Our Take: financial services regulatory update – May 03, 2024

• What happened? On April 30th, the Basel Committee on Banking Supervision (BCBS) released a consultative document on proposed guidelines for counterparty credit risk (CCR) management. The proposed guidelines are intended to replace the Committee's January 1999 Sound Practices for Banks’ Interactions with Highly Leveraged Institutions.
• What do the proposed guidelines say? The guidelines provide a comprehensive overview of key practices that are intended to “resolve long-standing industry weaknesses” in CCR management, including:
  • Performing due diligence, both at counterparty onboarding and on an ongoing basis
  • Developing a comprehensive credit risk mitigation strategy
  • Measuring, controlling and limiting CCR using complementary metrics; and
  • Building a strong governance framework
• Which organizations are the guidelines intended to cover? The proposed guidelines are designed to be “broadly applicable” to help banks manage CCR exposures to all types of counterparties. However, the greatest potential benefit are cases where banks have high-risk exposures, including to non-bank financial institutions. The BCBS encourages banks to take a risk-based, proportional approach to applying the guidelines that takes into account the degree of CCR generated by the business model, the complexity of CCR exposures and the overall risk appetite of the bank.
• What’s next? The BCBS is welcoming comments on the proposed guidelines until August 28th, 2024.

Our Take

BCBS joins the chorus. The proposed guidelines follow recent statements on CCR management from other regulators, including Fed Vice Chair for Supervision Michael Barr’s recent speech outlining supervisory expectations and the European Central Bank’s October 2023 sound practices publication. Taken together, they reflect regulators’ recognition of significant growth in CCR complexity and the need for more comprehensive and specific guidelines following events such as the 2021 collapse of Archegos Capital Management. While the proposal largely echoes the statements by other regulators, it underscores what is now becoming the baseline expectation across multiple jurisdictions, including:

• Due diligence and monitoring. While due diligence during onboarding has long been an expectation, regulators will look for ongoing due diligence and review of updated information (e.g. real time monitoring of news, company disclosures) at both the counterparty and portfolio levels.
• Credit risk mitigation. Firms should have transparent margining that is regularly assessed for adequacy and calibrated to the overall relationship risk profile rather than a response to the competitive landscape. Consideration should be given to static versus dynamic initial margin methodologies, variation margin components such as minimum transfer amounts and thresholds along with the dispute resolution framework. In addition to margining, contractual provisions and guarantees should also be incorporated into the regular review of credit exposure.
• Exposure measurement. Regulators will expect that firms understand the limitations of each risk metric and how they complement one another at both the counterparty and portfolio levels.
• Governance. Firms are expected to have effective board and senior management oversight of CCR strategy, reporting and decision making.
• Infrastructure, data and risk system. This includes simplifying data flows and ensuring adequate compensating controls for more complex infrastructures.
• Closeout practices. Firms should have a clear understanding of the full costs and legal considerations of liquidating a counterparty.

As banks review the new guidelines and provide commentary back to the BCBS, there is an opportunity to look at their own CCR management processes and capabilities to ensure suitability against their business models and risk appetite. While none of the message is new, the reinvigorated nature of the guidance indicates more to come.