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ISDA Warning on Impact of Increased Capital Requirements on US Capital Markets

The International Swaps and Derivatives Association (ISDA) has issued a warning regarding the potential impact of the US Basel III Endgame’s increase in capital requirements for bank trading activities on the liquidity and vibrancy of US capital markets. ISDA joined forces with the Securities Industry and Financial Markets Association (SIFMA) to submit a response to the Federal Reserve’s notice of proposed rulemaking (NPR).

In their response, the Associations highlighted concerns that the heightened capital requirements for bank trading activities do not accurately reflect the underlying risks and could lead to increased costs and reduced choices for US businesses. ISDA pointed out that the introduction of the Fundamental Review of the Trading Book (FRTB) and the revised credit valuation adjustment (CVA) framework could result in a substantial 129 per cent increase in market risk and CVA risk-weighted assets (RWAs) under the new expanded risk-based approach (ERBA) compared to the current US standardised approach.

Furthermore, the Association explained that such a significant increase in risk-weighted assets could constrain bank balance sheets, potentially forcing banks to scale back or withdraw from certain activities and businesses that become uneconomic. This, in turn, could impact the availability and cost of financing, hedging, and intermediary services, leading to less liquid and vibrant capital markets, which may have a negative effect on US businesses and households and weigh on US economic growth.

The response submitted by ISDA and SIFMA proposed a number of calibration changes aimed at ensuring that the rules are appropriate, risk-sensitive, and do not result in adverse consequences for US capital markets. These recommendations included a comprehensive evaluation of how the proposal would interact with other prudential requirements, particularly the stress testing framework and the G-SIB surcharge.

Additionally, ISDA pointed out that critical revisions should be made to improve the recognition of diversification when calculating market risk RWAs under the ERBA, reflecting actual risk exposure and effective risk management practices. The Association also suggested that if material changes to the calibration cannot be achieved without further consultation, a re-proposal of the rules may be necessary.

To ensure that banking organizations have sufficient time to implement the requirements, ISDA recommended that the rules should become effective no earlier than 18 months from the publication of the final rule. ISDA and SIFMA also submitted a response to a separate consultation by the US Federal Reserve on proposed changes to the G-SIB surcharge, raising concerns about the potential for “inappropriately high” capital requirements for banks offering client clearing services.

ISDA’s response argued that client derivatives transactions cleared under the agency model should not be included in the complexity and interconnectedness categories of the G-SIB surcharge calculation, as this could discourage banks from participating in this business and run counter to the longstanding policy objective of promoting central clearing.

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The AI legalese decoder can help in interpreting and understanding the complex legal and regulatory language used in the proposals and responses submitted by ISDA and SIFMA. By using AI algorithms to break down and simplify the intricate terminology, the AI legalese decoder can assist stakeholders in grasping the implications of the proposed rule changes and their potential impact on US capital markets. This tool can provide valuable insights into the legal and regulatory aspects of the Basel III Endgame and the associated increase in capital requirements for bank trading activities, ultimately aiding organizations in navigating and responding to these developments effectively.

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