Backing the NSFR
09 December 2014
The introduction of new regulations is going to cause uncertainty, but the BCBS remains steadfast in its commitment to Basel III
Image: Shutterstock
In the wake of the global financial crisis, the Basel Committee on Banking Supervision (BCBS) was tasked with revising the core principles around banking supervision in the G20 countries. In recent times, despite much work being done, capital adequacy and liquidity risk have both emerged as big issues that remain unresolved. The BCBS deduced that strong capital requirements were not enough to meet these issues and set about planning what stands as its flagship set of regulations鈥擝asel III.
Regardless of the good intentions of Basel III and the BCBS, compliance with the regulation is anticipated by many to be a massive challenge. In particular, uncertainty surrounding the intricacies and effects of the upcoming net stable funding ratio (NSFR) is causing concern.
The NSFR, finalised by the BCBS on 31 October, adds another piece to the liquidity regulation of international banks. It seeks to improve their funding profiles by requiring a reliance on funding sources determined to be sufficiently stable and longer term in nature.
As law firm Debevoise & Plimpton pointed out in its NSFR client update, this differs from the recently finalised liquidity coverage ratio (LCR), which focuses on 30-day liquidity needs of banks. In its client publication, Shearman & Sterling explained that in broad terms, the NSFR is calculated by dividing available stable funding by required stable funding.
As with the LCR, compliance with the NSFR is likely, according to Debevoise & Plimpton, to increase the costs of certain activities of banks, including securities finance, proprietary trading and various types of traditional lending. These impacts will also affect various businesses of the broker-dealer affiliates within the bank, as part of the consolidated group.
Counsel at Debevoise & Plimpton, Lee Schneider, says: 鈥淭he first important thing to note is that the NSFR was published by the BCBS and so has not yet been adopted by US regulators. There is a fair amount of flexibility for these regulators in the adoption and, because of that, we do not know exactly what each country鈥檚 NSFR regulations are going to look like.鈥�
鈥淎s we have seen with the BCBS鈥檚 LCR, for example, the US adopted stricter rules than the BCBS did. Whether or not that will happen in the NSFR context remains to be seen鈥攚e just don鈥檛 know.鈥�
In its recent report, Opportunities and Challenges for Hedge Funds in the Coming Era of Optimization, Citi Investor Services stated that the NFSR has been developed to provide a 鈥渟ustainable maturity structure of assets and liabilities鈥�. The liquidity standards proposed have also been ongoing since the crisis and, as a result, have to provide reporting in accordance with LCR and NSFR guidelines.
An important difference, as far as US-based bankers are concerned, between the LCR and NSFR is the timeline for implementation. The NSFR has to be implemented by 2018, whereas the LCR must be introduced by 2019, while the US version of the LCR has to be implemented by 2017. This mismatch in the implementation periods has been a sore point for some as it has the potential to cause problems.
Many commentators believe that there will also be issues with liquidity in the repo and securities lending markets because of the tandem nature of the LCR and NSFR, and Schneider agrees.
He comments: 鈥淭hey are designed by the regulators to work in tandem. The way they do will likely make life harder for banks, and there will be a huge amount of data gathering carried out by them to understand what their positions are. This will include calculations to determine what their requirements for high quality liquid assets are under the LCR and what their requirements for long-term lines of credit and other sources of stable funding are for the NSFR. It is going to be a lot of work.鈥�
The main problem with this is that this it has the potential to cause further expense for banks and it is not clear, at this point, how they will respond. This also means that the impact on markets is unclear. Schneider says: 鈥淲here there is more expense, it typically either has to get passed onto customers or it means that people will limit the amount they do of certain kinds of business鈥攐r cease it altogether.鈥�
The intention of the NSFR, according to Debevoise & Plimpton partner Gregory Lyons, is to ensure that banks have sufficient stable funding relative to their financial obligations, so as to reduce the likelihood that disruptions to a regular funding source will erode an entity鈥檚 liquidity position enough to put it at risk of failure .
Lyons says: 鈥淭his aim includes a goal of reducing reliance on short-term wholesale funding as a financing mechanism. However, securities lending transactions do not involve funding; they are driven by demand from securities borrowers. No short (or even long) term financing is provided to the lender, the agent bank (or conduit lender bank), or the securities borrower in connection with a transaction.鈥�
For Lyons, this means that the NSFR 鈥渋nappropriately captures鈥� non-financing transactions, which, although similar in structure to financing transactions, do not have the same underlying purpose and do not expose participating financial institutions to the funding risks that the NSFR seeks to curtail.
He explains: 鈥淭herefore, any burden placed upon broker-dealers in connection with the NSFR as it applies to securities lending transactions is misplaced.鈥�
Associate at Debevoise & Plimpton, Melissa Mitgang, echoes this sentiment, claiming that it is 鈥渦nclear鈥� why the NSFR should apply to securities lending transactions, as these transactions are demand-driven rather than funding-driven.
The fact remains that these regulations are going to stand front and centre for the next few years at least, for banks and their clients. A hedge fund with $10 billion in assets under management recently commented that the European Markets Infrastructure Regulation, Alternative Investment Fund Managers Directive and the Foreign Account Tax Compliance Act 鈥渁re really 鈥榖lue collar鈥� regulatory work from our perspective鈥�, adding: 鈥淒odd-Frank and Basel III are big concerns to us. Financing is going to become significantly tougher.鈥�
Regardless of the good intentions of Basel III and the BCBS, compliance with the regulation is anticipated by many to be a massive challenge. In particular, uncertainty surrounding the intricacies and effects of the upcoming net stable funding ratio (NSFR) is causing concern.
The NSFR, finalised by the BCBS on 31 October, adds another piece to the liquidity regulation of international banks. It seeks to improve their funding profiles by requiring a reliance on funding sources determined to be sufficiently stable and longer term in nature.
As law firm Debevoise & Plimpton pointed out in its NSFR client update, this differs from the recently finalised liquidity coverage ratio (LCR), which focuses on 30-day liquidity needs of banks. In its client publication, Shearman & Sterling explained that in broad terms, the NSFR is calculated by dividing available stable funding by required stable funding.
As with the LCR, compliance with the NSFR is likely, according to Debevoise & Plimpton, to increase the costs of certain activities of banks, including securities finance, proprietary trading and various types of traditional lending. These impacts will also affect various businesses of the broker-dealer affiliates within the bank, as part of the consolidated group.
Counsel at Debevoise & Plimpton, Lee Schneider, says: 鈥淭he first important thing to note is that the NSFR was published by the BCBS and so has not yet been adopted by US regulators. There is a fair amount of flexibility for these regulators in the adoption and, because of that, we do not know exactly what each country鈥檚 NSFR regulations are going to look like.鈥�
鈥淎s we have seen with the BCBS鈥檚 LCR, for example, the US adopted stricter rules than the BCBS did. Whether or not that will happen in the NSFR context remains to be seen鈥攚e just don鈥檛 know.鈥�
In its recent report, Opportunities and Challenges for Hedge Funds in the Coming Era of Optimization, Citi Investor Services stated that the NFSR has been developed to provide a 鈥渟ustainable maturity structure of assets and liabilities鈥�. The liquidity standards proposed have also been ongoing since the crisis and, as a result, have to provide reporting in accordance with LCR and NSFR guidelines.
An important difference, as far as US-based bankers are concerned, between the LCR and NSFR is the timeline for implementation. The NSFR has to be implemented by 2018, whereas the LCR must be introduced by 2019, while the US version of the LCR has to be implemented by 2017. This mismatch in the implementation periods has been a sore point for some as it has the potential to cause problems.
Many commentators believe that there will also be issues with liquidity in the repo and securities lending markets because of the tandem nature of the LCR and NSFR, and Schneider agrees.
He comments: 鈥淭hey are designed by the regulators to work in tandem. The way they do will likely make life harder for banks, and there will be a huge amount of data gathering carried out by them to understand what their positions are. This will include calculations to determine what their requirements for high quality liquid assets are under the LCR and what their requirements for long-term lines of credit and other sources of stable funding are for the NSFR. It is going to be a lot of work.鈥�
The main problem with this is that this it has the potential to cause further expense for banks and it is not clear, at this point, how they will respond. This also means that the impact on markets is unclear. Schneider says: 鈥淲here there is more expense, it typically either has to get passed onto customers or it means that people will limit the amount they do of certain kinds of business鈥攐r cease it altogether.鈥�
The intention of the NSFR, according to Debevoise & Plimpton partner Gregory Lyons, is to ensure that banks have sufficient stable funding relative to their financial obligations, so as to reduce the likelihood that disruptions to a regular funding source will erode an entity鈥檚 liquidity position enough to put it at risk of failure .
Lyons says: 鈥淭his aim includes a goal of reducing reliance on short-term wholesale funding as a financing mechanism. However, securities lending transactions do not involve funding; they are driven by demand from securities borrowers. No short (or even long) term financing is provided to the lender, the agent bank (or conduit lender bank), or the securities borrower in connection with a transaction.鈥�
For Lyons, this means that the NSFR 鈥渋nappropriately captures鈥� non-financing transactions, which, although similar in structure to financing transactions, do not have the same underlying purpose and do not expose participating financial institutions to the funding risks that the NSFR seeks to curtail.
He explains: 鈥淭herefore, any burden placed upon broker-dealers in connection with the NSFR as it applies to securities lending transactions is misplaced.鈥�
Associate at Debevoise & Plimpton, Melissa Mitgang, echoes this sentiment, claiming that it is 鈥渦nclear鈥� why the NSFR should apply to securities lending transactions, as these transactions are demand-driven rather than funding-driven.
The fact remains that these regulations are going to stand front and centre for the next few years at least, for banks and their clients. A hedge fund with $10 billion in assets under management recently commented that the European Markets Infrastructure Regulation, Alternative Investment Fund Managers Directive and the Foreign Account Tax Compliance Act 鈥渁re really 鈥榖lue collar鈥� regulatory work from our perspective鈥�, adding: 鈥淒odd-Frank and Basel III are big concerns to us. Financing is going to become significantly tougher.鈥�
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