The leverage ratio is a key part of the Basel III capital and liquidity framework, and is designed to act as a non-risk based backstop to the minimum capital requirements when it takes effect in 2018. The leverage ratio is defined as the Capital Measure (based on Tier 1 Capital) divided by the Exposure Measure (the crucial sum of on-balance sheet exposures, derivative exposures, securities financing transaction exposures and other off-balance sheet exposures), which must give a minimum ratio of3% (this figure is not yet set in stone but has been suggested by the Basel Committee - see below) during a "parallel run" period from 1 January 2013 to 1 January 2017, with the final standard migrating to Pillar 1 treatment (i.e. the requirement becomes part of the minimum requirements, rather than being part of the supervisor's additional regulatory tools under Pillar 2) on 1 January 2018. The Basel Committee finalised the leverage ratio framework and accompanying disclosure framework earlier in 2014. The European Commission has now issued the final Delegated Regulation amending the Capital Requirements Regulation (CRR) regarding the leverage ratio, which amends the CRR capital measure and total exposure measure (which the Commission is empowered to do if there are shortcomings found in the way those measures are defined prior to the date on which institutions must start disclosing their leverage ratio on 1 January 2015, which have given rise to differences in how Member States understand and interpret the rules on the leverage ratio). The Delegated Regulation does not set any binding calibration (or figure) for the leverage ratio, which 'may' be decided upon at the end of 2016. What it does do is fine-tune the composition of the leverage ratio and align the Basel III text with the provisions of the CRR such that Article 429 CRR is amended to clarify that:

  • The calculation and reporting period is defined as at the end of the reporting period (i.e. the end of each quarter) and not a three-month average. This reduces the operational burden and also aligns the leverage ratio with other data reporting requirements;

  • The scope of consolidation will be the regulatory scope of consolidation used for the risk-based (capital) framework instead of the accounting scope of consolidation, which (amongst other things) eliminates differences arising from use of, e.g. International Financial Reporting Standards (IFRS) and local Generally Accepted Accounting Principles (GAAP);

  • For securities financing transactions (SFTs) such as repo transactions, collateral received cannot be used to reduce the exposure value of the SFTs, but the Delegated Regulation clarifies that cash receivables and payables of SFTs with the same counterparty can be netted (subject to strict criteria);

  • The calculation will use the "credit conversion factors" of the Basel III Standardised Approach to credit risk, subject to a floor of 10%, instead of using the 100% risk-weighting for off-balance sheet exposures;

  • For derivatives transactions, the cash variation margin received can be deducted from the exposure value, provided strict conditions are met; and

  • Written credit derivatives are measured at their gross notional amount instead of at their fair value, but fair value offsetting of protection sold with protection bought is allowed, again, subject to strict criteria being met.

Corresponding changes to the supervisory reporting forms for the leverage ratio will also be made, and published in the form of an Implementing Technical Regulation in due course. A set of Frequently Asked Questions have also been made available by the European Commission, and a Basel Committee set of Frequently Asked Questions on the Basel III leverage ratio framework have also been made available recently. The Commission has clarified that a report on the leverage ratio will be submitted to the European Council and Parliament by the end of 2016, which will be accompanied by a legislative proposal to introduce a binding leverage ratio (under Pillar 1) from 1 January 2018. The Delegated Regulation will take effect on the day following its publication in final form in the Official Journal of the EU. Having released a Consultation Paper in July 2014 about the UK implementation of the leverage ratio, the UK's Financial Policy Committee is due to make its final announcement about the level of the final UK leverage ratio towards the end of October 2014. The final UK ratio is expected to be tougher than the Basel III minimum at 4%, or possibly even higher.

Useful links:

European Commission Delegated Regulation and FAQs

Basel Committee Leverage Ratio FAQs