When Leverage Ratio Meets Derivatives: Running Out Of Options?

29 Pages Posted: 24 May 2019 Last revised: 9 Jun 2019

See all articles by Richard Haynes

Richard Haynes

Commodity Futures Trading Commission (CFTC)

Lihong McPhail

Commodity Futures Trading Commission (CFTC)

Haoxiang Zhu

Massachusetts Institute of Technology (MIT) - Sloan School of Management; National Bureau of Economic Research (NBER)

Date Written: April 30, 2018

Abstract

This paper examines the impact of Basel III leverage ratio on the competitive landscape of US derivatives markets. Because the leverage ratio focuses on notional amounts and does not fully recognize offsetting positions and risk-mitigating collateral, it is more likely the binding constraint for derivatives. The leverage ratio also put heterogeneous constraints on different types of institutions and activities. Using daily positions of clearing members and their customers on S&P 500 E-mini futures options, we test the following four hypotheses when the public disclosure of the leverage ratio became mandatory in January 2015: (1) banks lose market share to nonbanks; (2) US banks lose market share to European banks; (3) banks' clearing activities shift away from customer accounts to house accounts; (4) low-delta options are affected most by the leverage ratio. All hypotheses are confirmed in the data. Short-dated US Treasury futures options, which receive zero exposure in the leverage ratio calculation, do not exhibit such behavior. Our evidence suggests that the leverage ratio requirement pushes derivatives activities toward less constrained institutions and market segments.

Keywords: capital requirement, leverage ratio, Basel III, options

JEL Classification: G18, G21

Suggested Citation

Haynes, Richard and McPhail, Lihong and Zhu, Haoxiang, When Leverage Ratio Meets Derivatives: Running Out Of Options? (April 30, 2018). Available at SSRN: https://ssrn.com/abstract=3378619 or http://dx.doi.org/10.2139/ssrn.3378619

Richard Haynes

Commodity Futures Trading Commission (CFTC) ( email )

1155 21st Street NW
Washington, DC 20581
United States

Lihong McPhail (Contact Author)

Commodity Futures Trading Commission (CFTC) ( email )

1155 21st Street NW
Washington, DC 20581
United States

Haoxiang Zhu

Massachusetts Institute of Technology (MIT) - Sloan School of Management ( email )

100 Main Street E62-623
Cambridge, MA 02142
United States

HOME PAGE: http://www.mit.edu/~zhuh

National Bureau of Economic Research (NBER) ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

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