Bank Capital: Supplementary Leverage Ratio; Federal Banking Agencies Issue Final Rules Revising the Supplementary Leverage Ratio’s Exposure Measure Denominator

Sullivan & Cromwell LLP - September 16, 2014
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Earlier this month, the Federal Deposit Insurance Corporation, the Board of Governors of the Federal Reserve System and the Office of the Comptroller of the Currency (collectively, the “Agencies”) issued final rules (the “Final SLR Rules”) that revise the definition and scope of the “total leverage exposure” measure, which is the denominator of the new Basel III-based supplementary leverage ratio requirement (the “SLR”) that the Agencies adopted as part of their July 2013 comprehensive revisions to their regulatory capital rules (the “Revised Capital Rules”) applicable to U.S. banking organizations.  Under the Revised Capital Rules, the SLR is calculated as the ratio of Tier 1 capital to total leverage exposure. When it becomes effective on January 1, 2018, the SLR will apply only to “advanced approaches banking organizations”   that is, those with $250 billion or more in total consolidated assets or $10 billion or more in foreign exposures. 

The Final SLR Rules revise the definition of total leverage exposure to:

  • include the effective notional principal amount of credit derivatives and other similar instruments through which a banking organization provides credit protection (that is, sold credit protection);
  • modify the calculation of the components of total leverage exposure for derivative and repo-style transactions; and
  • conform the credit conversion factors (“CCF”) applied to certain off-balance sheet exposures to CCF used by the Revised Capital Rules’ standardized approach, subject to the minimum 10% CCF.
The Final SLR Rules also change the frequency with which certain components of the SLR are calculated and establish the public disclosure requirements for various items associated with the SLR.
 
The amendments adopted in the Final SLR Rules are largely consistent with the final revisions (the “BCBS 2014 Revisions”) adopted in January 2014 by the Basel Committee on Banking Supervision (the “BCBS”) to the denominator of the Basel III leverage ratio (defined in Basel III as the “exposure measure”).  The BCBS’ initial 2013 proposals to revise the exposure measure would have had the effect of substantially limiting banking organizations’ recognition of cash collateral as an offset to exposures under derivatives and repo-style transactions, notwithstanding that applicable accounting standards (whether GAAP or IFRS) permitted recognition of cash collateral.  Although the final BCBS 2014 Revisions and the Final SLR Rules do not simply defer to accounting principles for circumstances when cash collateral may be recognized as an offset, both are expected to permit recognition of cash collateral as an offset to exposures under many derivatives and repo-style transactions.

The Final SLR Rules were adopted unchanged as a substantive matter from the proposed rules included in the SLR proposal published for comment by the Agencies in April 2014 (the “SLR Proposal”) with one key exception:  the Agencies modified the calculation of total leverage exposure so that off-balance sheet exposures included in the total leverage exposure are calculated as the arithmetic mean (that is, average) of such exposures as of the last day of each of the most recent three months (rather than the mean of such exposures as of each day of the reporting quarter as included in the SLR Proposal).
 
The Agencies also included in the Final SLR Rules and/or the preamble thereto a number of clarifications in response to comments received on the SLR Proposal, including with respect to:
  • the circumstances under which a banking organization could offset cash variation margin for purposes of measuring total leverage exposure;
  • the criteria to reduce the effective notional amount of sold credit protection;
  • the criteria for recognizing the GAAP offset for repo-style transactions;
  • forward agreements associated with a repurchase or securities lending transaction that qualifies for sales treatment under GAAP; and
  • circumstances when a clearing member banking organization would be required to include in total leverage exposure an exposure to central counterparties for client-cleared transactions.