10 Recommendations to Revise the Basel III Endgame Proposal

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


Thank you Ken, and thank you, Governor Bowman. That was an excellent way to set the table for the rest of our roundtable discussion.

As Ken noted, the U.S. policymakers who proposed the Basel III Endgame package now acknowledge that they have more work to do and have stated that they plan to make material changes to the current proposal.

Why? Because it is overwhelmingly clear the proposal goes unnecessarily far and the negative consequences will be severe.

Joseph Seidel quote during SIFMA's Basel III Endgame Roundtable

U.S. bank capital levels are already extraordinarily robust by historical standards and in terms of overall levels and quality of capital. These levels appropriately balance financial stability with economic growth.

The U.S. proposal would, however, dramatically hike capital requirements even further.

While this complex proposal will have significant effects across the economy, one of its lesser discussed components would potentially have the most far-reaching impacts, and that is what we will focus on today.

As SIFMA called out in our multiple comment letters submitted earlier this year, the proposed increases in capital specifically for banking organizations’ capital markets activities under the Fundamental Review of the Trading Book (FRTB) and Credit Valuation Adjustment (CVA) are far greater than stated in the proposal and are not commensurate with the underlying risks.

In fact, the latest industry quantitative impact study estimates that capital for large banks’ trading activities would increase by 129% over their current historically high levels, leading to negative effects on the ability of large banks to provide a range of capital markets services to their clients.

Given that the U.S. capital markets provide 75% of the financing for the real economy, and given the vital role large banks play in intermediating those markets, such dramatic capital increases will likely impair market liquidity and vibrancy.

This will result in serious knock-on effects for the real economy, impacting companies, consumers and savers who benefit directly or indirectly from bank involvement in U.S. capital markets, and further hurting U.S. economic growth.

Indeed, we are seeing this negative impact occurring already as many firms begin to price the expected changes into certain long-dated instruments and have, in other instances, indicated an intention to scale back specific business lines.

Regulators have not fully accounted for these capital market impacts because in our view they did not conduct the necessary, robust analysis in advance of issuing the proposal.

As I mentioned, regulators have said they plan to make changes. But what will those be? What aspects will be changed? The devil is in the details.

In reality, the most prudent path ahead would be for the agencies to withdraw the proposal & re-propose the entire rule for public comment.

Any re-proposal should contain a robust holistic review of the entire capital framework and an economic analysis demonstrating the benefits and costs of the proposed changes.

More specifically, SIFMA would recommend the following top ten changes be made to the rule:

  1. Overlap With Stress Tests/Other Prudential Requirements: There should be a comprehensive evaluation of how the proposal would interact and overlap with other prudential requirements, particularly the stress testing framework, as well as the GSIB Surcharge and long-term debt requirements.
  2. The interaction between the Global Market Shock (GMS) & the FRTB: Regulators should address over capitalization of market risk between these two frameworks by, for example, applying the FRTB to the trading portfolio on a post-GMS shock basis. They should also only apply the Stressed Capital Buffer’s (SCB) annual stress to the U.S. standardized approach to avoid over capitalizing the CVA and operational risk measures which are already captured under the alternative, expanded risk-based approach.
  3. Diversification: Under both the FRTB’s internal models & standardized approaches, Regulators should give greater credit for diversification and hedging activities to better align with actual risk exposures and reward good risk management practices.
  4. NMRF & PLAT: In the FRTB portion of the proposal, adjustments should be made to lessen the impact of non-modellable risk factors (NMRF) and the P&L loss attribution (PLAT) test so that more firms are incentivized to adopt the internal models approach, which better reflects firms’ risk profiles.
  5. Credit Valuation Adjustment (CVA): Client-cleared derivatives should be excluded from the CVA’s scope in a manner similar to the approach taken in other jurisdictions & risk weights should be adjusted to reflect the different levels of regulation that a bank’s financial counterparties are subject to.
  6. Securitizations: The proposed framework for securitizations should be adjusted to avoid undue negative impacts on a wide range of asset-backed securitized products that businesses and households rely on to finance their activities, including mortgages and credit cards.
  7. Securities Financing Transactions (SFTs): In line with the approach taken by every other major jurisdiction, the U.S. should not adopt the SFT haircut framework, as doing so would have significant adverse effects on the critical securities borrowing and lending markets.
  8. Investment grade counterparties and collateral: Regulators should remove the public listing requirement while assigning lower risk weights to counterparties to avoid unduly penalizing credit worthy counterparties that do not have publicly listed securities such as pension funds and municipal issuers. They should also recognize the risk mitigation benefits of safe collateral to better reflect counterparty credit risks.
  9. Fee-based services: Regulators should revise the proposed operational risk framework including the treatment of capital markets fee-based services to appropriately incentivize sound risk management practices and diversified business models.
  10. Implementation Timeline: The agencies should provide an appropriate amount of time to implement the final Basel framework (at least 18 months from completion of the final rule).

These are items that are top of mind here at SIFMA and today’s panels should give policymakers additional food for thought as they re-analyze their approach.

Turning then to our program today. First, we will ask our participants for their overall reflections on the Basel III Endgame proposal and evaluate its impacts on U.S. capital markets, end users, and the broader economy.

Then we will move to a deeper dive on the proposal’s capital markets components, including the Fundamental Review of the Trading Book, Credit Valuation Adjustment, and the framework for haircuts on Securities Financing Transactions. We’ll identify some of the challenges with these aspects of the proposal and potential solutions.

We will end with a discussion of the proposal’s interactions with other components of the capital framework, particularly the supervisory stress tests, GSIB surcharge, and resolution-related capital requirements, as well as an evaluation of the road ahead for the proposal.

And now, let’s get started. 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. And as you all know, Jelena is also a former Chairman of the Federal Deposit Insurance Corporation.

Joseph L. Seidel is Chief Operating Officer of SIFMA. He manages the day-to-day operations of the Association, including core legal, regulatory, business practices, public policy and communications activities.