13 September 2013

GFMA: Letter to BCBS on financial institution deduction

The Global Financial Markets Association wishes to draw to the Committees attention a serious issue concerning the recognition of short positions in the calculation of capital deductions required for investments in unconsolidated financial institutions, as required under Basel III. GFMA believes that the current Basel III wording will unintentionally restrict banks' ability to provide liquidity and carry out market-making activities, and therefore ask the Committee to reconsider the requirement.

The issue relates to the maturity restriction applied to short positions to determine the "net long position" in an underlying exposure, and the implication of this for trading book exposures. The US Final Rules and EU Capital Requirements Regulation (CRR), implementing paragraphs 80 and 84 of Basel III, require banks to deduct from regulatory capital their "investments" in the capital instruments of financial institutions that are outside the scope of consolidation.

The deduction is based on the net long position, which is derived by calculating the value of the gross long position less the value of the gross short position in the same underlying exposure. Critically, only short positions which match the maturity of a long position or have a residual maturity of at least one year are eligible to be included in the population of short positions.

However, GFMA believes that the requirement for short positions to have a residual maturity either matching that of the long position or of more than one year is inappropriate for trading book positions for the following reasons:

• The requirement creates severe practical difficulties for trading book management
• The rule conflicts with the existing trading book capital treatment
• The rule is inconsistent with prudent risk-management activities
• The rule is inappropriate for long hedge positions
• The rule does not consider "economic" delivery of positions
• The maturity restriction does not recognise the significant liquidity of many trading book positions

All banks that facilitate clients' investment in financials or carry out market-making in financials will be affected by the rule, and particularly so for those banks that carry out such activities as a core part of their business model.

Specifically, GFMA asks that maturity restrictions are removed for short positions in the trading book in line with the conditions stipulated by the Committee for short index positions, where the firm can demonstrate that the hedge is effective under the bank‟s internal control processes assessed by supervisors.

Full letter

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