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E-MailThe following post comes to us from Byungkwon Lim, partner in the Corporate Department at Debevoise & Plimpton LLP and leader of the firm’s Hedge Funds and Derivatives & Structured Finance Groups. This post is based on the introduction to a Debevoise & Plimpton Client Update; the full publication is available here.
On September 3, the Board of Governors of the Federal Reserve (the “Federal Reserve”), the Federal Deposit Insurance Corporation (the “FDIC”) and the Office of the Comptroller of the Currency (the “OCC”) (collectively, the “Agencies”), released a final rule that applies a Liquidity Coverage Ratio (the “LCR”) to certain U.S. banking organizations (the “Final Rule”). The rule finalizes a proposal published by the Agencies on October 24, 2013 (the “Proposed Rule”), and includes a number of substantive and technical changes.
Currently, U.S. banking regulations do not impose a quantitative liquidity requirement on banking organizations but, instead, require the use of prudential risk management and other tools to manage liquidity needs. The Final Rule for the first time requires banking organizations to meet minimum quantitative liquidity standards and, thus, represents an important milestone in the post-crisis regulatory reform process.
The Final Rule is broadly consistent with the LCR finalized in January 2013 by the Basel Committee on Banking Supervision (the “Basel Committee”) and with the Proposed Rule. However, as with U.S. regulators’ implementation of other Basel Committee initiatives, the Final Rule is in certain key respects more stringent than the international standard. For example, the LCR has a shorter phase-in period than the Basel equivalent, and certain asset classes are treated less favorably by the Final Rule than by the Basel standards.
The LCR, in combination with recent regulatory initiatives, such as those relating to over-the-counter derivatives, may increase the demand for high-quality collateral, as banking organizations seek to optimize usage of these assets. This increased demand in turn may lead to shortages of key assets in the marketplace. In addition, because high-quality liquid assets tend to generate lower returns (and also count in the denominator of the supplementary leverage ratio), the net effect of these reforms may be to cause banking organizations to rethink business lines, such as prime brokerage that, while profitable, demand significant amounts the high-quality, low net margin collateral to meet the LCR.
The full publication is available here.
