January 16, 2024

Ann E. Misback
Secretary
Board of Governors of the Federal Reserve System
20th Street and Constitution Avenue NW
Washington, DC 20551

Re: Regulatory Capital Rule: Risk-Based Capital Surcharges for Global Systemically Important Bank Holding Companies; Systemic Risk Report (FR Y-15)

No. R-1814, RIN 7100-AG65

Dear Secretary Misback,

The International Swaps and Derivatives Association, Inc. (“ISDA”) and the Securities Industry and Financial Markets Association (“SIFMA” and, together with ISDA, the “Associations”) welcome the opportunity to comment on the proposal referenced above (the “GSIB Surcharge NPR”) issued by the Board of Governors of the Federal Reserve System (the “Federal Reserve”).1

Executive Summary

This letter addresses only issues under the GSIB Surcharge NPR that are most directly relevant to derivatives. In that regard, the Associations offer three specific recommendations, the first of which relates to client-cleared derivatives specifically and the latter two of which relate to derivatives in general:

1. Client-cleared derivatives cleared under the agency model should not be included in the complexity and interconnectedness categories of the GSIB surcharge calculation.
2. Derivatives exposures should not be included in the cross-jurisdictional activity indicators. At a minimum, derivatives exposures should be net of collateral in the cross-jurisdictional activity indicators.
3. The SA-CCR alpha factor should not be included in the interconnectedness indicators
   calculations.

Client-cleared derivatives under the agency model should not be included in the complexity and interconnectedness categories of the GSIB surcharge calculation.

We are concerned that the proposed inclusion of a banking organization’s guarantees of client performance to a central counterparty (“CCP”) with respect to client-cleared derivatives in the complexity and interconnectedness categories would (i) not align with the actual risk presented by this activity, (ii) sharply depart from the existing framework without sufficient explanation, (iii) reduce capacity and willingness of banking organizations to clear for clients, and (iv) contravene the long-standing public policy objective to promote central clearing. For these reasons, we urge the Federal Reserve not to adopt this aspect of the GSIB Surcharge NPR.

We strongly support the development of risk-sensitive capital requirements that are aligned with the economics of banking organizations’ exposures and activities. The proposed change to the treatment of a banking organization’s guarantees of client performance to a CCP with respect to client-cleared derivatives would frustrate this objective by further increasing capital requirements associated with client clearing, the risks of which are already over-capitalized in the U.S. regulatory capital framework. Client clearing is a low-risk activity that promotes financial stability and reduces the complexity of the financial system and individual banking organizations. In this regard, we share Chair Powell’s view that regulators “have a responsibility to ensure that bank capital standards and other policies do not unnecessarily discourage central clearing.”2 We also share Governor Bowman’s concern that an improperly calibrated capital requirement under the GSIB surcharge framework “may discourage low-risk activities or result in unintended consequences.”3

In addition to our specific concerns about the GSIB Surcharge NPR’s treatment of banking organizations’ guarantees of client performance to a CCP with respect to client-cleared derivatives, we are more generally concerned about the impact of higher capital requirements on the ability of banking organizations to intermediate client clearing. Higher capital requirements under the GSIB Surcharge NPR and the U.S. banking agencies’ Basel III Endgame proposal4 would further constrain large banking organizations’ balance sheet capacity available for a range of activities, potentially including client clearing. Insufficient access to client clearing could be detrimental to market structure and financial stability, particularly in times of volatility and market stress. We urge the Federal Reserve to consider the aggregate impact of its proposed regulatory capital- elated rules on the provision of critical financial services, including client clearing, and consult with the Securities and Exchange Commission (“SEC”)5 and the Commodity Futures Trading Commission (“CFTC”) on the interaction of its proposals with other regulatory mandates in critical markets.

According to the Associations’ quantitative impact study (“QIS”), in which all six GSIBs that provide clearing services in the United States participated, including derivatives notional exposures cleared under the agency model in the complexity indicator (+69.4 points) and the interconnectedness indicators (+4.5 points), would in aggregate increase the GSIB score of the six participating banking organizations by 74 points.6 This increase in method 2 surcharge scores would be applied to risk-weighted assets (“RWAs”) calculated under the proposed expanded risk-based approach and therefore would significantly raise capital requirements, by $5.2 billion,7 in the aggregate across all QIS participants. The effect of the proposed changes to the GSIB methodology cited above would be compounded by the significant impact of the higher RWA requirements under the U.S. Basel III Endgame proposal.

As this cost would be driven solely by GSIBs’ clearing businesses, there could be pressure on these businesses to reduce the notional amounts stemming from client clearing, especially if the marginal impact of clearing activity is to push a GSIB into the next GSIB surcharge bucket.

Part I of this letter discusses in greater detail why the Federal Reserve should retain the existing treatment of client-cleared derivatives under the GSIB surcharge framework.

Derivatives exposures should not be included in cross-jurisdictional activity indicators. At a minimum, derivatives exposures should be net of collateral in the cross-jurisdictional activity indicators.

It is unclear why the cross-jurisdictional activity indicators should include derivatives exposures (both client-cleared and otherwise), especially as these exposures are already captured in other indicators, including in the size, interconnectedness and complexity categories. By the Federal Reserve’s own analysis, the inclusion of derivatives exposures is one of the main drivers of the increase in method 2 scores as a result of the GSIB Surcharge NPR.8 We urge the Federal Reserve not to include derivatives exposures in the cross-jurisdictional activity indicators. At a minimum, banking organizations should be permitted to calculate derivatives exposures included in cross-jurisdictional claims and cross-jurisdictional liabilities net of collateral.

The SA-CCR alpha factor should not be included in the interconnectedness indicators calculations.

As stated in the preamble to the SA-CCR final rule, the alpha factor is “designed to address risks that are not directly captured under SA-CCR, and to ensure that the capital requirement for a derivative contract under SA-CCR is generally not lower than the one produced under IMM”.9 The “risks not directly captured” relate in particular to wrong-way risk.10 This risk adjustment is inappropriate in the context of an exposure metric to measure interconnectedness as opposed to a measure of risk as applicable in risk-weighted assets. An exposure metric to measure interconnectedness should not include unrelated multipliers. In addition, the second objective mentioned above does also not justify the inclusion of the alpha multiplier. In particular, the U.S. banking agencies’ Basel III Endgame proposal generally prohibits the use of internal models. Even without considering the elimination of the internal models methodology (“IMM”) from the RWA framework, the calibration comparability to IMM is simply not relevant in the context of the GSIB surcharge. Therefore, the Federal Reserve should not include the alpha factor in the calculation of derivatives exposures for the interconnectedness indicators.

Part II of this letter discusses in greater detail why our recommendations would improve the calibration and coherence of the GSIB surcharge framework.

1 Regulatory Capital Rule: Risk-Based Capital Surcharges for Global Systemically Important Bank Holding Companies; Systemic Risk Report (FR Y–15), 88 Fed. Reg. 60,385 (Sept. 1, 2023).

2 Federal Reserve Governor Jerome H. Powell, Central Clearing and Liquidity, Federal Reserve Bank of Chicago Symposium on Central Clearing, Chicago, Illinois (June 23, 2017), available at
https://www.federalreserve.gov/newsevents/speech/files/powell20170623a.pdf.

3 Statement by Governor Michelle W. Bowman (July 27, 2023), available at https://www.federalreserve.gov/newsevents/pressreleases/bowman-statement-20230727.htm.

4 Regulatory Capital Rule: Large Banking Organizations and Banking Organizations with Significant Trading Activity, 88 Fed. Reg. 64,028, 64,170-71 (Sept. 18, 2023).

5 Market participants are still analyzing the impact of the SEC’s recently finalized clearing requirements for U.S. Treasury security transactions. However, if clearing capacity is already constrained, it could be challenging to add a new asset class (U.S. Treasuries and repos) to the set of products that clients are required to clear.

6 Other proposed changes would reduce the impact of the GSIB Surcharge NPR: Expanding the FI
definition and the implementation of SA-CCR would reduce the impact by 7 points to a total increase of 67 points. This reduction is largely driven by SA-CCR implementation and could be less if, for example, the SA-CCR alpha factor were applied (see section II.B). In addition, the analysis excludes the impact of averaging, which the Federal Reserve estimates would raise method 2 GSIB scores by 9 points on average. See 88 Fed. Reg. at 60,397.

7 The total impact was calculated based on the total increase of the GSIB score for each firm, multiplied by the estimated Basel III expanded risk-based approach RWAs for each firm.

8 88 Fed. Reg. 60,397.

9 Standardized Approach for Calculating the Exposure Amount of Derivative Contracts, 85 Fed. Reg. 4,362, 4,366 (Jan. 24, 2020).

10 See 85 Fed. Reg. 4,372 (“Additionally, the alpha factor serves to capture certain risks (e.g., wrong-way risk, non-granular risk exposures, etc.) that are not fully reflected under either IMM or SA-CCR.”).