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FSB Issues Haircut Floors for Uncleared Securities Financing Transactions
Practical Law Legal Update 9-584-6645 (Approx. 4 pages)
FSB Issues Haircut Floors for Uncleared Securities Financing Transactions
by Practical Law Finance
| Published on 22 Oct 2014 • USA (National/Federal) |
The Financial Stability Board (FSB) has released a framework of numerical haircut floors for non-centrally-cleared securities financing transactions in which financing against collateral is provided to non-banks.
On October 14, 2014, the Financial Stability Board (FSB) published a Regulatory Framework for Haircuts on Non-centrally Cleared Securities Financing Transactions that proposes numerical haircut floors that would apply to non-centrally-cleared securities financing transactions in which collateral other than government securities is posted to non-banks. The framework is intended to limit the build-up of excessive leverage in transactions conducted outside international banking systems.
The backstop haircut floors proposed by the FSB are as follows:
Numerical Haircut Floors for Securities-against-Cash Transactions | |||||
Residual Maturity of Collateral | Haircut Level | ||||
Corporate and Other Issuers | Securitized Products | ||||
</= 1 Year Debt Securities, and Floating Rate Notes (FRNs) | 0.5% | 1% | |||
> 1 year, </= 5 Years Debt Securities | 1.5% | 4% | |||
> 5 years, </= 10 Years Debt Securities | 3% | 6% | |||
> 10 Years Debt Securities | 4% | 7% | |||
Main Index Equities | 6% | ||||
Other Assets Within the Scope of the Framework | 10% | ||||
Market participants would be permitted to set higher haircuts than any of the above numerical haircut floors. The FSB encourages market participants to determine their own more granular risk-based haircut schedules in accordance with the methodology proposed by the FSB.
The FSB also notes certain transactions to which the numerical haircut floors do not apply. First, cash-collateralized securities lending transactions are exempted from the framework of numerical haircut floors where:
- Securities are loaned at long maturities and the lender of securities reinvests or employs the cash at the same or shorter maturity, therefore not giving rise to material maturity or liquidity mismatch.
- Securities are loaned at call or at short maturities, giving rise to liquidity risk, only if the lender of the securities reinvests the cash collateral into a reinvestment fund or account subject to regulations or regulatory guidance meeting the minimum standards for reinvestment of cash collateral by securities lenders set out in Section 3.1 of the FSB's August 2013 report, Policy Framework for Addressing Shadow Banking Risks in Securities Lending and Repos.
Second, securities lenders may be exempted from the numerical haircut floors on "collateral upgrade" transactions. The FSB describes these transactions as securities borrowing/lending transactions against the pledging of other securities as collateral, rather than cash. The exemption may be available if the securities lender is unable to reuse, or if it provides representations that it does not and will not reuse, the securities received as collateral against the loaned securities.
In addition to adherence to these standards, the FSB also recommends that, when setting margin requirements for different counterparties and securities portfolios, market participants should consider the:
- Market risk of the portfolio.
- Portfolio concentration by geographies, economic sectors and individual issuers.
- Liquidity of the portfolio.
- Risks arising from non-correlated price and spread relationships between loaned securities and the collateral portfolio assets.
Banks conducting core transactions with non-banks in which haircuts are below the numerical floors would have a number of potential options:
- Switch to unsecured lending.
- Keep the current haircut level and hold more regulatory capital.
- Raise the haircut level to avoid the capital charge.
- Not conduct the transaction at all.
In addition to its guidelines for market participants, the FSB also sets out potential means by which regulators should enforce numerical haircut floors. According to the FSB, the framework for numerical haircut floors may be implemented through any of the following three approaches:
- Entity-based regulation, by which numerical haircut floors would be implemented through regulations targeted at each type of entity that engages in securities financing transactions.
- Product-based regulation (market regulation), by which numerical haircut floors would be implemented through product-based regulation or market regulation targeted at the activity of providing securities financing to non-banks against collateral other than government securities.
- A hybrid approach, by which numerical haircut floors would be implemented through a combination of the above approaches.
Annex 4 of the framework also includes a proposal covering numerical haircut floors to non-bank-to-non-bank transactions. The purpose of Annex 4 is to ensure that shadow banking activities are fully covered and to reduce the risk of regulatory arbitrage.
The FSB recommends that the Basel Committee on Banking Supervision (BCBS) review its capital treatment of securities financing transactions and incorporate the framework of numerical haircut floors into the Basel III framework by the end of 2015. Following this incorporation, authorities expect to implement the framework by the end of 2017.
The consultation closes on December 15, 2014. The FSB also issued a press release providing an overview of the framework.