On 16 December, the Basel Committee on Banking Supervision of the Bank for International Settlements (“Basel Committee”) announced its new global framework for regulating banks and banking systems, known as Basel III. The Basel Committee also released a number of documents relating to the new framework.
If you would like to read the following reports issued by the Basel Committee:
- Basel III: A global regulatory framework for more resilient banks and banking systems (“Basel III Framework document”), click here.
- Basel III: International framework for liquidity risk measurement, standards and monitoring (“Basel III Liquidity document”), click here.
- Guidance for national authorities operating the countercyclical capital buffer (“Basel III Countercyclical Buffer document”), click here.
- Results of the comprehensive quantitative impact study (“QIS document”), click here.
- Public announcement by the Basel Committee on the release of the Basel III framework and the results of the quantitative impact study, click here.
While the full scope of the new Basel III global framework for regulating banks and banking systems is beyond the scope of this Legal Update, interested observers of covered bonds and the development of a covered bond market in Australia will note some important aspects of the new Liquidity Coverage Ratio (“LCR”) requirement that will feature in the Basel III framework.
The Basel III Liquidity document states that the objective of Basel III framework “is to improve the banking sector’s ability to absorb shocks arising from financial and economic stress, whatever the source” and clarified that the LCR is designed to “promote short-term resilience of a bank’s liquidity risk profile by ensuring that it has sufficient high-quality assets to survive a significant stress scenario lasting for one month”. The LCR will be implemented with an observation period and will include a provision to review its operation to avoid any unintended consequences.
Meanwhile, the following day, on 17 December, in a joint media release, the RBA and APRA announced the joint approach agreed by the RBA and APRA in relation to the implementation of the LCR in Australia. The RBA and APRA recognise that, under the new LCR, the majority of high-quality liquid assets are likely to take the form of Government securities.
This causes potential difficulties in jurisdictions where there is a relative scarcity of Government securities, such as Singapore, Hong Kong SAR, Saudi Arabia and Australia. To that end, the new Basel III framework allows up to 40% of the high-quality liquid assets to comprise corporate bonds and (importantly) covered bonds rated AA- or above (and other assets), which reflected a political bargain struck at the G20 Conference in Seoul in November 2010. Therefore, covered bonds rated at least AA- will be available to satisfy this element of the LCR.
However, in their joint media release, the RBA and APRA announced that ADIs may establish a committed secured liquidity facility with the RBA which is sufficient in size to cover any shortfall between the ADIs’ holdings of high-quality liquid assets and its LCR requirement. Eligible collateral for use under this facility will comprise all assets which are eligible for repurchase (repo) transactions with the RBA under normal market operations.
Those facilities will count towards an ADI meeting its LCR requirement. Under the RBA’s current repo eligibility criteria, “ADI-issued Debt Securities” rated at least A- and “Other AAA-rated Debt Securities” rated AAA (among others) qualify as Eligible Securities for Buy Repos. As covered bonds typically are AAA rated, they can be expected to satisfy the rating requirements of the RBA’s current repo eligibility criteria as Eligible Securities for Buy Repos. Therefore, provided other aspects of the RBA’s repo eligibility criteria are addressed in structuring the covered bonds, ADIs can expect to be allowed to use AAA rated covered bonds in this way to meet their LCR requirement.
Allowing ADIs to issue covered bonds has also neatly dealt with the outstanding issue from the finalisation of the Basel III framework of how ADIs will satisfy their LCR requirement in the absence of a significant quantity of high-quality Australian liquid assets and its impact on the ability of ADIs to meet their LCR requirement. A deep and liquid market in ADI-issued covered bonds can be expected to significantly ease the LCR requirement pressure on ADIs under the joint approach announced by the RBA and APRA.
If you would like to read the joint RBA/APRA announcement (as published on the RBA’s website), click here.