Acuiti was commissioned by Quantile Technologies, to conduct a study into the impact and implementation of SA-CCR. In the first of four articles, taken from the whitepaper, we take a look at the impact across asset classes.
The data is based on a survey and series of interviews with over 40 banks and financial intermediaries. In order to gauge how SA-CCR would affect different asset classes and client types, Acuiti asked banks that had conducted analyses of the impact whether capital requirements would increase following its introduction.
We found differing views on the impact across asset classes and client types, which reflect the complexity of SA-CCR and the wide-ranging impact it has depending on the specific portfolio of positions.
Interest rates: higher capital requirements
While on the face of it, overall exposures in the rates market are expected to be significantly reduced by the ability to offset risk-cancelling positions and a relatively low supervisory factor, the construction of the netting sets allows only very limited offsetting between different maturity buckets. In addition, the hedging sets are limited to the same underlying currency and further fragmented for intra-currency basis trades. The introduction of a duration-based approach further penalises long-dated trades compared to CEM, where any trades longer than 5 years are subject to the same supervisory risk factor. The impact of SA-CCR on interest rates is diverse, which is reflected in the bimodal distribution of the reported changes in capital requirements set out in the chart above. Banks with multi-directional, predominantly cleared portfolios will benefit vs CEM. However, for banks and their clients with non-cleared, directional positions with a higher margin period of risk, the impact of SA-CCR can be punitive. Much of the rates market has moved to clearing already but SA-CCR is likely to further that trend.
FX: Significantly higher capital requirements
While FX only has one maturity bucket under SA-CCR, the market is one of the big losers from SA-CCR owing to both the current market structure and to the construction of the hedging sets, which are limited to each currency pair. Optimisation of portfolios can go a long way toward mitigating some of the impact. For example, a bank that is long euros/short dollars and then short sterling/long dollars can net out the positions to arrive at a long euro/short sterling position. However, this only has a limited impact on reducing increases in capital requirements. In terms of market structure, large swathes of the FX market remain bilaterally traded and many users, such as corporates, rely on non-cash collateral to margin positions, which is penalised under SA-CCR particularly for leverage ratio calculations. As a result, 38% of respondents predicted a significant increase in capital requirements for FX.
Equities: higher capital requirements
There is a single hedging set for equity derivatives and full offsetting is allowed for positions that reference the same underlying, whether a single name or index. Partial offsetting is allowed across different underlying entities. The supervisory factor add-on for equities is high at 32% for a single name and 20% for an index, which results in an increase for most positions compared to CEM. In addition, SA-CCR applies a ‘one-size fits all’ add-on for both single stock equities and equity indices, which does not account for the different risk and volatility profiles of, for example, investment-grade vs emerging market names – a distinction that is made for credit. However, this impact contrasts with the impact on market makers, particularly with regard to equity options, who benefit significantly from banks’ ability to offset trades. For this reason, several banks reported significant decreases in capital requirements for equities, while those who serve other parts of the market are subject to increases.
Credit: lower capital requirements
The calculation of the add-on for the equity derivatives is similar in construct to the calculation of the add-on for the credit in that it only gives full recognition of the offsetting of long and short positions for derivatives that reference the same entity or index. However, in credit, the supervisory factor scales up depending on the rating of the issuers as well as the tenor of the trade. In addition, the lower end of the scale is significantly lower compared to equities at 0.38% for AAA-rated names and investment-grade indices, reflecting the seniority of credit over equity in the capital structure leading to lower volatility assumptions. Additionally, as much of the credit market is now cleared, it is subject to additional benefits under SA-CCR. The result is that credit is one of the big winners from SA-CCR, with 68% of respondents saying that capital requirements will reduce.
Commodities: significantly higher capital requirements
Commodities under SA-CCR suffer from both a high supervisory factor and netting sets that do not fully reflect market structure. Electricity attracts the highest supervisory factor add-on at 40%, while other commodities are subject to 18%. These volatility assumptions and the broad nature of the hedging sets create significant adverse consequences for commodities. According to the study by ISDA, the FIA and other associations, EAD and RWA increase by 29% and 70%, respectively, when compared with CEM. The market structure also significantly impacts commodities, in particular with regard to energy. While parts of the market are exchange-traded and centrally cleared, thousands of very similar or identical instruments are listed on different exchanges. Netting is not permitted between exchanges, and so firms that actively trade across different markets are subject to significantly higher capital requirements. This is expected to have a particularly negative impact on market makers trading across different exchanges. Overall, 72% of respondents said that SA-CCR would increase capital requirements for commodities.