The objective of the BCBS proposal is to create incentives for banks to set their collateral haircuts above the floors rather than hold more capital.
The proposed haircut floors have been calibrated taking into account the two-stage QIS performed by the FSB and data on the historical price volatility of in-scope assets, as well as the existing market and central bank haircuts conventions. The haircut floors are intended to serve as “backstops” and limit the build-up of excessive leverage while maintaining incentives for market participants to conduct their own analysis of the appropriate level of haircuts, following the standards set out above.
The following principles were developed to implement the FSB’s recommendations while taking account of practical issues around varying methodologies for computing haircuts:
(a) The treatment should be consistently implemented across the different methods available under the Basel framework to compute the exposure of SFTs (ie Financial Collateral Comprehensive Method (FCCM), value-at-risk and Internal Models Method (IMM)).
(b) The treatment should be designed to incentivise banks to adopt the floors, but still allow them to hold additional capital if they do not.
(c) The treatment should apply at both the individual transaction level and at the portfolio level.
There are circumstances under which implementation of the haircut floors could be arbitraged when applied at a netting set (or portfolio) level. That is, banks could implement a strategy using one or more SFT transactions to deliberately avoid the higher capital requirements, while achieving a net position that is economically equivalent to a trade that should be subject to higher capital requirements under the proposal. These situations were considered when developing the proposed higher capital requirements for in-scope transactions under the Basel capital rules.
There is a possible regulatory arbitrage by using two or more offsetting trades with the same underlying securities in a netting agreement that will not be subject to the higher capital requirements at individual level, but would if the net position is considered. The possibility is due to the fact that when the bank lends cash, the STF is subject to the FSB floors, but if it borrows cash on that same SFT, the transaction will not be subject to the FSB floors.
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