, usually around 70% of the risk-weighted assets in a big universal bank, and they target banks which use their own models (IRB banks, in the jargon), which again, tend to be the biggest and most systemically important institutions.
But the Bundesbank threatened before Christmas to veto the very idea of output floors, an extraordinary move, given that the Basel Committee had been bandying the idea around in public since December 2014. If the Germans hated it that much, why did they not mention it earlier?
Anyway, thanks, perhaps, to that threat, the Basel Committee shelved its planned unveiling of the output floor calibrations, set for next week, which would have told the market which, if any, institutions would be affected.
At the same time, though, the SSM (the European Central Bank acting as bank supervisor) has kicked an initiative of its own into high gear, with the same objective of making bank risk weights more comparables and cutting down on the flexibility banks have to use their own modelling assumptions.
The exercise in question is called the Targeted Review of Internal Models, which makes a handy “TRIM” acronym, and involves the SSM conducting on-site visits and model reviews across the banks it supervises through the first half of 2017.
That might sound like ordinary bank supervision, but it’s already had some tangible effects — Bank of Ireland took a 60bp hit to its CET1 ratio just before Christmas, anticipating the impact of TRIM, and raised the risk-weights on its performing Irish mortgage book from 26% to 34% average.
That’s an increase not to be sniffed at, particularly if it has a read across to other European countries, where the average mortgage risk weights are far lower. Sweden isn’t in the SSM, but according the European Banking Authority, its banks have an average risk weight of 6% on their mortgage portfolios.
Reading across, however, is difficult. While the Basel output floor proposal would have acted consistently across all banks, following a European implementation in the form of “CRD V” or “CRD VI”, TRIM is bespoke. It depends on how conservative bank models are before the supervisors come in – or on the outcome supervisors want to achieve.
In this respect, it looks a little like the existing “Supervisory Review and Evaluation Process” (SREP), which the ECB uses to set required Pillar 2 capital ratios. However, it acts behind the scenes, and on Pillar 1 capital. It’s not a tool that spits out a ratio; instead, it tells a bank whether it calculated its existing ratios correctly.
But it is a tool with immense power and flexibility. Expect many more banks to follow Bank of Ireland’s lead and try to get ahead of it. Though sources close to the SSM are anxious to emphasise that it is different to, and does not supersede the Basel IV output floors, in practice, it can be used to achieve the same objectives with considerably more supervisory discretion.
If, therefore, Basel IV ends up dead in the water, or at least, so diluted it has no effect, Europe’s banks aren’t off the hook entirely. They should still expect pressure on capital ratios, but this time, coming from their supervisors, rather than supranational rule setting.
In the US, derivatives market participants are eagerly anticipating a change in regulatory approach with a change in chairman at Commodity Futures Trading Commission. Timothy Massad announced he will step down, staying on only until the presidential inauguration on January 20, leaving J Christopher Giancarlo, a former GFI executive, as the hot favourite for the job.
CFTC Commissioners get plenty of latitude to let their personal views shine through, and some have been notably market friendly — Scott O’Malia, the previous CFTC Commissioner from the Republican side of the fence, joined the International Swaps and Derivatives Association, an industry lobby group, as chief executive.
Giancarlo has expressed a desire to reduce regulatory frictions, listen more to industry and end-users, and take a more proportionate, principles-based approach to regulating derivatives. Issues like position limits, the competitiveness of swap execution facilities, and the regulation of automated trading could be move in an industry-friendly direction under his leadership.
There’s disagreement, however, about whether Giancarlo is likely to alter the March 1 deadline for the implementation of variation margin rules. He’s been a ferocious critic of arbitrary, compressed regulatory timetables, and of rushing to implement new rules, but at the same time, a delay could lead to bad blood with other international regulators.