The Basel Committee has been consulting on a new policy framework for calculating the capital requirements to be held by banks against their equity investments in funds, covering all types of fund investments held in the banking book, and applying irrespective of whether the bank applies the Standardised Approach (SA) or Internal Ratings-Based (IRB) Approach to its capital calculations. The Basel Committee defines "funds" as including hedge funds, venture capital and private equity, and extending to off-balance sheet exposures. The revisions to the policy framework follow-up on the work of the Financial Stability Board (FSB) to strengthen the oversight and regulation of "shadow banks", with the FSB specifically having asked the Basel Committee to consider introducing greater international harmonisation of capital requirements for investments in funds including shadow banks. The current rule is that banks must apply a flat 150% risk weighting to investments in funds, but the Final Standard retains the approach consulted upon whereby banks can choose one of three approaches with varying degrees of risk-sensitivity: the "look-through approach" (LTA), the most granular and risk-sensitive; the "mandate-based approach" (MBA), which is less sensitive and based on information contained in the fund's mandate; and the "fall-back approach" (FBA) which is the most basic and must be used when the conditions for using the LTA or MBA are not met. A leverage adjustment will also be incorporated. It requires the investing bank to prove that any given fund investment is low-risk (and thus the LTA or MBA can be used, subject to other criteria), otherwise it will be assigned a 1250% risk weight under the FBA (resulting in a pound-for-pound, or euro-for-euro, capital deduction). Exemptions will be available for certain investments (broadly, holdings in entities whose debt obligations qualify for a 0% risk weight, and holdings involving some form of government oversight), and exposures (including underlying exposures held by funds) are not required to be risk-weighted under this framework. The Final Standard will take effect on 1 January 2017, and the new rules form new paragraphs 80 (SA), 339 and 361 (IRB) of the Basel II framework. A useful set of worked examples in the paper show how capital calculations under each of the LTA and MBA would be made, and how the leverage adjustment should be applied.
Basel Committee: Capital Requirements for Banks' Equity Investments in Fund