The Group of Governors and Heads of Supervision of the Basel Committee (simply referred to here as the Basel Committee) announced in January 2013 that it had endorsed a new iteration of the Liquidity Coverage Ratio (LCR), one of the key liquidity measures for banks introduced under the Basel III framework and originally intended to take effect from 2015. The securitisation industry was lobbying for the inclusion of securitisation exposures in the LCR and, in line with other recent, welcome relaxations of its approach, the Basel Committee has now confirmed that (at least some) securitisations will be included in the LCR. Further, the original 2015 compliance date for the LCR requirements has been relaxed. The details of the Basel Committee's announcement have been set out in a separate document entitled Basel III: The Liquidity Coverage Ratio and Liquidity Risk Monitoring Tools, which is summarised in greater detail below.
As an initial starting point, it is worth recapping that Basel III's LCR is intended to ensure that banks hold a stock of unencumbered, High Quality Liquid Assets (HQLAs) equal to their potential losses during a 30-day market crisis, by providing that the stock of HQLAs divided by the total net cash outflows over the next 30 calendar days is equal to or greater than 100%. The Basel Committee notes that the LCR establishes a minimum level of liquidity, and that national supervisors can impose higher requirements if necessary. The LCR's sister ratio, the Net Stable Funding Ratio - which is even further away in terms of implementation - will eventually provide a similar ratio but calculated over a 12-month stressed period. The precise definitions of what comprises "HQLAs" and "net cash outflows" are key to the framework. The Basel Committee's document specifies (amongst other things) that:
- The composition of HQLAs has been revised and widened beyond the original proposal that favoured sovereign debt. To qualify as a HQLA, an asset should be liquid in markets in times of stress and, ideally, be central bank eligible. As was the case with the original LCR proposals, HQLAs are split into a hierarchy depending on their (perceived) quality. This hierarchy comprises Level 1 (the highest quality of assets and considered the most liquid) and Level 2 Assets, as follows and in the following proportions:
Level 1 assets - generally include cash, central bank reserves and certain marketable securities backed by sovereigns and central banks. There is no limit on a bank's holdings of Level 1 assets.
Level 2 assets - generally include sovereign and corporate debt. They must not in aggregate account for more than 40% of a bank's stock of HQLAs. Level 2 assets comprise Level 2A assets and (at the national supervisor's discretion - our emphasis) Level 2B assets:
- Level 2A assets - certain government securities, covered bonds and corporate debt securities, including (for the first time in the LCR) Commercial Paper (subject to applicable haircuts).
- Level 2B assets - lower rated (A+ to BBB-) corporate bonds, residential mortgage backed securities (RMBS) and equities that meet certain conditions (all with applicable haircuts). Level 2B assets may not account for more than 15% of a bank's HQLA.
The inclusion of RMBS comes with some restrictions. They must be subject to a long-term rating of at least 'AA' and they are subject to a minimum 25% haircut. They must be traded in large, deep and active repo or cash markets and have a proven track record as a reliable source of liquidity in the market. "Own name" deals appear to be excluded for obvious reasons. The underlying asset pool must be restricted to "full recourse" residential mortgages with maximum LTV limits of 80%. In addition, the RMBS must be subject to "risk retention" regulations (e.g. Article 122(a) of the Capital Requirements Directive).
The securitisation industry is welcoming the inclusion of (albeit a restricted amount of) RMBS in the LCR but argues for other, liquid asset classes to be allowed, such as auto loan securitisations that have also demonstrated strong performance and high liquidity in recent years. It had also been argued by some industry participants that any securitisation awarded the Prime Collateralised Securities (PCS) label should be eligible for inclusion in HQLAs, however, the Basel Committee is silent on this point. Both issues may be addressed by the European Commission when it uses its discretion in implementing these rules within Europe via the Capital Requirements Directive IV.
- The composition of net cash outflows has also been revised. They are defined as total expected cash outflows, minus total expected cash inflows, during the specified stress scenario for the next 30 calendar days. Inflows are subject to an aggregate cap of 75% of total expected cash outflows, ensuring a minimum level of holdings of HQLA at all times. Some changes to the proposed composition of cash outflows result in the unused portion of committed liquidity facilities provided to non-financial corporates being included up to 30% of their value, rather than 100%, which is another slight positive. However, the full 100% of liabilities from maturing ABCP, SIVs, SPVs and other ABS will still be counted as outflow.
- A revised timetable for the phasing-in of the LCR standard will be applied. While the LCR will be introduced as planned on 1 January 2015, the minimum requirement will be for banks to hold 60% of the full LCR, rising by 10% for each of the next four years, so that the full 100% requirement is reached by January 2019.
- The Basel Committee reaffirms that banks can draw down on their stock of HQLAs during times of stress, such that their LCR can drop below 100%. Supervisory guidance on the usability of HQLAs will be issued in due course.
- The document also confirms that the Basel Committee will conduct further work on the interaction between the LCR and the provision of central bank facilities, and in the areas of disclosure requirements for bank liquidity and funding profiles.
Broadly, banks have welcomed these developments, but some commentators suggest that the potential for use of securitisation in banks' stocks of HQLAs will in fact be relatively limited due to the 15% cap. It has also been noted that any benefit is counteracted by the potential harsher treatment of securitisation in the Basel Committee's broader proposals for revisions to the securitisation risk-weighting framework (see our related Feature on this topic). While the full impact of the new iteration of the LCR remains to be seen (and may even be subject to further change between now and 2015 and beyond), it may be viewed as a positive development overall, not least since it is the first attempt to set internationally-agreed liquidity standards for banks, which were distinctly lacking before the global financial crisis.
Basel Committee announcement
Basel Committee LCR Document