LCR and PRA110 - Currency Derivatives Cashflows Calculation

Dear Followers,

In our previous articles, we discussed High-Quality Liquid Assets (HQLA), the treatment of Covered Bonds in the Liquidity Coverage Ratio (LCR) & PRA110, and Liquidity Stress Testing scenarios.

Today, we'll explore how to calculate cash flows from Currency Derivatives for regulatory liquidity reports such as LCR and PRA110 (Prudential Regulatory Authority).

Background: Currency derivatives are financial contracts that allow for the buying or selling of a specific currency at a future date. They can include products such as currency futures, currency options, currency swaps, and Foreign Exchange (FX) forwards.        

The total of all net derivative cash outflows/inflows must have a 100% factor. Banks must calculate expected contractual derivative cash inflows and outflows using their existing valuation methodologies. Cash flows can be calculated on a net basis, meaning inflows can offset outflows, but only by counterparty and only when a valid master netting agreement exists.

Cash flows resulting from foreign exchange derivative transactions, which entail a complete exchange of principal amounts on the same day (or in a simultaneous manner), may be represented as a net cash flow figure, even if these transactions are not governed by a master netting agreement.

Options that can be exercised within the next 30 days, including options with expiration dates beyond 30 days (such as American-style options), should be considered as exercised when they are “In The Money” for the option buyer.

LCR by significant currency

The Basel III liquidity risk framework outlines several key monitoring tools for assessing liquidity risk.

These monitoring tools comprise:

(i) Contractual maturity mismatch;

(ii) Concentration of funding;

(iii) Available unencumbered assets;

(iv) LCR by significant currency; and

(v) Market-related monitoring tools.

Let’s delve into the intricacies of the ‘LCR by significant currency’ tool.

Although the Liquidity Coverage Ratio (LCR) must be satisfied in a single currency, it is advisable for banks and supervisors to monitor the LCR in significant currencies as well. This approach enables them to identify and address potential currency mismatch concerns that may arise.

A currency is deemed “Significant” if the total liabilities denominated in that currency constitute 5% or more of the bank’s overall liabilities.

Supervisors must assess banks’ capacity to source funds in foreign currency markets and their ability to transfer excess liquidity from one currency to another and across different jurisdictions and legal entities.

“Cash flows arising from assets, liabilities, and off-balance sheet items will be calculated in the currency that the counterparties are obligated to deliver for contract settlement. This determination is independent of the currency to which the contract is indexed or linked, or the currency intended for hedging fluctuations.”

Pre-requisite for calculation:

1. Net Basis Calculation: The net basis should be computed by considering the net impact of collateral to be posted (Outflows) or received (Inflows) within the next 30 calendar days.
2. Significant Currency Reporting: It is essential to report significant currencies.
3. Net Basis by Counterparty: Evaluate the net basis across counterparties.

As depicted in the table, while calculating and reporting all currency combined LCR the cashflows were netted occurs across counterparties rather than across significant currencies like USD, GBP, and EUR.

• Barclays [Net Inflows: 0],
• JP Morgan & Chase Co., [Net Outflows: -55]
• Societe Generale [Net Inflows: 10]

However, the total inflows or outflows balance would be reported in case of significant currency reporting as follows:

• USD: Total Inflows of 25 and total Outflows of (10)
• GBP: Total Inflows of 25 and total Outflows of (50)
• EUR: Total Inflows of 15 and total Outflows of (50)

Here are the reporting rows for LCR:

Here are the reporting rows for PRA110:

Reporting Row: 1.4 - FX swaps maturing Total amount of cash outflows resulting from the maturity of FX swap transactions such as the exchange of principal amounts at the end of the contract.

Reporting Row: 2.3 - FX swaps maturing Total amount of contractual cash inflows resulting from the maturity of FX Swap transactions such as the exchange of principal amounts at the end of the contract. This reflects the maturing notional value of cross-currency swaps, FX spot and forward transactions in the applicable time buckets of the template.

Exploring this intricate calculation together promises to be an engaging and enlightening journey. Let’s delve deeper into the intricacies and unravel the requirements step by step.

#LCR #PRA110 #LiquidityRisk #Regulatoryreporting #Regulatorycompliance #BCBS #Basel3 #Derivatives #Currencyswaps #FXForwards