In its original form, the US Basel III endgame proposal would have resulted in disproportionate increases in capital for trading book activities, forcing banks to make difficult choices about their participation in certain businesses. After two-and-a-half years, a revised proposal is expected to be published soon, paving the way towards finalization and implementation of the rules. At ISDA, we’ve advocated relentlessly for calibration changes to achieve a robust, more risk-sensitive framework, and we hope this will be a turning point effectively balances the need for safety and soundness with market vibrancy.

ISDA’s commitment to risk-appropriate capital rules isn’t confined to the US – it’s critical in every jurisdiction around the world. If capital requirements are disproportionate to the underlying risk, companies and governments that rely on banks for financing would face reduced support, as well as a lack of hedging solutions and increased vulnerability to external shocks. In turn, this would undermine economic growth and stability – outcomes we can’t afford to risk. To avoid this happening in the US, changes need to be made in certain key areas.

First, we need to ensure internal models have a viable future for the calculation of market risk capital. While the Basel III market risk framework – the Fundamental Review of the Trading Book (FRTB) – deliberately raises the bar for the use of internal models, the proposed rules are so complex and operationally challenging that they threaten to choke off the use of internal models altogether. This would be a major change that we don’t think is in line with the Basel Committee’s intentions. We’ve proposed certain adjustments, including reducing the stringency of the profit-and-loss attribution test and addressing long-standing issues in the treatment of non-modellable risk factors, which would ensure the continued viability of internal models under the FRTB.

Second, we believe the standardized approach for counterparty credit risk should be amended to recognize the risk-reducing benefits of netting across products, including repos and futures. With mandatory clearing of certain cash US Treasury securities set to begin at the end of this year, and repos following in the middle of next year, the lack of recognition of cross-product netting would constrain banks’ balance sheets and limit their ability to offer client clearing. This issue must be addressed to enable the smooth implementation of the Treasury clearing rule.

Third, the combined effect of the proposed Basel III endgame and the capital surcharge for global systemically important banks (G-SIBs) would increase capital for US G-SIB client clearing businesses by more than 80%. That’s completely at odds with the policy objective to promote and incentivize clearing and would negatively affect market stability. By excluding the client-facing leg of a cleared derivatives transaction from the Basel III credit valuation adjustment framework and adjusting the G-SIB surcharge, policymakers can reduce this disproportionate tax on clearing.

These are just three of the important issues we’ve been focusing on as US policymakers have weighed up industry feedback and redrafted the original endgame proposal. Once the revisions are published, focus will shift to finalization and implementation of the rules. We’ll test the recalibrated framework to make sure it delivers the risk sensitivity that is so crucial. We’ll then work with our members to address any challenges on the road to implementation and pursue the end result that is needed – a robust, risk-sensitive trading book capital framework that stands the test of time.