Lawyers discuss how the US' Basel Endgame will be implemented, the implications for the CRT market, and what could stop it.

Despite the recent and potentially exponential growth of the US CRT market, regulatory clarity is still out of reach. So how will the Basel Endgame regulation be implemented and when can investors expect to see it?

Recent re-proposals from the Federal Reserve (Fed) looking to reshape the regulation have already been rejected (SCI, 24 September) in a saga which has seen unusual twists and turns such as regulatory capital receiving negative advertising campaigns in mainstream spots such as bus shelters and baseball games.

Matt Bisanz, the financial regulatory partner at Mayer Brown, believes the final regulation will not be implemented until the end of 2026 (although the Fed itself gives a more optimistic prediction of mid-2026). He explains: “There are challenges beyond the rejection of the re-proposal. The Fed just made a big rate cut and may be planning another rate cut in the next few months. Plus, there is a reluctance for the regulators to make big proposals before an election as you don’t want to affect the result. Then, depending on how the election goes, there may be a new comptroller, which would impact how the re-proposal is finalised.”

Politics could also throw a spanner into the works. The election of the Republican Party in November would probably lead to the shelving of changes to capital requirements or even a modest reduction in line with the tailoring rule, which in turn would be a slight dampener on the CRT market. However, as Bisanz points out, “The current capital rules, risk weights which aren’t granular enough, and other market drivers like a high rate are still ongoing and will be regardless of the regulation.”

Congress could theoretically veto the rules within 60 days of its adoption however this would require the legislature and executive to agree to do this. In this polarised political environment this would likely mean the Republicans have to win the White House, House of Representatives and the Senate – or for an incoming Harris administration to turn against the regulation.

A more likely alternative is a new comptroller of the currency, appointed by a winning Republican president, to completely stop the implementation of the regulation. As Bisanz explains: “You don’t need to use congressional mechanisms as they are clunky and don’t work in the same way for the Fed as they do for other agencies the President doesn’t directly control. But the most likely scenario is they just stop the rules dead.”

Furthermore, a panellist at SCI’s recent conference In Chicago (SCI, 2 October) pointed out the key people in the Fed are unlikely to change regardless of who sits in the Oval Office come 2025.

However, despite the changes, it seems as if the inclusion of unrealised losses in capital calculations will remain. This has been credited as a driver for smaller regional banks who have issued CRT, such as Valley National Bank and Pinnacle Financial Partners.

Bisanz explains: “That will be in the final proposal no matter what. I also think the change in market risk to go from value at risk to expected losses, is a fundamental change to the market risk formula but the way it happens it subject to change. The way people think of market risk has changed since 1996. And the other big one which will come through is there will be some change to operational risk capital.”

The rules were first finalised in 2017 and proposed by US regulators in July 2023. They were delayed by Covid, ensuring the rules were compliant with the Collins Amendment and Section 939 which restrict how US regulators design capital requirements, and criticism of the increasing p-factor, and various surcharges and add-ons which were only applicable to US banks and considered by many industry insiders to be unnecessarily punitive.

Jo Goulbourne Ranero, banking regulatory lawyer at A&O Sherman, tells SCI the gold plating of US regulation has also made implementation of Basel Endgame more complicated in the US: “US Basel implementation is comparatively gold plated for the big banks that are actually subject to it which means the regulation has a bigger impact for them. For example, a US specific floor (the Collins floor) stops the Basel derived standards from undercutting the US domestic standardised approach, internal modelling is only permitted in relation to market risk, and external credit ratings can’t be used for prudential purposes.”

She also notes: “In relation to securitisation, specifically, the US is also playing catch up, in that it has not implemented post-GFC reforms to the securitisation risk weighting framework that were introduced in the EU and UK in 2019. The US is also not proposing to implement the Basel securitisation STC framework, which offers favourable prudential treatment to simple, transparent and comparable securitisations (the UK has implemented STC via the simple, transparent and standardised (STS) framework, the EU has implemented it and extended it to synthetics).”

She adds that the market risk framework is the biggest consideration in the US as it is an economy funded by capital markets, as opposed to the UK and EU which are primarily funded by banks. The biggest potential disruption in the UK and EU is the output floor, but this is not a consideration in the US due to the Collins floor and absence of credit risk modelling.

Changes in the re-proposal are not expected to be hugely impactful for securitisation. The p-factor is still expected to rise from 0.5 to 1.0 – which is not a doubling in capital requirements but “it’s bad for banks” according to Bisanz. Banks which have over US$250bn assets on balance sheet will face the largest restrictions, and not those over US$100bn as originally proposed. This reduces the number of banks impacted from 36 to 16.

Other changes which would have an impact include the expansion of institutions with high quality corporate assets with access to a reduced risk weight (from 100% to 65%). This would affect pension funds without public debt positively. The re-proposal also suggests reducing the US surcharge on residential mortgage loans, which will filter through to RMBS, and calculating bank’s fee income on a net basis rather than gross revenue – which will impact major loan servicers and administrators of securitisation.

Joe Quiruga