On December 19, 2016, the Federal Reserve Board (FRB) finalized a rule requiring covered institutions to publicly disclose their Liquidity Coverage Ratio (LCR), including quantitative and qualitative information underlying the LCR.1 Relative to the proposal, the final rule did not revise the reporting frequency or quantitative data requirements. However, it did amend the qualitative information requirements.
While the public disclosure requirement is an extension of the post-crisis banking regulation on the monitoring of liquidity risk, it introduces a new dimension that firms need to consider: market discipline and peer comparisons. The rationale presented for the requirement is the promotion of sound liquidity practices, as the market can reward firms with resilient liquidity profiles with access to lower cost funding and penalize those with less resilient profiles via higher relative funding costs. In the final rule, the FRB signals its expectation that the qualitative information will be used by investors to evaluate the stability of the firm relative to its peers, suggesting that sound liquidity practices will factor into equity valuations. Firms would be wise to view quality control for the LCR disclosure in the same manner as quality control for their 10-K submissions.
Coverage and disclosure
With the exception of foreign banking organizations (FBOs), institutions that are required to submit the Complex Institution Liquidity Monitoring Report (FR 2052a) are required to comply with LCR public disclosure requirements. The disclosure requirement applies to firms covered by the LCR or modified LCR requirement.
LCR disclosures are required on a quarterly basis. Firms are directed to include to the disclosure in a “direct and prominent manner” on its public internet site, or in a public financial or other public regulatory report.2 Disclosure information must remain available for five years.
In response to public comments, the FRB extended the implementation timeline for the public disclosure requirement by nine months such that firms subject to the LCR rule are required to make their initial disclosures approximately five quarters after the covered company’s first FR 2052a report.
Accordingly, the rule sets forth the following implementation timeline:
The quantitative requirements were adopted as proposed. Here, firms are required to report simple averages of the components used in calculating their LCR (e.g., high-quality liquid assets (HQLA), inflows, and outflows). Firms must report both unweighted and weighted values. “Weighted” HQLA values are adjusted by the LCR required haircuts. “Weighted” inflow and outflows are calculated using the LCR inflow and outflow percentages. Companies subject to the full LCR requirement will disclose averages of the daily components values over the past quarter. Companies subject to modified LCR will disclose averages of the monthly values over the past quarter. Standard LCR firms are required to disclose the result of the maturity mismatch add-on; modified LCR firms are not required to report the add-on.
The disclosed data is fairly granular in that HQLA, inflows, and outflows are reported by LCR classification. HQLA data is reported by LCR level: 1, 2A, and 2B. Data on outflows and inflows is reported by the LCR account categorizations (e.g., Stable Retail, Operational Deposit, Unsecured Wholesale Cash Inflow).
When developing processes for the quantitative disclosure, firms should give strong consideration to basing the disclosure on FR 2052a data. Aligning the LCR, 2052a, and the disclosure submission to a single data source appears to be the broad direction the FRB is taking to ensure data quality. Furthermore, the FRB included detailed mappings to LCR components in the final versions of both the FR 2052a guideline and public disclosure requirements. By aligning disclosure with 2052a, a firm will align its regulatory and public liquidity reporting.
The qualitative requirements were adopted with modifications from the original proposal. The qualitative section is intended to complement the quantitative data with information that allows counterparts and investors to assess and compare liquidity risk practices by and across covered institutions.
As a way of defining its expectations for qualitative disclosure, the FRB provided the following examples of what could be considered to be “relevant” for a qualitative disclosure:
The final rule differs from the proposed rule in its clarifications of what firms can exclude from the quantitative section and what is the standard for inclusion. First, the FRB clarified that firms are not required to disclose any information that is proprietary or confidential. If LCR has been impacted by proprietary or confidential circumstances or events, firms are required to disclose “general information” about these items and on the reason for the disclosure.4 Second was a refinement to the standard for disclosure. The proposed rule would have required the disclosure of “significant” information. The disclosure standard was refined in response to comments that the FRB should adopt a materiality standard akin to other filings rather than requiring firms to provide information that is “significant.” The final rule is based on a compromise. “Significant” remains the standard, but covered companies are permitted to consider materiality when determining whether to disclose. “Material” is defined as information that would “change or influence” an investment decision where it to be omitted or misstated.5
Two additional modifications were made in the final rule. The first was the elimination of a requirement to describe any significant changes that have occurred since the end of the quarter that would cause its quarter-end quantitative disclosures to no longer reflect its liquidity profile. The FRB explains that this requirement was eliminated because compliance would have required covered firms to disclose information about specific and recent developments in their liquidity risk profiles, and that disclosure of this information could have adversely affected these firms. The second was the final rule dropped the requirement that a covered institution discuss other inflows and outflows in the LCR that are not specifically covered in the quantitative disclosure. The FRB considered this requirement to be redundant.
Of the two disclosures, the qualitative section is the more challenging in that firms will need to provide a sufficient picture of their liquidity risk processes without disclosing information that could potentially trigger a negative reaction by counterparts or investors. An effective process for qualitative disclosure will require the input of multiple stakeholders within the covered company, including risk management and legal counsel. Firms should prioritize defining an approach to the qualitative disclosure. Finally, firms should engage peers and the FRB in developing leading practices around disclosure.
1 Federal Reserve System, “Liquidity Coverage Ratio: Public Disclosure Requirements; Extension of Compliance Period for Certain Companies to Meet the Liquidity Coverage Ratio Requirements,” Final Rule, (December 19, 2016), available at https://www.federalreserve.gov/newsevents/press/bcreg/bcreg20161219a1.pdf.
2 Id, at 30.
3 Id, at 37.
4 Id, at 38.
5 Id, at 16.