Opening Remarks as Prepared for SIFMA’s Basel III Endgame Roundtable

Remarks by Joseph Seidel, Chief Operating Officer for SIFMA, as prepared for delivery at SIFMA’s Basel III Endgame Roundtable

 Good morning. I’m Joe Seidel, Chief Operating Officer of SIFMA.

I would like to welcome everyone today and before we begin, I would like to thank my colleagues Carter McDowell, Peter Ryan and Guowei Zhang as well as our CEO Ken Bentsen for their leadership in developing this program.  I would also like to thank our moderators, Jelena McWilliams and Jonathan Gould, and all our participants and audience for joining today.

We’re gathered here today for what I expect will be a robust conversation around a quickly moving and increasingly urgent topic: the Basel III Endgame, its forthcoming implementation in the U.S., and its potential substantial impacts on the capital markets and U.S. economy.  At SIFMA as the primary trade group for the investment industry, we are particularly interested in the impact these changes will have on the trading book, on market-based risk management tools, and on the overwhelming amount of US financing done thru the U.S. capital markets.

As we begin the discussion we should take a brief step back to recall how we got to where we are today –  after the Global Financial Crisis, the Basel Committee on Banking Supervision –– as well as other standard setters such as the Financial Stability Board and national authorities, instituted a series of wholesale reforms to the pre-crisis prudential regulatory framework to increase both the quality and quantity of capital in the banking system, as well as a whole suite of other prudential regulations designed to enhance bank resiliency.

These reforms resulted in a sweeping set of revisions, including:

• Heightened risk-based capital requirements for trading, lending and derivatives activities;
• New leverage-based capital requirements;
• New capital requirements for Global Systemically Important Banks;
• And the introduction of stress testing capital requirements including the Global Market Shock here in the United States, amongst many other reforms that go above-and-beyond both the minimum Basel standards and the policies that other major jurisdictions have adopted.

Today, U.S. bank capital levels are extraordinarily robust – both in terms of overall levels and quality of capital. In fact, a recent comprehensive PWC survey found that capital levels in the U.S. banking system are currently “optimal” – meaning they are at levels that appropriately balance financial stability with economic growth.

However, global regulators remained concerned that the current Basel III capital standards result in excessive variability in the way risk-based capital requirements are calculated across banks.  To this end, the Basel Committee on Banking Supervision finalized revisions to its risk-based capital standards in 2019, commonly referred to as the “Basel III Endgame.” These aim to promote greater standardization and thus comparability across risk-based capital requirements.

Since then, national regulators have been working to implement the Basel III Endgame package, with proposals issued in both the EU and the UK.  Some jurisdictions have already finalized their rules.  The U.S. federal banking agencies have jointly reaffirmed their commitment to implement the Basel III Endgame package and we expect the U.S. Notice of Proposed Rulemaking implementing the reforms to be published in relatively short order.

The Basel III Endgame will significantly overhaul the current risk-based capital framework in the US. It is expected to raise overall U.S. capital levels by more than 20% and capital for banks’ trading book activities by almost 60%. That ultimately means less capital will be available at a higher price to provide financing to the real economy.

U.S. regulators have indicated their intent to propose significantly higher capital requirements for the largest U.S. banks following a “holistic review” that has been conducted by the Federal Reserve staff without public input and without any final written work product available for public review.

Why does this matter?

The U.S. capital markets are critical to U.S. economic activity, funding three-quarters of equity and debt financing for non-financial corporations and facilitating prudent business risk management by end-users. Banks play a critical role in the capital markets facilitating capital formation, end-user hedging needs, and ensuring liquidity in these markets. The GSIBs collectively have over 90% of U.S. market share of core capital markets activities affecting commercial businesses and consumers.

The expected large increases in trading book capital will likely result in affected banks raising costs and reducing their capital markets activities. This will lead to a reduction in the products and services they offer and lead to a loss of capacity in many key markets. There is no guarantee that this lost market capacity will be made up by other market participants.

The consequence will likely be higher funding and hedging costs, as well as reduced market access for end-users- as highlighted in a letter submitted to the banking agencies last week by the Coalition for Derivatives End-Users. It will also likely result in reduced market liquidity during times of stress, with potential broader consequences for financial stability.

In addition, it is also important to note that the Basel III Endgame will affect certain capital markets activities more than others. The areas that will be hardest hit include securitization products trading, securities underwriting, equity investments in funds, securities borrowing by banks, and derivatives.

Moreover, these impacts will be felt in the near-term, regardless of whether a “phase-in” period is included in the final rule, as markets and investors will expect financial firms to come into compliance as soon as possible.

We are here today to talk about what policymakers can and should do to avoid these wholly unnecessary consequences, and I will leave the vast majority of that substance to our respected experts joining us today.

But before I do so, we would like to make an appeal for some degree of transparency from U.S. policymakers:

The Federal Reserve’s “holistic review” exercise should be made public in conjunction with the publication of the rule proposal. Both should be subject to public comment, allowing sufficient time for external stakeholders to perform quantitative impact studies and provide those analyses to the agencies.

• Publishing the holistic review in conjunction with the NPR would yield several benefits:
• It would allow a broader audience to evaluate how capital and other prudential requirements have performed since the last financial crisis, particularly during the COVID event and other periods of recent market stress.
• It would provide the Federal Reserve with an opportunity to explain why the Basel III Endgame capital increases are needed at this time, and what the costs of doing so would be for specific markets and sectors as well as the broader economy.
• Crucially, it would allow for a better understanding of how the Basel III Endgame package interacts with other elements of the prudential framework and whether recalibrating existing requirements may be appropriate. These interactions include the significant duplication between the FRTB portion of the Basel III Endgame and the GMS component of the stress testing process.
• Public input would also help the Federal Reserve and other agencies to identify an optimal level of capital that balances micro-and macro-prudential safety with economic costs.

Today, we will attempt to tackle some of these issues and concerns from a diverse set of viewpoints – we have regulatory views from both the prudential and capital markets perspectives, industry experts and academic researchers.

We will start with a panel moderated by Jelena McWilliams, covering “A Review of Post-Crisis Prudential Reforms and an Evaluation of the Basel III Endgame.”

The next panel will discuss “The Impacts of the Basel Endgame on End-Users, the Capital Markets, and the U.S. Economy” and we will end with a session looking to get a deeper sense of “The Interaction Between the Basel Endgame and Other Elements of the U.S. Capital Framework and Potential Reforms.”

And with that – let’s get to it. Please join me in welcoming Jelena McWilliams, Managing Partner of the Washington, D.C. office and Head of the Financial Institutions Group Practice at Cravath, Swaine & Moore. She is also a former Chairman of the Federal Deposit Insurance Corporation (FDIC).