The leverage ratio is a risk-neutral backstop to the rest of the Basel III capital framework. It is a measure of the ratio of tier one capital to total bank exposure.
Regulators across the globe have complained in the past year about the leverage ratio and its uncomfortable relationship with clearing derivatives. Under the regime, the leverage ratio does not recognise initial margin posted by counterparties as offsetting derivatives exposure, making it costly for banks from a capital perspective.
The Bank of England, the Commodity Futures Trading Commission, the Financial Stability Board (FSB), the Basel Committee for Banking Supervision (BCBS) and the International Organization of Securities Commissions (IOSCO) have all highlighted this point in recent months.
The WFE was responding specifically on Friday to an August report released by global financial watchdogs including the Committee on Payments and Market Infrastructures, the BCBS, the FSB and IOSCO on the incentives to centrally clear derivatives.
"We believe that client initial margin that is segregated should be recognised in the capital regime as reducing the leverage exposure measure," said the WFE.
"We concur with the report’s analysis that, left unmodified, the leverage ratio poses problematic disincentives to client clearing. Collateral posted by a client to a bank to support clearing is subject to protection within the CCP’s rulebook (and regulatory framework) and often the regulatory framework for banks."
The WFE added that this was more the case when collateral was held in a segregated account that was "bankruptcy remote", and thus not exposed to a bank's bankruptcy.
"The failure of the current leverage ratio calculation to recognise the exposure-reducing impact of client collateral held by a bank —where it meets requisite criteria — has made the provision of client clearing services uneconomical for some banks, driving them from the market," the report added.
Regulators see clearing as desirable as it can allow for greater transparency over derivatives markets, while allowing dedicated institutions to manage risk coming from derivatives positions. It also allows counterparties to take advantage of netting efficiencies, making clearing more capital efficient.
CCP12, a trade body of 36 clearing house operators, on Monday echoed the calls of the WFE, suggesting there was an "urgent need to re-calibrate the leverage ratio to recognise the central clearing market structure".
The trade body commended the FSB, BCBS, CPMI and IOSCO for their analysis of how G20 reforms had impacted clearing incentives for market participants.
The August report by the global watchdogs highlighted that 64.7% of client clearing service providers thought the leverage ratio had a "significant negative impact" on their ability to offer clearing services.
A separate report by the watchdogs released in August highlighted that almost 40% of total prefunded financial resources by clearing members were being held at two CCPs. The report's authors highlighted that prefunded financial resources should be taken as a "proxy for the size of CCPs". This raises questions about the systemically important nature of some CCPs.
