09 May 2013

APRA sets a high water mark for implementing Basel III liquidity reforms

On 6 May 2013 the Australian Prudential Regulation Authority (APRA) released a second consultation package outlining updates to its proposals to implement the Basel III liquidity reforms for authorised deposit-taking institutions (ADIs) in Australia.

The package, comprising a discussion paper, a revised draft Prudential Standard APS 210 Liquidity (APS 210) and a draft Prudential Practice Guide APG 210 Liquidity, addresses several of the issues raised in submissions on APRA’s previous discussion paper released in November 2011.

The 2011 discussion paper outlined APRA's proposals for the implementation of the Basel III liquidity standards in Australia, including the introduction of the 30 day Liquidity Coverage Ratio (LCR), which accounts for an acute stress scenario, and the Net Stable Funding Ratio (NSFR) to encourage longer-term funding resilience. The consultation package maintains these measures in the updated draft APS 210 subject to some adjustments to the cash flow assumptions, as outlined below.

It also incorporates revisions to draft APS 210 to reflect updates to the Basel III liquidity reforms published by the Basel Committee on Banking Supervision in January 2013.

This article considers APRA's response to the Basel III liquidity reforms and other issues raised following APRA's previous discussion paper.

APRA's response to updates to the Basel III Liquidity Reforms

The second consultation package canvasses a number of issues, including the extent to which APRA will implement recent adjustments by the Basel Committee to the LCR, including the broadening of the definition of high-quality liquid assets (HQLA) to encompass a wider range of assets (such as equities and high quality residential mortgage backed securities), amendments to the net cash outflow assumptions in calculating the LCR and allowing a phase-in period for the introduction of the LCR. APRA's response to these Basel III level adjustments is discussed below.

LCR implementation timetable

Under the new Basel III phase-in arrangements, the LCR will be introduced as scheduled on 1 January 2015, but the minimum requirement will begin at 60%, rising in equal annual steps of 10percentage points to reach 100% on 1January 2019. This graduated approach is designed to ensure that the LCR can be introduced without disrupting the orderly strengthening of banking systems or the ongoing financing of economic activity. It is not clear whether the changes to the LCR timetable will lead to the Basel Committee announcing a corresponding phase-in for the NSFR.

Notwithstanding the new Basel III phase in arrangements, APRA is proposing to implement the liquidity reforms on its previously published timetable. The LCR will therefore become effective in Australia as of 1 January 2015 with no phase-in and the NSFR from 1 January 2018.

High quality liquid assets (HQLA)

The changes to the LCR announced in the Basel III liquidity reforms included a discretion for national authorities to widen the range of liquid assets in the definition of high quality liquid assets (HQLA). Under the Basel Committee's original measures, HQLAs were categorised according to the liquidity characteristics of the assets. APRA characterised these as HQLA1 and HQLA2.

Following a review of the marketable instruments denominated in Australian dollars, APRA previously advised that the only assets that qualified for HQLA1 were cash, balances held with the RBA, and Commonwealth Government and semi-government securities and moreover, that there were no assets that qualified as HQLA2. This approach was confirmed in the updated draft APS 210.

The Basel Committee has since introduced a third level of HQLA assets, known as Level 2B assets, which regulators have a discretion to allow banks in their jurisdiction to count towards their LCR calculations. These are:

  • RMBS rated AA or higher not issued by the bank itself or any of its affiliate entities;
  • corporate debt securities rated between A+ and BBB- not issued by a financial institution or any of its affiliate entities; or
  • ordinary shares not issued by a financial institution or any of its affiliate entities.

APRA has opted not to recognise any Level 2B assets and so the definition of HQLA in the updated draft APS 210 remains unchanged.

At the same time, APRA has indirectly recognised the role of certain Level 2A (ie. former HQLA2 assets) and Level 2B assets in liquidity management by permitting these to be repo-eligible with the RBA for normal market operations and also eligible collateral for the committed liquidity facility (CLF) from the Reserve Bank of Australia (RBA). These include certain sovereign, supranational and foreign agency Australian dollar-denominated bonds, RMBS rated AAA or higher, and some corporate debt securities. ADIs with access to the CLF are therefore likely to have appetite to hold these types of assets as part of a well-diversified liquid assets portfolio.

Equities are not repo-eligible with the RBA.

Cash inflow and outflow rates

The Basel Committee has made a number of revisions to the cash outflow assumptions affecting the LCR calculations. These include the following:

  • Non-financial corporate, sovereigns, central banks and public sector entity (PSE) deposits: The revised framework has reduced the assumed cash outflow rate for non -operational non-financial corporate, sovereign, central bank and PSE deposits from 75 per cent to 40 per cent. APRA proposes to adopt this amendment.
  • Liquidity facilities for non-financial corporates: The revised Basel III framework has reduced the cash outflow rate for liquidity facilities provided to non-financial corporate customers from 100 per cent to 30 per cent. APRA proposes to adopt this amendment.
  • Collateral outflows attributable to market moves: The original Basel III liquidity framework gave national authorities discretion in setting the methodology for the calculation of collateral outflows related to market movements of derivative positions. The revised framework has removed this discretion and provides a standardised method for this calculation. APRA proposes to incorporate the standardised method into APS 210. This method requires ADIs to take the largest absolute net 30-day collateral flow realised in the past 24 months and model this balance as an outflow.
  • Committed but unfunded inter-financial liquidity and credit facilities: The revised framework has reduced the cash outflow rate for committed but unfunded liquidity and credit facilities provided to banking institutions that are prudentially supervised from 100 percent to 40 percent. APRA proposes to adopt this amendment.
  • Additional derivatives risks: The revised framework includes a number of additional collateral outflow categories designed to ensure that risks associated with derivative positions are correctly captured in the LCR. The cash outflow rate for these categories is 100 per cent of the measured value. APRA proposes to adopt these amendments.
  • Derivatives secured by HQLA: The revised framework has clarified that where a derivative cash flow is secured with an HQLA1 asset, a cash outflow rate of zero per cent is to be applied. APRA proposes to adopt this amendment.
  • Maturing secured funding transactions: The revised framework has reduced the outflow rate on maturing secured funding transactions with a central bank from 25 percent to zero percent. In the event that a secured funding transaction backed by CLF eligible collateral matures during a stress event, an ADI with a CLF will be able to roll the secured funding transaction because of the RBA’s commitment under the CLF. This will result in an outflow against this transaction of zero per cent. However, if the same transaction matured for an ADI that did not have a CLF, that ADI would have no guaranteed ability to roll the transaction, resulting in a possible outflow rate of 100 percent. APRA therefore proposes to include an additional category for maturing secured funding transactions backed by CLF eligible debt securities (where the ADI has capacity available under its CLF limit) with an outflow rate of zero percent. Following consultations with the RBA, APRA proposes that all other maturing secured funding transactions with the RBA that are not backed by HQLA will receive an outflow rate of 100 percent.
  • Fully insured unsecured wholesale funding: The revised framework includes an additional outflow category for fully insured non-operational, non-financial, unsecured wholesale deposits. APRA proposes to adopt the outflow rate of 20 percent.

APRA has received submissions on a number of other cash outflow assumptions. Its response to these has been mixed, ranging from their partial acceptance, where submissions are consistent with the Basel III liquidity framework provisions, to the wholesale acceptance or rejection of the relevant submissions.

Other issues raised in submissions

Minimum liquidity holdings regime

The 2011 discussion paper proposed that ADIs subject to the minimum liquidity holdings (MLH) regime, would not be subject to either of the two new Basel III global standards. Instead, they would be required to maintain minimum liquidity holdings, as outlined in APS 210.

This approach was confirmed in the updated draft APS 210. However, in response to submissions, APRA has made some minor adjustments to the MLH regime. These include the removal of the previously proposed 20 percent limit on the holding of assets with a credit rating grade 3 or lower as part of an ADI's MLH. However, APRA has maintained its exclusion on holding RMBS and ABS in MLH portfolios.

Qualitative requirements

In its 2011 discussion paper, APRA proposed to incorporate into the revised APS 210, the qualitative requirements for liquidity risk contained in the Basel III liquidity framework.

These include:

  • requirements for enhanced board oversight of ADI's liquidity risk management framework;
  • an articulation of the board's tolerance for liquidity risk;
  • quantification and allocation of liquidity costs and benefits; and
  • other matters.

Submissions were supportive of these measures and so these remain unchanged in the updated draft APS 210.

As part of the 2011 discussion paper, APRA had proposed the introduction of prudential disclosure requirements in respect of an ADI's liquidity risk management framework and liquidity position. Submissions concerning this proposal raised the undesirable market outcomes that may result from the disclosure of an ADI's LCR. APRA has clarified that it is not intending to introduce its disclosure requirements at this stage. It will consult separately on these requirements after the Basel Committee has published further guidance on this issue.

Next steps

APRA has invited submissions on the second consultation package by 17 June 2013. As part of the consultation process APRA has also asked for information from interested parties on the financial impact of its proposed implementation of the Basel III liquidity framework. Following consideration of submissions received, APRA has indicated that it will issue a final APS 210 and APG 210 in mid-2013.

If you have any questions in relation to the above, please contact Andrew Jinks on (02) 9353 5818.

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Clayton Utz communications are intended to provide commentary and general information. They should not be relied upon as legal advice. Formal legal advice should be sought in particular transactions or on matters of interest arising from this communication. Persons listed may not be admitted in all States and Territories.