Anu Munshi, managing partner at B&B Structured Finance, assesses the current regulatory environment

Anyone trying to keep track of bank regulations should be excused for clutching their head, screaming or both. The dizzying rash of regulations - with their revisions, implementation dates and their interpretation by different regions - is enough to give one a headache.

Take the credit valuation adjustment (CVA) charge for OTC derivative trades required by Basel 3 as an example. The CVA charge is an amount banks have to reserve against potential mark-to-market losses from a deterioration in the creditworthiness of their counterparties to non-cleared derivative trades.

The US has adopted the CVA charge in a way that is broadly consistent with Basel 3. However, the EU has diverged from Basel 3 by adopting the CVA charge in a form that exempts EU-based banks from this charge for transactions with non-financial corporates¹.

The idea is to be consistent with the European Market Infrastructure Regulation (EMIR), which exempts non-financial corporates from centrally clearing derivatives, effectively allowing them to enter into OTC derivative trades without having to post collateral. If non-financial corporates were subject to the CVA charge, it would undermine their benefit of avoiding collateral costs under EMIR.

While such treatment for non-financial corporates in the EU may be consistent with European regulation, it diverges from internationally agreed standards and creates an uneven playing field for banks globally. Given these concerns, some EU member states are considering imposing a capital 'add on' to address the CVA exemption, which gives national regulators the ability to impose requirements for additional capital. So, not only is the EU approach different from the US approach, but there is the potential for a lack of consistency within the EU itself.

Then there's the leverage ratio - a key component of Basel 3, which requires banks to hold at least 3% of their overall assets in Tier 1 capital. The leverage ratio is meant to constrain excessive leverage by setting a minimum standard for how much capital banks must hold against all their assets, not just their risk-weighted assets.

The US is moving towards a more stringent approach to the leverage ratio, subjecting banks to tougher requirements than the Basel 3 leverage ratio - from 'advanced approaches' banks² having to comply with both the Basel 3 leverage ratio (3%) and the US Tier 1 capital-to-assets leverage ratio (generally 4%), to the largest banking organisations having to maintain a supplementary Basel 3-based leverage ratio of at least 5%, failing which they would be restricted in making capital distributions and discretionary bonus payments.

On the other hand, the European Commission has indicated that it is still reviewing whether the leverage ratio should be introduced as a binding measure at all. The EU has adopted the leverage ratio as a measure determined by the national regulator for each institution.

While the UK has introduced a binding 3% leverage ratio on its largest banks, other EU member states may choose lower ratios. So, again we have a divergence of approach between the US and the EU, and also within the EU.

The Basel Committee recently revised its definitions of bank exposures used to calculate the leverage ratio and will continue to review the ratio, as it will only be implemented on 1 January 2018. So further changes could be afoot, and this means that the US and the EU could revise their positions yet again.

And then there are the Basel 3 risk weights for bank securitisation exposures. The Basel Committee has prescribed different ways for banks to assign risk weights for their securitisation exposures when determining their risk-weighted assets for regulatory capital.

The Basel Committee recently published its second consultative document on risk weights for bank securitisation exposures under Basel 3. The recent proposal prescribes a different set of approaches from the originally proposed rules for banks to risk-weight securitisations. Among other changes, the new proposed rules no longer confer an automatic 1250% risk weight to senior securities downgraded to a rating between double-B minus and double-C plus.

The US, however, has already finalised its version of Basel 3 rules, so US banks will have different risk weights against their securitisation exposures than European or international banks. If the Basel securitisation proposal is finalised in its current form, US regulators may look at revising the US bank securitisation framework to be more in line with the revised Basel 3 rules.

And round and round we go... And no, you can't get off this ride.

¹ Where transactions are considered bona fide hedges for the non-financial corporate and do not exceed certain thresholds specified in EMIR.
² US banking groups with consolidated assets of at least US$250bn or consolidated foreign exposures of at least US$10bn.