1. December 2010 The Emerging Basle III and its implications for Structured Trade Finance Banks Andrew Gamble – Afreximbank Seminar on Fundamentals of Structured Trade Finance

2. Hogan Lovells2 Background Bank for International Settlements based in Basel (Basle), Switzerland Secretariat for Basel Committee on Banking Supervision (BCBS) Group of Central Bank Governors and Heads of Supervision Forum for co-operation on banking supervisory matters Seeks to promote and strengthen supervisory and risk management practices globally

3. Hogan Lovells3 The Story so far Basel I (1988) Basel II (2004) Basel III (to be continued) Recommendations of best practice to governments / supervisors

4. Hogan Lovells4 Basel I Common measurement of capital Common framework for allocation of risk to bank assets (including off balance sheet assets) Minimum level of capital by reference to ratio of capital to aggregate risk weighted assets Capital Ratio = Regulatory Capital x 100 Risk Weighted Assets

5. Hogan Lovells5 Basel II No change to minimum Capital Ratio No change to definition of Regulatory Capital Change in the definition of Risk-Weighted Assets More convergence of  Allocated Economic Capital  Allocated Regulatory Capital Not raise overall Regulatory Capital but redistribute

6. Hogan Lovells6 Basel III Prompted by 2007-8 crisis which exacerbated by weaknesses in banking sector Problems  excessive leverage  inadequate and low-quality capital  insufficient liquidity buffers  procyclical deleveraging process  interconnectedness of systemically important financial institutions Proposals announced 12 September 2010, endorsed by G20 at Seoul Summit 11-12 November 2010

7. Hogan Lovells7 Proposed solutions Raising quality of capital  going concern  gone concern Increasing risk coverage Raising level of minimum capital Restrict leverage Enhance supervisory review process (Pillar 2) and public disclosures (Pillar 3) Introduce global liquidity standards Promote capital buffers More capital for systematically important banks

8. Hogan Lovells8 What is capital for? Cushion against losses Demonstrate to depositors willingness of shareholders to put own funds at risk on permanent basis Provide resources free of fixed financing costs Finance for general infrastructure of the business Source: The measurement of capital 1980 Bank of England

9. Hogan Lovells9 What is "Basel" capital? Principles:  Ability to absorb loss  No fixed costs  Fully paid up Tier 1:  permanent share capital and reserves ("common equity")  perpetual non-cumulative preference shares Tier 2 (upper): hybrid instruments, eg  Perpetual cumulative preference shares  Perpetual subordinated debt Tier 2 (lower): subordinated term debt Tier 3: short term subordinated debt

10. Hogan Lovells10 Capital – "Quality" proposals Still minimum Capital Ratio 8% of Risk Weighted Assets Current requirements:  Common equity – minimum of 2%  Tier 1 – minimum of 4%  Tier 1, 2 and 3 – minimum of 8% Proposals:  Common equity – 3.5% (2013), 4% (2014), 4.5% (2015)  Tier 1 – 4.5% (2013), 5.5% (2014), 6% (2015) Definition of capital e.g. innovative capital instruments (interest rate step-ups) cease to be eligible for Tier 1

11. Hogan Lovells11 Capital – "Quantity" proposals Capital Conservation Buffer  required when credit growth increases risk  increases when good performance  drawn upon in times of economic stress and distributions restricted  countercyclical effect Timetable:  0.625%-2.5% of RWA (2016-2019)  Met by provision of common equity Aggregate effect (2019):  Total common equity – 7%  Total Tier 1 – 8.5%  Total minimum capital requirement – 10.5%

12. Hogan Lovells12 Leverage ratio proposal Calculates risk-adjusted exposure to certain on- and off- balance sheet items and derivatives Exposure not to exceed 3% of Tier 1 starting in 2013 Impact on trade finance:  unconditionally cancellable facilities up from 0% to 10% CCF  self-liquidating trade LCs/SBLCs/performance guarantees/shipping guarantees up from 20% to 100% CCF (possibly) Off-BSA x CCF x RW for on-BSA

13. Hogan Lovells13 Effect of Risk Weighted Assets $10m asset 20 % CCF $2m Risk Weighted Asset Minimum $160,000 capital 8% min. ratio > 100 % CCF $10m Risk Weighted Asset Minimum $800,000 capital Capital 'used' Total Capital

14. Hogan Lovells14 RAROC: The link between capital and pricing RAROC 25% 20% 15% 10% 5% 0% Typical RAROC hurdle Capital allocation under-performing Capital allocation performing RAROC = RETURN – EL – COST CAPITAL Where: EL = 'Expected Loss'

15. Hogan Lovells15 Liquidity proposals Designed to:  make banks more resilient to short-term disruptions in funding  address longer-term structural liquidity mismatches From 2015, Liquidity Coverage Ratio (LCR) will require banks to hold sufficient high-quality liquid assets measured by reference to cash outflows over 30 day period From 2018, Net Stable Funding Ratio (NSFR) will require banks to have minimum level of stable funding More an issue for Project Finance?

16. Hogan Lovells16 Counterparty credit risk proposal New stress tests to measure exposure of banks to counterparties Have to take into account  market factors (e.g. interest rates, market values)  correlation of risk amongst multiple counter-parties (e.g. several borrowers exposed to commodity price volatility)  risk weighting of central counterparties (e.g. clearing houses) Issues for trade finance  hedging  insurance  commodity price risk

17. Hogan Lovells17 Supervisory Review Process of Capital Adequacy To ensure banks have good monitoring and management of risk processes Market Discipline and Disclosure Requirements that allow capital adequacy to be compared across institutions Minimum Capital Requirements to cover: Credit Risk -Market Risk -Operational Risk Pillar 1Pillar 2Pillar 3 Greater focus on Pillars 2 and 3

18. Hogan Lovells18 Industry reaction HSBC: unfair treatment of trade finance Standard Chartered: "2% fall in global trade and a 0.5% fall in global GDP" (Karen Fawcett, Head of Transaction Banking) BAFT-IFSA: "Basel II got it wrong even more than Basel I, and now we're jumping off a cliff in terms of Basel III" (Dan Taylor, President and Chief Operating Officer)

19. Hogan Lovells19 Time to push the panic button? Long transition phase (2013-2019) Still being finalised  Lobbying continues (BAFT – IFSA, ICC)  National implementation required (e.g. CRD4 to be published in March 2011) Other competitors for capital harder hit (e.g. derivatives, trading) Impact on pricing?  but lower cost of own funds  more distribution (e.g. MDBs) Basel II  not terminal  platform to revisit this?  ICC/ADB: building trade finance credit-loss database

20. Hogan Lovells20 Documentation impact (Increased Cost Clause) The Borrower need not make any payment for an Increased Cost to the extent that the Increased Cost is:  attributable to the implementation or application of or compliance with the "International Convergence of Capital Measurements and Capital Standards, a Revised Framework" published by the Basel Committee on Banking Supervision in June, 2004 in the form existing on the date of this Agreement (Basel II) or any other law or regulation which implements Basel II (whether such implementation, application or compliance is by a government, regulator, Finance Party or any of its Affiliates);  attributable to the implementation or application of or compliance with the “Consultative proposals to strengthen the resilience of the banking sector” published by the Basel Committee on Banking Supervision on 17 December 2009 as amended or supplemented (including by the agreements of the Governors and Heads of Supervision summarised in the Annex to their communiqué dated 29 July 2010) (Basel III) or any other law or regulation which implements Basel III (whether such implementation, application or compliance is by a government, regulator, Finance Party or any of its Affiliates).

21. Hogan Lovells21 The Story continues BCBS continues to work on other initiatives  fundamental review of trading book framework (e.g. retain distinction between banking and trading book?)  reduce reliance on external rating agencies  higher capital for systemically important banks  "Gone concern" capital proposal and cross border crisis management  reviewing large exposure rules No particular horrors for Trade Finance here?

22. www.hoganlovells.com Hogan Lovells has offices in: Abu Dhabi Alicante Amsterdam Baltimore Beijing Berlin Boulder Brussels Budapest* Caracas Colorado Springs Denver Dubai Dusseldorf Frankfurt Hamburg Hanoi Ho Chi Minh City Hong Kong Houston Jeddah* London Los Angeles Madrid Miami Milan Moscow Munich New York Northern Virginia Paris Philadelphia Prague Riyadh* Rome San Francisco Shanghai Silicon Valley Singapore Tokyo Ulaanbaatar* Warsaw Washington DC Zagreb* "Hogan Lovells" or the "firm" refers to the international legal practice comprising Hogan Lovells International LLP, Hogan Lovells US LLP, Hogan Lovells Worldwide Group (a Swiss Verein), and their affiliated businesses, each of which is a separate legal entity. Hogan Lovells International LLP is a limited liability partnership registered in England and Wales with registered number OC323639. Registered office and principal place of business: Atlantic House, Holborn Viaduct, London EC1A 2FG. Hogan Lovells US LLP is a limited liability partnership registered in the District of Columbia. The word "partner" is used to refer to a member of Hogan Lovells International LLP or a partner of Hogan Lovells US LLP, or an employee or consultant with equivalent standing and qualifications, and to a partner, member, employee or consultant in any of their affiliated businesses who has equivalent standing. Rankings and quotes from legal directories and other sources may refer to the former firms of Hogan & Hartson LLP and Lovells LLP. Where case studies are included, results achieved do not guarantee similar outcomes for other clients. New York State Notice: Attorney Advertising. © Hogan Lovells 2010. All rights reserved. LWDLIB01/2348666 *Associated offices