CPSS-IOSCO Principles for Financial Market Infrastructures*

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1 CSS-IOSCO rinciples for Financial Market Infrastructures* Workshop on ayments Systems Oversight Banco de Guatemala Guatemala, Guatemala, October 16-18, 2013 Klaus Löber CSS Secretariat Bank for International Settlements * Views expressed are those of the author and not necessarily those of the BIS 1

2 Outline The financial crisis and OTC derivatives markets reform rinciples and the role of CSS and IOSCO The new principles for Financial Market Infrastructures (FMIs) Implementation monitoring 2

3 The Basel process BIS G20 CENTRAL BANKS IAIS BCBS CGFS CSS IMF IBRD JOINT FORUM INSTITUTIONS MARKETS INFRASTRUCTURE 3 IOSCO G20 Regulators plus these groups = FINANCIAL STABILITY BOARD 3

4 Experience during the financial crisis FMIs generally proved resilient to the crisis due to the efforts of overseers and regulators during the last 20 years No materialisation of systemic risk in FMIs Global efforts towards intraday finality essential: RTGS, Dv and v Abnormally high settlement volumes managed during volatility FMIs could cope with the default of a large counterparty Beneficial role of CLS and CCs were widely acknowledged However the recent financial crisis also highlighted i.a.: Significant counterparty credit risk in OTC derivatives markets Shortcomings in default and liquidity risk management Severe lack of transparency in the OTC derivatives market and absence of infrastructure to mitigate risk Insufficient (cross-border) information flow G20 recommendations - ittsburgh communiqué of September 2009 Standard setting bodies to strengthen risk management standards 4

5 OTC Derivatives Market Reforms G20 recommendations - ittsburgh communiqué of September 2009 Trading and Clearing: All standardised OTC derivative contracts should be traded on exchanges or electronic trading platforms, where appropriate, and cleared through central counterparties (CCs) by end 2012 at the latest Reporting: OTC derivative contracts should be reported to trade repositories (TRs) Non-centrally cleared contracts should be subject to higher capital requirements The FSB and its relevant members should assess regularly progress and whether it is sufficient to improve transparency in the derivatives markets, mitigate systemic risk, and protect against market abuse Standard setting bodies to strengthen their risk management standards 5

6 Role of CSS and IOSCO standards CSS and CSS-IOSCO standards are increasingly becoming the foundation of FMI related oversight, supervision and regulatory activities The CSS is a standard setting body for payment, clearing and securities settlement systems. It also serves as a forum for central banks to monitor and analyse developments in domestic payment, clearing and settlement systems as well as in crossborder and multicurrency settlement schemes The FMIs are recognised by the FSB among the key standards for sound financial systems 6

7 New rinciples for the Financial Market Infrastructures: Replace former three standards with one single, comprehensive set of principles for all FMIs: Core rinciples for SIS (2001), Recommendations for SSSs (2001) and Recommendations for CCs (2004) Incorporate the lessons drawn from recent crisis experiences more demanding requirements in many areas new principles that were not or not fully addressed by the existing standards Ensure consistency among requirements to different FMIs while reflecting the specific role of certain types of infrastructure (e.g. CCs, TRs) rovide revised responsibilities of relevant authorities in regulating, supervising and overseeing FMIs The new principles are designed to be applied holistically because of their significant interaction 7

8 Development of the FMIs A comprehensive review of the old sets of standards was launched in February 2010 to support G20 and FSB objectives to strengthen core financial infrastructures and markets by strengthening existing standards and broadening their coverage incorporate lessons learned from the recent financial crisis to adapt to greater uncertainties and risks in financial markets promote consistent global enforcement across different FMI types, different FMI designs, and different jurisdictions CSS and IOSCO issued a consultative draft of the FMI in March 2011 and conducted extensive market consultation A final version of the FMI published in April 2012 incorporated the results of the market consultation 8

9 Status of the FMIs Not legally binding as such but national regulation increasingly based on them (sometimes by way of incorporation) because of: ower of the arguments they contain ( soft law ) Commitment of members of the relevant bodies (CSS, IOSCO, FSB) to adopt the principles in the FMI and put them into effect as soon as possible FMIs are expected to observe the principles as soon as possible Compliance of CCs with the FMIs is a condition for banks to benefit from lower capital requirements (see Capitalisation of bank exposures to central counterparties, BCBS, 2012) Subject to implementation monitoring by CSS-IOSCO and FSB peer reviews Basis of assessments by IMF and World Bank as part of the financial sector assessment programmes (FSAs) 9

10 Guiding philosophy in drafting Express standards as broad principles in recognition that FMIs differ significantly in organization, function, and design Recognize that FMIs can achieve a particular result in different ways Incorporate minimum requirements where appropriate to ensure a common base level of risk management across FMIs Adopt a functional approach to the applicability of the principles in the FMI to different types of FMIs Adopt a holistic approach to the principles in the FMI by having them build upon and complement each other 10

11 Interaction between the principles The principles have significant interaction with each other and, as previously noted, must be read holistically

12 General organisation Credit and liquidity risk Settlement CSDs and Exchange Value Settlements Default Management General business and operational risk management Access Efficiency Transparency 12

13 Responsibilities of Authorities Responsibility A: FMIs should be subject to appropriate and effective regulation, supervision, and oversight by a relevant authority Responsibility B: Authorities should have the powers and resources to carry out effectively their responsibilities in regulating, supervising, and overseeing FMIs Responsibility C: Authorities should clearly define and disclose their regulatory, supervisory, and oversight policies with respect to FMIs Responsibility D: Authorities should adopt and consistently apply the FMI Responsibility E: Relevant authorities should cooperate, both domestically and internationally, as appropriate, in promoting the safety and efficiency of FMIs 13

14 Key differences between old and new standards Unifies the set of standards for systemically important payment systems, CSDs, SSSs, CCs, and TRs (a new type of FMI) Focuses requirements on safety and efficiency to limit systemic risk and to foster transparency and financial stability Introduces more-demanding (e.g. credit risk, collateral) or new (e.g. comprehensive risk management, tiering) requirements and provides greater guidance (e.g. disclosure) when compared with previous standards Addresses a number of important issues across several principles financial resources recovery and orderly wind down fair and open access tiered participation arrangements interdependencies, including interoperability 14

15 rinciple 4: Credit risk rinciple 7: Liquidity risk New requirement Distinction between current exposures and FEs Full coverage of exposures with high degree of confidence Specific requirements for DNS with and without settlement guarantee Greater emphasis on crisis scenarios especially for CCs Reference to exposure of all affiliated entities of same group Contingency planning for uncovered credit losses Greater clarity on range of eligible funding arrangements Greater emphasis on crisis scenarios Reference to different roles of defaulter including as liquidity provider Key discussion issues Cover 1/2, cover all Does the FMI have enough collateral? How to estimate potential future losses? What stress scenarios to apply? Loss allocation in normal versus extreme conditions: use margins versus other resources? Separate default funds? What funding arrangements are eligible (only committed or more)? Multiple roles of participants Role of central bank facilities? 15

16 Current vs. potential future exposures Current exposure is the loss an FMI would face immediately if a participant were to default Technically, the greater of zero or the market value of a transaction with a counterparty that would be lost upon the default of the counterparty A S or SSS faces current exposure when it extends intraday credit to a participant A CC faces current exposure equal to the difference between the current market value of open positions and the value of the positions when the CC last marked them to market otential future exposure is an estimate of credit exposure than an FMI could face at a future point in time Technically, the maximum exposure expected to occur at a future point in time at a high level of statistical confidence; arises from potential fluctuations in the market value of positions and/or collateral A S or SSS faces potential future exposure if the value of collateral securing an extension of intraday credit could fall below the amount of credit extended, leaving a residual exposure A CC faces potential future exposure from potential fluctuations in the market value of open positions with a defaulting customer between the last time they were marked to market value and the time that they are liquidated or hedged 16

17 S and SSS requirements Cover exposures to each participant fully with a high degree of confidence This means that a S or SSS must strive to collect collateral or maintain other resources with values equal to or greater than the current and potential future exposures to each participant S and SSS generally collect collateral to mitigate current exposure and apply haircuts to that collateral to mitigate potential future exposure Note: high degree of confidence is not explicitly defined Exception to requirement: DNS S and DNS SSS where there is no settlement guarantee A settlement guarantee may be provided either by the FMI itself or by the participants For DNS systems where there is no settlement guarantee but where participants face credit exposures, the FMI should maintain resources to cover the exposures of the two participants and their affiliates that would create the largest aggregate credit exposure in the system A higher level of coverage should be considered for a S or SSS that creates large exposures or that could have a significant systemic impact if more than two participant families were to default 17

18 Key highlights in liquidity risk Requirements are similar to those for credit risk, with a few key differences The likelihood that an FMI would have to cover two for liquidity is lower than for credit Ss and SSSs in addition to CCs are required to perform stress testing of liquid resources Strengthened as compared to previous standards Requires maintenance of sufficient liquid resources to effect settlement of payment obligations same-day (for S and SSS) or on time (for CCs) with a high degree of confidence Requires maintenance of sufficient liquid resources to withstand at least the default of the participant and its affiliates that would generate the largest aggregate liquidity obligation for the FMI in extreme but plausible market conditions However, the FMI expands the types of qualifying liquid resources as compared to previous standards 18

19 New requirement Key discussion issues rinciple 6: Margin rinciple 5: Collateral Initial margin to cover not only normal market conditions From quarterly to monthly sensitivity analysis, daily back-testing, annual methodology testing Avoid concentration risk Avoid procyclicality Avoid wrong-way risks Higher quality Does the FMI have the right margining methodology? What and how frequent back testing, stress testing, model testing? Initial margin also to cover extreme losses? What type of collateral, e.g. government debt? How to reconcile trade off as regards procyclicality? Does the FMI have the right collateral? How much can/should wrongway risk be avoided? 19

20 Key highlights in collateral An FMI should establish prudent valuation practices to have adequate assurance of its collateral s value in the event of its liquidation Mark-to-market collateral daily Ensure haircuts reflect potential values and liquidity to decline over the interval between their last revaluation and the time by which an FMI can reasonably assume that the assets can be liquidated Incorporate assumptions about collateral value during stressed market conditions (including extreme price moves and changes in market liquidity) An FMI should disclose its policies on the reuse of collateral (that is, the use of collateral that has been provided by participants in the normal course of business) Do not rely on the reuse of collateral to increase or maintain profitability May, however, invest any cash collateral received from participants on their behalf 20

21 rinciple urpose Key discussion points rinciple 14: Segregation and portability rinciple 15: Business risk rinciple 19: Tiered participation rotect indirect participants; Increased importance following mandatory clearing Recognise the fact that FMIs may fail and create systemic disruptions not only as a result of member default, but also as a result of non-default related risks Identify and address any risks that that the FMI may face from indirect participants What model of segregation, at the level of CC or participant? Other equivalent models? What form of portability (relevant for capital requirements)? What types of non-default related business risks? What on-going quantitative requirement (at least 6 months)? What liquid composition? How far down the chain of tiering? FMIs as quasi-regulators? 21

22 Key highlights in segregation and portability Segregation and portability arrangements must have a strong legal basis and have a high degree of legal certainty under applicable law rotection of customer assets through the use of individual or omnibus customer accounts Individual account structures and the collection of margin on a gross basis provide flexibility in how a customer s portfolio may be ported to another participant, but are operationally and resource intensive Omnibus account structures are less operationally intensive and can be more efficient when porting positions and collateral for a group of customers, but may expose customers to fellow-customer risk and undermargined positions with net margining 22

23 Key highlights in general business risk An FMI should maintain liquid net assets funded by equity equal to at least six months of current operating expenses Actual amount held should be determined by the FMI s general risk profile and the length of time required to achieve a recovery or orderly wind-down of its critical operations and services (and projected in its recovery or orderly wind-down plan) Actual amount held should be reviewed periodically using a variety of scenarios Calculation of operating expenses for these purposes may exclude depreciation and amortization expenses Liquid net assets held for these purposes cannot be used for any other purpose However, equity held under international risk-based capital standards should be included where relevant and appropriate to avoid duplicate capital requirements An FMI s capital plan should specify how it would raise new capital if its equity capital were to fall close to or below the amount needed The capital plan should consider such factors as ownership structure and any insured business risks 23

24 Risks from tiered participation Operational dependencies between direct and indirect participants could affect the smooth functioning of the FMI, such as in the case of An FMI with a few direct participants and many indirect participants A large indirect participant operating though a small direct participant Credit and liquidity risks between direct and indirect participants may affect the FMI The failure of an indirect participant may affect the credit and liquidity needs of the direct participant A CC may face exposures to indirect participants upon the failure of a direct participant (at least until such time that customer positions are ported or closed out) Default scenarios can create uncertainty about whether indirect participants transactions have been settled or will be settled and whether settled transactions can be unwound 24

25 rinciple rinciple 3: Comprehensive risk management rinciple 18: Access and participation requirements rinciple 20: FMI links urpose Need for a holistic risk management view FMIs should address risks to and from other FMIs Facilitate expanded direct access without compromising the safety of the FMI (CGFS report) More specific and demanding requirements on different types of links 25

26 Elements of a risk-management framework A sound risk-management framework should identify the range of risks that an FMI faces and should appropriately address these risks Types of risks that should be addressed Legal Credit Liquidity Settlement General business Custody and investment Operational Reputational Tiered participation Other otential sources of risks articipants and their customers Other FMIs Settlement and custodian banks Liquidity providers Service providers Components of a riskmanagement framework to address these risks FMI design olicies (including participant incentives) rocedures Information and control systems Internal controls Recovery and orderly wind-down plans 26

27 New requirement Key discussion issues Responsibility C: Disclosure of policies with respect to FMIs Responsibility E: Cooperation with other authories Clear definition of policies towards FMIs ublic disclosure of policies Effective communication, cooperation and coordination among relevant authorities Domestic and cross-border Information on cross-border and multicurrency FMIs Lead authority What are each authorities policies with respect to FMIs (are there overlaps)? How are they defined (e.g. law, policy statement)? Which form of disclosure (e.g. explicit reference to FMIs, to international standards)? Which form of cooperation (college, bilateral arrangements, informationsharing only)? Legal Barriers? Role of cooperative oversight? 27

28 Co-operation of authorities Need to align conflicting objectives Need to promote consistency of regulatory requirements and approaches and avoid duplication Need for access to comprehensive and timely information on factors that may impact on the safety and resilience of infrastructures, institutions or markets Need for ex-ante clarification of responsibilities and procedures for cooperation among authorities during crisis situations Arrangements can take many forms (e.g. based on mutually consistent regulation, bilateral or multilateral treaties or MoUs), i.a.: - Information-sharing arrangements - Allocation of responsibilies (home/host supervision, lead overseer, etc.) - Colleges (supervisors/overseer/others; national/regional/global; single entity/group) - Crisis management and resolution groups 28

29 Consistency of rules Which transactions have a domestic relevance? Who is subject to which jurisdiction (e.g. branch, foreign entity)? Global consistency of rules would minimise impact Consistency - with the FMIs - of outcomes - across jurisdictions 29

30 FMI Implementation monitoring Full, timely and consistent implementation of the FMIs is fundamental to ensuring the safety, soundness and efficiency of key FMIs and for supporting the resilience of the global financial system. Global central clearing requirements reinforce the importance of strong safeguards and consistent oversight of derivatives CCs in particular CSS and IOSCO members are committed to adopt the principles and responsibilities in line with G20 and FSB expectations. In April 2013, CSS and IOSCO announced that they have started the process of monitoring implementation of the FMIs Reviews are carried out in three stages: Level 1 - ensuring the timely implementation Level 2 - ensuring regulatory consistency Level 3 - ensuring consistency of outcomes 30

31 FMI Implementation monitoring Implementation monitoring covers both the principles for FMIs contained in the FMIs as well as the responsibilities A to E that are addressed to competent supervisors and overseers Jurisdictional coverage: Argentina, Australia, Belgium, Brazil, Canada, Chile, China, the European Union, France, Germany, Hong Kong SAR, India, Indonesia, Italy, Japan, Korea, Mexico, the Netherlands, Russia, Saudi Arabia, Singapore, South Africa, Spain, Sweden, Switzerland, Turkey, the United Kingdom and the United States Types of FMI: Systemically important payment systems, central securities depositories/securities settlement systems, central counterparties and trade repositories Relevant authorities: Regulators, supervisors (e.g. securities regulators) and overseers (central banks) having responsibilities for at least one of the above types of FMIs 31

32 Global Representation EU 3 7 (8) 1 3

33 FMI Implementation monitoring Number of FMIs covered: 48 ayment Systems 83 Central securities depositories/securities settlement systems 62 Central counterparties and 15 Trade repositories Authorities covered: 27 Central Banks 31 Regulatory authorities 33

34 FMI Implementation monitoring Regulatory framework means whatever legislation, rules, regulations, guidance, policy statements, other requirements, or combination thereof that are needed to enable the relevant authorities to require systemically important FMIs to observe the principles and for relevant authorities to observe the responsibilities. Regulatory frameworks (as of 5 April 2013) differ, comprising frameworks based on (mixed appraoaches possible): Legislation or regulation (19 jurisdictions) Guidance and policy statements (13 jurisdictions) FMI rule book based approaches (6 jurisdictions) - In most cases, the headline standard forms basis for the method chosen - In few cases, key considerations are being incorporated explicitly - Some have merged content of headline standards - Some have implemented select principles to fill gaps in the regulatory framework 34

35 ercentage of Respondent Jurisdictions Country rogress by FMI Type 100% 80% 60% 40% Rating Level % 0% CCs TRs Ss CSDs/SSSs Rating Level 1: Draft implementation measures not published Rating Level 2: Draft implementation measures published Rating Level 3: Final implementation measures published Rating Level 4: Final implementation measures fully in force Rating Level NA: No implementation measures needed

36 FMI Implementation monitoring Level 1 The first Level 1 assessment is finalised Results of this assessment were published in August 2013 on both CSS and IOSCO websites: As of April 2013, only few jurisdictions have completed the process for all types of FMIs but many are making good progress and expect to be well advanced by the end of the year - given that the FMI were only issued in April 2012 this represents substantial progress) Further update reports to follow on a regular basis Assessments will be complementary to the FSB SCSI assessments and IMF-World Bank FSAs 36

37 FMI Implementation monitoring Further work Level 2 assessments are scheduled to start by the end of 2013 Scope: Evaluating the consistency of implementation measures in each jurisdiction with the FMIs allowing for horizontal comparison ossible prioritisation in a first round (i) on CCs and TRs, given their importance for the successful completion of the G20 commitments regarding central clearing and transparency for derivative products, and (ii) on jurisdictions hosting global CCs and TRs Future level 3 assessments may evaluate consistency of outcomes at FMI and authority level themselves resulting from the application of the FMIs 37

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