And we thought the CVA risk capital charge exemption was safe…..
April 24, 2013
If anyone ever cares in the future to write the history of the extension of financial regulation to the real economy – so clearly best selling material – it will I hope be remembered how much of a volte-face the EU policy makers performed. At the outset, in the summer of 2009, the official position was adamantly that there would be no special treatment for non-financial users of derivatives. We fought and won, always remembering that our victory in battle could be overcome by the loss of the war.
That war was of course Basel III and its European incarnation, CRD IV / CRR. Funnily enough we won the war as well, especially once we secured support in the European Parliament for the extension of the EMIR exception principle to the CVA risk capital charge in CRR.
So there we are; or at least we think we are there. There are troubling signs of a major pushback in the United States against the CVA risk capital charge exemption. The stage it would be unfair to focus on individual banks; that may come later. What we do know is that the investment banks’ US trade association, SIFMA, has written to the Secretary of the US Treasury. The letter is diplomatically worded but its intent is fairly clear. SIFMA states:
“While we share the concern that the CVA is incorrectly calibrated and in need of major revision, this action is a significant deviation from Basel III and the G-20 principles of uniform application. Not only is this exemption inconsistent with implementation of the Basel III standard, it has the knock-on effect of placing non-EU banks on an unlevel playing field with EU supervised banks…..
We would respectfully request that you raise with the EU that this difference in regulatory treatment runs counter to the Financial Stability Board’s and G20’s stated objectives of promoting internationally coordinated and consistent implementation of its regulatory action plan.”
I believe that the US banks want to kill the CVA risk capital charge exemption as soon as possible. They may be right about the failings in Basel III; but this argument looks like a Trojan Horse masking the real issue, which is about the ability of US banks to compete with other international banks.
Why has the CVA risk capital charge exemption so royally irritated the US banking community? And why is that community so belatedly trying to appear on the side of the good, when it neglected Basel compliance for so long?
Some elements that I have pieced together all revolve around our maligned ‘friend’, the CDS market. My personal, lay understanding is as follows:
- banks can manage their CVA exposure by taking CDS positions
- the CDS market for corporate names is substantially more developed in the US than anywhere else – and the limitations of the market other than in the US severely restrict the ability of banks to hedge the CVA exposures
- compounding the advantages for US banks, they have been, over the last decade, at the forefront of the development of risk management of CVA, e.g. by using CDS
How should we respond to this? Whilst this is still work in progress, my view is that we need to bring the debate fully out into the open (see Financial Times “JPMorgan Under Pressure in Basel Spat”) and make sure that there is real transparency about the issues and the objectives of the major players. We have started that process but there is more to be done before we can have any confidence that the CVA risk capital charge exemption is indeed safe.