Yesterday the Australian Prudential Regulatory Authority (APRA) issued a media release which seeks to clarify the types of high-quality liquid assets that Australian ADIs will be able to count towards their Liquidity Coverage Ratio (LCR) under APRA's implementation of Basel III's new global liquidity standards.

When the LCR comes into effect for Australian ADIs on 1 January 2015, APRA will only allow Australian ADIs to count towards their LCR assets comprising cash, balances held with the Reserve Bank of Australia (RBA) and Commonwealth Government and semi-government securities.

What did the Basel Committee say about liquidity?

In its December 2010 paper, the Basel Committee released new global liquidity standards which were designed to ensure that banks will have adequate liquidity buffers to survive liquidity shocks. One of the cornerstones of the new standards was the introduction of the LCR to test whether a bank has sufficient high-quality liquid assets to survive a significant stress scenario lasting for 30 days. In its December 2010 paper, the Basel Committee indicated that high-quality liquid assets could include:

  • cash, central bank reserves and certain categories of government debt (Level 1 assets); and
  • a lesser quantity of other types of government debt, highly rated corporate bonds (non-bank issuers) and covered bonds, provided that these instruments were traded in large, deep and active markets and could demonstrate a proven track record as reliable sources of liquidity (Level 2 assets).

What does the announcement mean for Australian ADIs?

Yesterday's announcement by APRA effectively confines the assets that an Australian ADI can count towards their LCR to Level 1 assets and confirms that no assets can be counted towards Level 2 assets.

What does the announcement mean for Kangaroo and covered bonds?

Highly rated corporate bonds and covered bonds are conspicuously absent from APRA's list of LCR-eligible assets, which suggests that APRA does not believe these instruments to be reliable enough sources of liquidity to be counted towards an Australian ADI's LCR.

Although this appears to be a set back for Australia's Kangaroo and fledgling covered bond markets, there is always the possibility that APRA will expand the list of Level 1 or Level 2 Assets before the LCR comes into effect on 1 January 2015. APRA has already indicated that it will consider expanding the list of LCR-eligible assets pending the outcome of testing by the Basel Committee on the liquidity characteristics of Level 2 assets and APRA's assessment of market developments over the period leading up to 1 January 2015.

It is also possible that Kangaroos and covered bonds may indirectly assist the larger Australian ADIs (which APRA has indicated is initially the "top 40") to satisfy the new liquidity requirements. This is because under the RBA's committed secured liquidity facility, larger Australian ADIs may use certain RBA repo-eligible assets (which currently include certain categories of Kangaroo bonds and highly rated debt issued by ADIs) as collateral under the RBA facility to meet any shortfall in their LCR requirements.

Having said this, the joint APRA/RBA announcement in December 2010 made it clear that the RBA facility was only able to be accessed as a last resort after an Australian ADI has demonstrated that it has taken "all reasonable steps towards meeting their LCR requirements through their own balance sheet management". Therefore, although Australian ADIs may indirectly utilise certain Kangaroo and covered bonds to meet their LCR requirements by posting these under the RBA facility, the RBA facility may only be available to Australian ADIs who have first demonstrated genuine efforts to source sufficient Commonwealth Government securities.

Outlook

APRA has indicated that the implementation of the global liquidity framework in Australia (including the LCR requirements), will be subject to consultation during 2011 and 2012. Given the high ratings of covered bonds and many of the Kangaroo issuers into the Australian market, it is hoped that the Australian Kangaroo and covered bond market will develop sufficient levels of depth and liquidity during the consultation period to persuade APRA to reconsider their inclusion as Level 2 assets for the purposes of the LCR.