A bank using Option 3 must be able to manage the price risk associated with the additional Level 2A assets. At a minimum, they must be able to conduct stress tests to ascertain that the value of its stock of HQLA remains sufficient to support its LCR during a market-wide stress event. The bank should take a higher haircut (ie higher than the supervisor-imposed Option 3 haircut) on the value of the Level 2A assets if the stress test results suggest that they should do so.
8. As the quality of Level 2A assets is lower than that for Level 1 assets, increasing its composition would increase the price risk and hence the volatility of the bank’s stock of HQLA. To mitigate the uncertainty of performance of this option, banks are required to show that the values of the assets under stress are sufficient. They must, therefore, be able to conduct stress tests to this effect. If there is evidence to suggest that the stress parameters are more severe than the haircuts set by bank supervisors, the bank should adopt the more prudent parameters and consequently increase HQLA as necessary.
(vii)
A bank using Option 3 must show that it can reasonably liquidate the additional Level 2A assets in a stress scenario.
9. With additional reliance on Level 2A assets, it is essential to ensure that the market for these assets has sufficient depth. This standard can be implemented in several ways. The supervisor can:
•
require Level 2A assets that can be allowed to exceed the 40% cap to meet higher qualifying criteria (eg minimum credit rating of AA+ or AA instead of AA-, central bank eligible, etc.);
•
set a limit on the minimum issue size of the Level 2A assets which qualifies for use under this option;
•
set a limit on the bank’s maximum holding as a percentage of the issue size of the qualifying Level 2A asset;
•
set a limit on the maximum bid-ask spread, minimum volume, or minimum turnover of the qualifying Level 2A asset; and
•
any other criteria appropriate for the jurisdiction.
These requirements should be more severe than the requirements associated with Level 2 assets within the 40% cap. This is because the increased reliance on Level 2A assets would increase its concentration risk on an aggregate level, thus affecting its market liquidity.
