28 June 2021 marks the implementation date for the Net Stable Funding Ratio (NSFR) in Europe(1). This article looks at what NSFR means, its potential impact if implemented in its current form, and how market participants can assist LBMA’s important data analysis.
What is NSFR?
NSFR’s wider objective, within the Capital Requirements Regulation (CRR) II framework, is to oblige banks to finance long-term assets with long-term money in order to avoid the liquidity failures seen during the 2007/08 global financial crisis. For precious metals, NSFR will require 85% of Required Stable Funding (RSF) to be held against the financing and the clearing and settlement of precious metals transactions. Current status In light of the COVID-19 pandemic, the Basel Committee on Banking Supervision (BCBS) recently announced the deferral of some Basel III standards by one year, however these do not include NSFR. Until the framework is fully implemented around the world, we may not see true NSFR impact statistics until 2021 and beyond.
Why 85%?
In December 2013, the European Banking Authority (EBA) published its Report which included an analysis of the liquidity and credit quality of various asset classes. In the Report, government bonds and certain covered bonds were considered extremely High-Quality Liquid Assets (HQLA), while corporate bonds and certain residential mortgage-backed securities (RMBS) were deemed HQLA.
Gold was not given HQLA status, largely as a result of incomplete data. There was a lack of daily trading volume data available, therefore no trading volume or turnover measures were calculated for gold. For this reason, the Amihud illiquidity ratio (based on the absolute value of asset return per unit traded) was not applied to gold. Instead, only an unscaled price impact measure was used to assess gold’s price impact. This limited price impact assessment led to gold requiring 85% RSF.
LBMA-i data analysis
From our analysis, the EBA would have a compelling case to classify gold as an extremely HQLA if the Amihud ratio was recalculated with LBMA-i trade reporting data.
Since November 2018, LBMA has been analysing the level of liquidity in the precious metals market using LBMA-i data, which covers gold, silver, palladium and platinum from LBMA members in Loco London and Loco Zurich. The key finding of the analysis is that, on every metric, gold performs significantly better than government bonds and covered bonds which have been classed as extremely HQLA by the EBA.
The EBA had previously concluded that LBMA’s 2019 analysis did not demonstrate how gold’s liquidity is affected in times of market stress. In these unprecedent times caused by the COVID-19 pandemic, gold has justified its status a safe haven, and therefore liquid, asset. In March, daily trade volumes reached almost $100bn – on the same day where almost £125 billion was wiped off the FTSE 100 and markets were hit by an oil price war. See the tables below which set out gold’s trading growth since LBMA-i reporting began.
Implications
Should the 85% RSF requirement be introduced, we may see:
- A rise in the cost of the clearing and settlement service provided by LPMCL which may impact the service;
- A fall in market liquidity as banks look to exit the market;
- A rise in the cost of business across the supply chain.
While we support the NSFR’s objective to mitigate liquidity failures in the banking system, NSFR does not account for the unallocated balances of precious metals held on balance sheet by LPMCL banks. As a result, the cost involved for LPMCL banks in ensuring the 85% RSF would significantly increase the cost of conducting transactions in the wholesale OTC market, which would be felt by all market participants. This would likely impact the trade volumes we see today and, as an unintended consequence of NSFR, reduce the liquidity within the precious metals market.
Next steps
We aim to work with the regulators to support gold’s claim as an extremely HQLA. We believe that, had LBMA’s data was available for the 2013 Report, a different conclusion for gold would have been reached. We hope to revisit those calculations using our data spanning over 18-months to ensure the reasonable treatment of gold among the other asset classes.
Other possible advocacy activities include:
- Advocate a carve-out from NSFR for LPMCL banks to enable to continued mitigation of risk by reducing transport movements;
- Request that the BCBS consider providing gold with a 50-95% ASF in order to enable the clearing market to continue in its current form;
- Propose asymmetry between Available Stable Funding (ASF) and RSF: unallocated accounts on a balance sheet could be treated in the same way as cash, meaning gold does not require HQLA status to avoid 85% RSF, or instead you could net them;
- Wait until 2021 to compare the performance of gold versus other HQLA and extremely HQLA assets.
We also hope to discuss the risks NSFR is seeking to mitigate in relation to precious metals and what liquidity risks the EBA believes are posed by the LPMCL clearing and settlement model. The EBA’s review period for any amendments to the RSF closes on the 2021 implementation date.(1) Brexit’s impact on the UK implementation date remains unclear.
Contact us
If you have any questions or would like to support our data analysis for the EBA, please contact Sakhila.Mirza@lbma.org.uk