When leverage ratio meets derivatives: Running out of options?*

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.