In part 1 of the "Basel III cracks are appearing" post which can be accessed by clicking here, we discussed the general misunderstanding on how capital works in Basel III. In this article we are going to look at some of the disparate issues around the new Liquidity Coverage Ratio.
All that aside, there are some broad concerns with the way in which specific elements are being interpreted by national regulators across the globe.
These new aspects of Basel III need careful tweaking to avoid unintended market consequences.
At the end of February 2011, the Australian Prudential Regulatory Authority (APRA) issued a memorandum on the type of instruments it accepts as high quality liquid assets. To the surprise of the market, Kangaroo Bonds were not included in the itinerary, even though many of these bonds are AAA rated. What is even more amazing is that these bonds do actually qualify as haircuts or collateral for repo style transactions which are accepted by the Reserve Bank of Australia.
Kangaroo bonds are debt securities with relatively long tenors and are issued by offshore firms into the Australian domestic market. They are denominated in Aussie Dollars, have to meet the Australian investment legal requirements, are settled through Austraclear and they are listed on the Australian Stock Exchange. Financial institutions such as the Asian Development Bank and the European Investment Bank issue Kangaroo bonds to raise cash for funding world class infrastructure projects, the instruments have surged over 80% in the market over the last twelve months before the APRA announcement.
There are several concerns with this ruling.
Firstly, if a AAA rate bond with no currency exposure is not up to standard for a quality liquid asset, then banks will be forced onto a slim range of instruments which could eventually be a driver for concentration risk down the track.
Secondly, if debt issued by a world class development bank is below the bar, countries further afield, especially in the emerging markets are going to struggle to find anything that comes close to being a "quality asset". The result of all of this will be an uneven global playing field on what one regulator classifies as liquid capital in one jurisdiction, another regulator will disallow it elsewhere. Finally for the Kangaroo market, there will be a noticeable drop in demand for this paper as the institutional buyers move away from the asset class.
I would not agree that our bonds are not liquid enough, this ruling was surprising
Eila Kreivi | EIB
On the other side of the planet, Denmarks regulator, the Finanstilsynet has stated that it wants to move the definition of the Liquidity Coverage Ratio away from any puritanical set of assets altogether. While it is strongly supporting the liquidity cover ratio concept, it has issues with the classing some top rated instruments as liquidity and others as not.
Finanstilsynet strongly supports the aim of the Basel Committee's capital and liquidity reform package. We are however deeply concerned with the treatment of Danish covered bonds in the definition of liquid assets in the Liquidity Coverage Ratio.
Finanstilsynet | Finanstilsynet link
APRA ON CAPITAL
When it comes to capital rules and preparedness specifically, APRA defends the case that Australian banks are already well capitalised and APRA has clearly stated this opinion with the Bank for International Settlements.
Australian banks and authorised deposit taking institutions already or nearly meet the central Basel III capital rules ... It is a long transition period to the new rules and there is a virtue in being able to declare Australian banks compliant with Basel III ahead of schedule
Wayne Byres | APRA