Monday, February 27, 2017

Basel Clarifies NSFR Repo Treatment

On February 24, 2017, the Bank for International Settlements (BIS) published a new set of responses to interpretation questions related to the Net Stable Funding Ratio (NSFR).[1] This release is a follow-up to the initial FAQ published in July of 2016 and includes important guidance concerning the treatment of repo for purposes of calculating the ratio. The purpose of the NSFR to move banks to more stable sources of funding that are less vulnerable to shocks. Banks and financial institutions that rely on short-term financing have raised a number of concerns about the ratio’s treatment and weighting of repo and reverse repo transactions, with some even calling for repo to be exempt from the ratio altogether. The Basel Committee’s FAQ does not address all of these concerns. But the interpretations do provide valuable clarifications to some technical aspects the treatment of repo and securities finance transactions (SFT) for the purpose of calculating the ratio, including netting of repo and reverse repo and RSF factors applicable to secured funding transactions.[2]

 

This latest FAQ provides interpretive guidance in areas such as: 

 

  • the required stable funding factor for non-operational deposits held at other financial institutions, and for loans that have optionalities; 
  • treatment of retail and small-business deposits and term deposits; allocation of assets according to maturity buckets; 
  • circumstances for net basis reporting for certain securities financing transactions (such as repo or reverse repo);
  • determination of adequate period for a non-maturity reverse repo (also known as open reverse repo); and 
  • treatment of margining for derivative contracts.

 

Repo Netting

 

Netting of repo and reverse repo for purposes of the NSFR has been an area of ambiguity since the NSFR was first proposed. The February FAQ provides some measure of clarity in that regard with the following guidance approving netting of securities financing transactions in fairly narrow circumstances: 

 

5. Under what circumstances can positions arising from securities financing transactions (such as repo or reverse repo) be reported on a net basis in the NSFR? 

 

Answer: Amounts receivables and payable under these securities financing transactions should generally be reported on a gross basis, meaning that the gross amount of such receivables and payables should be reported on the RSF side and ASF side, respectively. The only exception, as per paragraph 33 in the NSFR standard, is that “securities financing transactions with a single counterparty may be measured net when calculating the NSFR, provided that the netting conditions set out in Paragraph 33(i) of the Basel III leverage ratio framework and disclosure requirements document are met.”

 

Pargraph 33(i) of the Basel III Leverage Ratio Framework and Disclosure Requirements provides for netting of SFTs under prescribed conditions including cash payables and cash receivables in SFTs (1) having the same counterparty, (2) the same explicit final settlement date, (3) legally enforceable rights to offset amounts owed to and owed by a single counterparty, and (4) an intention to settle net or settle simultaneously (or its equivalent).

 

Repo Weighting and Collateral Treatment

 

In addition to clarifying repo netting, the FAQ provides interpretive guidance on some technical aspects of applying required stable funding factors (RSF) to amounts receivable and collateral under repo transactions. 

 

4. What is the treatment in terms of encumbrance for collateral pledged in a repo operation with remaining maturity of one year or greater but where the collateral pledged matures in less than one year

Answer: In this case, for the purpose of computing the NSFR, the collateral should be considered encumbered for the term of the repo or secured transaction, even if the actual maturity of the collateral is shorter than one year. This follows because the collateral would have to be replaced once it matures. Thus, the collateral pledged under a transaction maturing beyond one year should be subject to a RSF factor of 100%, regardless of its maturity. 

 

5.1 How should reverse repo and secured funding transactions be treated in the NSFR? 

 

a. What is the applicable RSF factor for the amount receivable by a bank under a reverse repo transaction? 

Answer: With the exception of loans (reverse repos) to financial institutions with residual maturity of less than six months secured by level 1 assets (which receive a 10% RSF factor as per paragraph 38 of the NSFR standard) or by other assets (which receive a 15% RSF factor as per paragraph 39 of the NSFR standard), the treatment for the amount receivable is the same as with any other loan, which will depend on the counterparty and term of the operation. 

 

b. What is the treatment for the collateral received? 

Answer: According to paragraph 32 of the NSFR standard governing secured funding arrangements, the NSFR treatment of collateral received in a reverse repo is determined by the collateral’s balance sheet and accounting treatments, which should generally result in banks excluding from their assets, securities that they have borrowed in securities financing transactions (such as reverse repos and collateral swaps) which are kept off-balance sheet. In this case, there is no NSFR treatment for the collateral. If, however, the collateral received is kept on-balance sheet, such collateral should receive an RSF factor according to its characteristics (whether it is HQLA, its term, issuer, etc). 

 

c. How should the encumbrance treatment as specified in paragraph 31 of the NSFR framework be applied to secured lending (eg reverse repo) transactions where the collateral received does not appear on the bank’s balance sheet, and it has been rehypothecated or sold thereby creating a short position? 

Answer: The encumbrance treatment should be applied to the on-balance sheet receivable to the extent that the transaction cannot mature without the bank returning the collateral received to the counterparty. As per paragraph 31 of the LCR framework (referenced in footnote 14 of paragraph 31 in the NSFR framework), for a transaction to be “unencumbered”, it must be “free of legal, regulatory, contractual or other restrictions on the ability of the bank to liquidate, sell, transfer or assign the asset”. Since the liquidation of the cash receivable is contingent on the return of collateral that is no longer held by the bank, the receivable should be considered as encumbered. When the collateral received from a secured funding transaction has been rehypothecated, the receivable should be considered encumbered for the term of the rehypothecation of the collateral. When the collateral received from a secured funding transaction has been sold outright, thereby creating a short position, the receivable related to the original secured funding transaction should be considered encumbered for the term of the residual maturity of this receivable. Thus, the on- balance sheet receivable should:− be treated according to the answer to question 5.1.a if the remaining period of encumbrance is less than six months (ie it is considered as being unencumbered in the NSFR);− be assigned a 50% or higher RSF factor if the remaining period of encumbrance is between six months and less than one year according to paragraph 31; and− be assigned a 100% RSF factor if the remaining period of encumbrance is greater than one year according to paragraph 31. 

 

d. How should the encumbrance treatment specified in paragraph 31 of the NSFR framework be applied to secured lending (eg reverse repo) transactions where the collateral appears on the bank’s balance sheet, and it has been rehypothecated or sold, thereby creating a short position? 

Answer: Collateral received that appears on a bank’s balance sheet and has been rehypothecated (eg encumbered to a repo) should be treated as encumbered according to paragraph 31. Consequently, the collateral received should:− be treated as being unencumbered if the remaining period of encumbrance is less than six months according to paragraph 31 of the NSFR standard, and receive the same RSF factor as an equivalent asset that is unencumbered;− be assigned a 50% or higher RSF factor if the remaining period of encumbrance is between six months and less than one year according to paragraph 31; and− be assigned a 100% RSF factor if the remaining period of encumbrance is greater than one year according to paragraph 31.If the collateral has been sold outright, thereby creating a short position, the corresponding on- balance sheet receivable should be considered encumbered for the term of the residual maturity of this receivable, and receive an RSF factor according to the answer to question 5.1.c above. 

 

6. Some loans are only partially secured and are therefore separated into secured and unsecured portions with different risk weights under Basel II. How should these portions be treated for the calculation of the NSFR?

Answer: The specific characteristics of these portions of loans should be taken into account for the calculation of the NSFR: the secured and unsecured portions of a loan should each be treated according to its characteristics and assigned the corresponding RSF factor. If it is not possible to draw the distinction between the secured and unsecured part of the loan, the higher RSF factor should apply to the whole loan. 

 

7. What is the adequate period for a non-maturity reverse repo (also known as open reverse repo)? Would that be categorised under “loans with residual maturities of less than six months”?

Answer: Paragraph 29 states that assets should be allocated to the appropriate RSF factor based on their residual maturity or liquidity value. When determining the maturity of an instrument, investors should be assumed to exercise any option to extend maturity. For assets with options exercisable at the bank’s discretion, supervisors should take into account reputational factors that may limit a bank’s ability not to exercise the option. In particular, where the market expects certain assets to be extended in their maturity, banks and supervisors should assume such behaviour for the purpose of the NSFR and include these assets in the corresponding RSF category. In the case of a non-maturity reverse repo, they should be assigned as RSF=100% (to continue over the one-year term), unless banks can demonstrate to supervisors that the non-maturity reverse repo would effectively mature in a different period.

 

The full text of the February 24,2017 FAQ is available via: https://www.bis.org/bcbs/publ/d396.pdf

 

 


 

[1] The NSFR was first proposed by the Basel Committee (BIS) in 2009 and included in the 2010 Basel III Agreement. BIS issued a consultation on the NSFR in January 2014, and final guidelines in October 2014.  At present, the NSFR is in an observation period until January 1, 2018 when it becomes a minimum standard under the Basel III liquidity risk framework.

 

[2] The NSFR is defined as the amount of available stable funding (ASF) relative to the amount of required stable funding (RSF). The ASF is defined as the portion of capital and liabilities expected to be reliable over the time horizon considered by the NSFR, which extends to one year.  NSFR = ASF (Available Stable Funding) ÷ RSF (Required Stable Funding) ≧ 100%

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