Bank Capital Requirements: Basel Committee Significantly Revises Leverage Ratio Treatment of Client Cleared Derivatives and Introduces New Leverage Ratio Disclosure Requirements

Sullivan & Cromwell LLP - June 27, 2019

Yesterday, the Basel Committee on Banking Supervision released a significant revision to the leverage ratio treatment of client cleared derivatives, as well as new leverage ratio disclosure requirements. As revised, the Basel leverage ratio will permit cash and non-cash initial margin and variation margin received from clients to offset the replacement cost and potential future exposure for derivatives that banking organizations centrally clear on behalf of clients, subject to a limit on the amount of initial margin that may be recognized based on the amount that is subject to appropriate segregation by the banking organization as defined in the relevant jurisdiction. The revised leverage ratio treatment of client cleared derivatives will generally align with the measurement determined under the standardized approach to measuring counterparty credit risk exposures used for risk-based capital requirements. As with all Basel Committee standards, the revision will not be effective for any banking organization until it is implemented in the laws or regulations of the applicable jurisdiction. It remains to be seen whether national authorities – including the U.S. banking agencies – will implement this revision in connection with their broader implementation of Basel IV or as a standalone change to their capital requirements. It also remains to be seen whether national authorities will seek to implement this change in advance of January 1, 2022 in order to address the effects of the Basel leverage ratio on central clearing sooner. 

The new leverage ratio disclosure requirements are aimed at addressing potential “window-dressing,” described by the Basel Committee as the reporting and disclosure of elevated leverage ratios following temporary reductions in transaction volumes around reference dates. Under the new requirements, banking organizations must disclose the amounts of adjusted gross securities financing transaction (“SFT”) assets based on quarter-end values and average-daily values over the quarter, in addition to disclosure of the total leverage exposure and the leverage ratio as calculated using the averaged values of SFTs.