Asia Focus: Basel III and the Leap Toward Better Collateral Management

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Asia Focus: Basel III and the Leap Toward Better Collateral Management

Developed in response to inadequacies in financial regulation exposed during the global financial crisis, Basel III calls for tough new rules on bank capital and liquidity. Although the new rules have a phased implementation from 2013 to 2019, the implications for the banking industry could be profound.

Collateral—its limits, optimal use and proper management—is also under intense focus after the global financial crisis. Whilst there is a lot of awareness in the market that the provision of collateral will be a key tool in mitigating the increased capital charges under the Basel III framework, there is less awareness that regulators are also raising the bar to strengthen collateral risk management practices and keep liquidity intact by ensuring that the right collateral has gone to the right counterparty, including central clearing counterparties. The new Basel III framework will ensure quality collateral and improved processes to ultimately benefit all market participants.

Adoption in Asia

The Basel Committee on Banking Supervision periodically issues a progress report on the implementation of its rules to promote a level playing field and to enhance transparency. The table on page 19 is based on the report published in May this year demonstrating Asia's implementation status of Basel III— essentially an enhancement of the Basel II and Basel 2.5 frameworks. Member countries across the region are still in the process of drafting regulations around Basel III. Instead of taking a waitand- see approach, many banks in Asia have already started forming their own due diligence committees to review their current operations—including collateral management—and preparing to meet the requirements of the new framework.

Enhanced processes, not just more collateral

In light of enhancements and changes surrounding counterparty risk management and liquidity, collateralized financing and repo/security lending assume greater relevance with respect to both capital and liquidity efficiencies. Key factors include the following:

Banks falling under the Basel III regime must ensure sufficient resources are allocated to the efficient operation of margin agreements with OTC derivative and securities financing as measured by the timeliness and accuracy of its outgoing margin calls and response time to incoming margin calls.
Banks must have collateral management policies in place to control, monitor and report concentration risk and the reuse of collateral.
Depending on a bank's chosen method to calculate risk, the collateral management unit must have tools to control the integrity of data, provide internal reports indicating reuse of assets and concentration in any collateral class.
Each bank must conduct an independent annual review of its collateral management structure to assess the performance of these criteria.
Finally, a high number of margin disputes (which per definition only applies to the non-cleared market) will be penalized such that banks have to apply longer margining periods as a basis for determining the regulatory capital.

Key elements of Basel III¹

Better quality capital, with more reliance on common equity or 'Core Tier 1' capital
Minimum Core Tier 1 ratio increased from 2.0% to 4.5%, with an additional capital conservation buffer of 2.5%
Additional capital requirement to address pro-cyclicality in the form of counter-cyclical buffers
Surcharge on minimum capital requirements of up to 2.5% on Global Systemically Important Banks (GSIBs)
Introduction of a liquidity regime to address liquidity risks in banks, comprising a liquidity coverage ratio (LCR) and net stable funding ratio (NSFR)
- LCR requires banks to demonstrate that they have sufficient liquidity to meet outflows in a 30-day period of stress
- NSFR addresses liability structure risks by setting out stable funding requirements
Higher risk weightage for a range of exposures including certain inter-bank exposures and securitization exposures
Introduction of a new capital requirement framework for credit value adjustment (CVA) to capture the spread volatility in derivative counterparty risk
Significantly enhanced risk management and governance requirements covering counterparty risk and collateral management
New regime for measuring capital requirement for centrally cleared trades and banks' exposures to central counterparties (CCPs)

The requirement to improve collateral processes is not just limited to banks falling under the Basel III framework. In fact, regulators are beginning to incorporate this requirement into other pieces of legislation. For example, the Committee on Payment and Settlement Systems (CPSS)² and the International Organization of Securities Commissions (IOSCO) published their final report in April 2012 on standards (called "principles") for financial market infrastructures (FMIs) such as Central Securities Depositories or Central Counterparties. CPSS-IOSCO recommends that relevant authorities should strive to incorporate the principles into their legal and regulatory framework by the end of 2012 in line with the G-20 deadline for derivatives clearing.

The new principles require that FMIs use well-designed and operationally flexible collateral management systems that meet certain requirements such as functionalities to accommodate timely deposits, withdrawals, substitution and liquidation of collateral. Other relevant market participants are also increasingly faced with a regulatory push to have robust collateral management solutions to support their business growth.

Better collateral management

In preparation for Basel III, banks should consider how best to leverage collateral management as a key differentiator to help improve their capital management.

The new Basel III framework will ensure quality collateral and improved processes to ultimately benefit all market participants.

By taking concrete actions now such as determining regulatory status and impacts, reviewing current collateral requirements and collateral management systems as well as using technology to provide a common framework for enterprisewide collateral management, banks can make better use of their assets, manage complex collateral schedules and become more competitive.

Although global financial reform can be daunting in its breadth and complexity, with early planning and implementation firms cannot only retain their flexibility to accommodate years of future fine tuning and reforms, but also make the leap to better collateral management.

Implementation of Basel in Asia at end of May 2012
Country	Basel 2.5 Status	Basel III Status
Australia	4	2

China	4	2

Hong Kong SAR	4	1, 3

India	4	3

Indonesia	1	1

Japan	4	3

Korea	4	1

Singapore	4	2
Key: 1 = draft regulation not published 2 = draft regulation published 3 = final rule published 4 = final rule in force

O'Delle Burke
Product Manager,
Collateral Management, Asia-ex Japan & Australia

Chunhua Ou
Product Specialist,
Collateral Management, Asia Pacific

Thought, Fall 2012

¹ Some aspects of the Basel III rules are not finalized and other aspects (e.g., LCR) may be adjusted from what is presently proposed. The national implementation may differ from the Basel III framework.
² The forum of central banks to monitor and analyze developments in payment, settlement and clearing systems.

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