1. 96) High quality liquid assets are strictly defined in the LCR to ensure that these assets remain liquid³ under severe stress scenarios both firm specific and market wide. It is worth mentioning that the asset that is usually liquid under normal conditions might not be liquid under a severe stress scenario. Therefore, these assets must fulfill certain pre-defined criteria before they can be considered eligible, they must be:
   • • traded in large, deep and active repo or cash markets characterized by a low level of concentration;
   • • have a proven record as a reliable source of liquidity in the markets (repo or sale) even during stressed market conditions. Level 2A and 2B must meet a predefined test that the maximum decline of price must not exceed volatility targets over a 30 day period during a relevant period of significant liquidity stress;
   • • not an obligation of a financial institution or any of its affiliated entities
2. 97) High quality liquid assets are separated into two categories, Level 1 and Level 2 liquid assets. Level 1 liquid assets must only be those assigned a 0% risk weight under Basel II Standardized Approach for credit risk and are allowed with no haircuts and no cap applied to them. These assets are:
   • • Cash at Central Bank and physical cash at the bank.
   • • Reserves and account balances held at the Central Bank
   • • Central Bank CDs and all debt issued or explicitly guaranteed by UAE Federal Government or Local Governments.
   • • Debt issued by multilateral development banks and the IMF.
   • • Foreign Sovereign or Central Bank debt or guaranteed debt receiving 0% Risk Weight under Basel II standardized approach.
   • • UAE Public Sector Entities’ (PSE or GRE) debt securities which receive 0% Risk Weight under Basel II Standardized approach
3. Those assets that are 0% risk weighted and unrated are unlikely to have the same depth of market as those that are rated above investment grade in a stress scenario. Banks must take this into account when assessing an asset’s suitability and a liquidity premium charged. In any case, 0% risk weighted assets that are not rated cannot exceed 25% of the total Level 1 HQLA.
4. 98) Level 2 liquid assets (comprising Level 2A and Level2B) are also classified as highly liquid assets. However, the realizable market value under a liquidity stress might be lower than the normal market value. Level 2 assets are allowed up to 40% in total of high quality liquid assets. The following assets, after being reduced by the corresponding haircuts, are eligible as Level 2A liquid assets (‘Corporate’ in this sense may include Sovereign securities).

Table 2 Level 2 A Liquid Assests

Level 2B assets (subject to a 15% ceiling of the total) consist of residential mortgage backed securities, lower rated debt securities and common equity shares. The qualifying tests for these types of assets are to be strictly applied as per the Basel rules and it is unlikely that many domestic assets will qualify, if any. (‘Corporate’ in this sense may include Sovereign securities).

Table 3 Level 2B Liquid Assets

1. 99) Only unencumbered liquid assets that meet the above criteria are eligible for the LCR.
2. 100) Banks should endeavor to hold eligible liquid assets in the currencies that match the currencies of the net cash outflow.
3. 101) Liquid asset portfolio should be well diversified in terms of counterparties and tenor and held for the sole purpose of managing liquidity risk.
4. The Central Bank recognizes that given the nascent debt markets that exist in the UAE, the qualitative requirements placed by Basel around the robustness of markets that underpins the liquidity and pricing of these assets may require a less strict interpretation – except in the case of Level 2 B assets. However, banks must be able to demonstrate to the Central Bank that assets held in the LCR are liquid.
5. Unrated UAE domiciled GRE or PSE issuers that do not receive a 0% risk weighting can be included in Level 2A liquid assets with a 30% haircut, for the time being at least.
6. Given that the UAE Dirham is pegged to the US Dollar, for the sake of flexibility US$/AED currency mismatches can be offset. It should be noted though that Basel III requires that liquid assets be held in the currency of the net outflow, including both the US$ and AED individually, and banks are expected to comply where possible. However, net outflows in other GCC currencies pegged to the US$ that exceed 15% of the total LCR net outflows must be matched. Other pegged and free floating currencies must be matched if they exceed 10% of total net LCR outflows.
7. Where no suitable HQLA exists in the currency of the net outflow O/N placements, in that currency, with either the relevant Central Bank or a bank rated at A or better will suffice.

³ Liquidity is the ability to convert the asset immediately into cash at little or no loss in market value under a liquidity stress.