1 Consultation Paper Proposed rules for recognised clearing houses and approved operators February 2013
3 Consultation Paper Proposed rules for recognised clearing houses and approved operators February 2013 The Bank of England invites comments on this consultation paper. Comments should reach the Bank by 21 March Comments may be sent by to Alternatively, please send comments in writing to: FMI Feedback Market Infrastructure Division Bank of England Threadneedle Street London EC2R 8AH The Bank may make responses to this consultation public unless the respondent requests otherwise. A standard confidentiality statement in an message will not be regarded as a request for non-disclosure. If the Bank receives a request under the Freedom of Information Act 2000, the Bank may consult respondents who had requested confidentiality. Any decision the Bank makes not to disclose a response is reviewable by the Information Commissioner and the Information Rights Tribunal. Copies of this consultation paper are available to download from the Bank s website at
5 Contents 1 Overview 5 2 Consultation on rules to carry forward the substance of certain FSA rules 6 3 Consultation on new rule relating to expert reports on recognised clearing houses 9 4 Consultation on new rules relating to the introduction of excessive requirements on market participants by approved operators under the uncertificated securities regulations, and to expert reports on approved operators 11
7 5 1 Overview This consultation seeks comments on five rules that the Bank of England ( the Bank ) as future supervisor of central counterparties and securities settlement systems (1) is proposing to make for: (a) Recognised Clearing Houses (RCHs) under the Financial Services and Markets Act 2000 (FSMA); (2) and (b) persons approved to operate a system for dematerialised settlement ( Operators ) under the Uncertificated Securities Regulations (USRs). (3) Two of these proposed rules aim to carry forward, in substance, proposed or existing Financial Services Authority (FSA) rules for RCHs. These relate to: (1) reporting to the supervisor an RCH s key individual appointments; (4) and (2) notifying the supervisor before an RCH introduces rules that impose liabilities, restrictions or reporting requirements on market participants. (5) The Bank also proposes to introduce three new rules. These are: (3) a rule that would enable the Bank to recover from RCHs any charges that it incurs when commissioning expert reports; (4) a new rule for Operators under the USRs equivalent to rule (2) above; and (5) a USR equivalent of rule (3) above. The proposed RCH rules set out in this consultation paper would be made using the Bank s new powers under FSMA. As a result, the relevant procedural requirements are those set out in s138j of FSMA. The Treasury s transitional legislation will specify that the Bank can make these rules irrespective of whether the published draft is accompanied by a cost-benefit analysis. The Bank does not intend to make these rules until this transitional legislation is in force. (6) Accordingly the Bank has not undertaken a cost-benefit analysis of these proposed rules. The proposed USR rules set out in this consultation paper would be made in new provisions in the USRs that the Treasury is proposing to introduce. (7) (1) Under the Financial Services Act 2012, the Bank will assume responsibility for supervision of RCHs and Operators on 1 April (2) References in this document to FSMA are to that Act, recently amended by the Financial Services Act 2012, as it applies in respect of the Bank s supervision of RCHs by virtue of Schedule 17A of FSMA. (3) See the Uncertificated Securities Regulations 2001 (s /3755) as amended. (4) This FSA rule has been the subject of a public consultation but has not yet come into effect: (5) See FSMA, s.290a and s.300a. (6) See the forthcoming Financial Services and Markets Act 2000 (Transitional Provisions) (Miscellaneous Provisions) Order (7)
8 6 2 Consultation on rules to carry forward the substance of certain FSA rules Currently FSMA allows the FSA to make rules requiring RCHs to provide information or notifications to the FSA. (1) The FSA handbook currently contains a number of such rules. (2) The Bank will be able to make rules of this kind as well as obtain information from RCHs by notice under s.165 of FSMA. The Bank will, for most purposes, collect information by notice rather than by rules. The scope of the information that will be collected by the Bank under s.165 will initially encompass the FSA s existing notification requirements as well as some further quantitative data requests. As noted in The Bank of England s approach to the supervision of financial market infrastructures, (3) the Bank will confirm the detail of new data reporting obligations with each RCH on a bilateral basis. The Bank is, however, proposing to retain the substance of two proposed or existing FSA rules on information-provision by the RCHs. The Bank has, for clarity, made some changes to the detailed drafting of these rules. The substantive effect of these rules is not, however, intended to change. Background The two areas in which proposed or existing FSA rules will, in substance, be retained are: (1) reporting to the Bank key individual appointments by an RCH (as recently consulted upon by the FSA as part of the EMIR implementation process) (4) ; and (2) giving notice to the Bank in relation to the provisions in ss.300a-e of FSMA, the purpose of which is to prevent RCHs from imposing excessive requirements on market participants. In relation to (1), the Bank will require notification, prior to appointment, of certain RCH appointments, and of certain resignations. (5) As set out in The Bank of England s approach to the supervision of financial market infrastructures, the Bank will liaise with each RCH regarding the particular appointments of which the Bank expects to be notified under this rule. The Bank may modify the application of the rule to focus on areas of interest, or waive it, but the Bank would ordinarily expect to be notified at least in relation to appointments to the roles of chair, chief executive, chief risk officer, chief financial officer, chair of the risk committee, senior independent non-executive director, head of internal audit, chair of audit committee, and chair of remuneration committee. The Bank will review those proposed appointees for competence and suitability. The Bank expects to interview nominated candidates for the most significant of these roles, and may ask to interview candidates for other roles depending on the circumstances. In addition to the notifications required under this rule, the Bank would expect to be notified of appointments to group-level roles that could have material influence on the RCH. In relation to (2), the Bank will broadly retain the FSA s existing regime for the practical implementation of the provisions (in FSMA s.290a and s.300a) to prevent the introduction by RCHs of excessive requirements on market participants (termed regulatory provisions under FSMA). The Treasury introduced these provisions to give certainty about the UK regulatory regime applying to users of UK Recognised Investment Exchanges (RIEs) and RCHs, in particular in light of concerns about the interaction of UK and foreign regulation where UK RIEs and RCHs are subsidiaries of foreign companies. As part of the Treasury amendments to implement the European Regulation on OTC derivatives, central counterparties and trade repositories of 4 July 2012, commonly known as the European Market Infrastructure Regulation (EMIR), this obligation is expected to fall away for RCHs that are recognised central counterparties (CCPs) once they are authorised under EMIR. Other RCHs that are not CCPs may, however, still be subject to this obligation both as an RCH and as an Operator, and the Bank therefore proposes to have a consistent rule in respect of both RCHs and Operators (see Section 4). The Bank will in practice expect all supervised financial market infrastructures (FMIs) to consult their Bank supervisors before making material changes to their rules or to other aspects of system design. This is because rules and design of an FMI can influence the level and distribution of risks in the financial system. Other areas where FMIs are required by regulation to provide prior notice to the Bank of changes include amendments to default rules by FMIs designated under the Settlement Finality Directive and significant changes in relation to margin risk models, default fund contributions and other risk controls by RCHs authorised as CCPs under EMIR. (6) The above rules (1) and (2) would be made under s.293 and s.300b of FSMA. FSMA requires that the Bank provide an explanation of the purpose of the proposed rules, and an explanation of the reasons for considering that making the proposed rules is compatible with the Bank s financial stability objective. Purpose and financial stability objective Rule 1 on prior identification of key individuals enables supervisors to assess the reputation, expertise and experience (1) See FSMA s.293 and s.300b(2). (2) (3) Published December 2012, Comments are invited on this paper. A final version will be published in due course. (4) See footnote 4 on page 5. (5) The FSA previously consulted in relation to CCPs, the scope of this proposed rule is RCHs. (6) See EMIR, article 49. uri=oj:l:2012:201:0001:0059:en:pdf.
9 7 The proposed rules Interpretation In these rules: the Act means the Financial Services and Markets Act 2000 as amended; the Bank means the Bank of England. RCH 1 Appointment and resignation of key individuals (proposed REC 3.4.1A). (1) 1.1 A UK RCH must give the Bank written notice, together with the information specified in 1.2: at least 30 days before the event, of a proposal to appoint or elect an individual as a key individual of the RCH; forthwith if a key individual has resigned as, or otherwise ceased to be, a key individual of the RCH. 1.2 The information specified for the purposes of this rule is: in relation to an individual s appointment or election as a key individual: (a) the individual s name and date of birth; (b) a description of the responsibilities that the key individual will have in the post to which the appointment or election relates; and in relation to an individual s resignation or ceasing to be a key individual, the individual s name. 1.3 In this rule key individual means, in respect of an RCH: (a) its chairman, president or equivalent; (b) its chief executive or equivalent; (c) a member of its governing body; (d) a person, alone or jointly with one or more others, who is responsible under the immediate authority of a person in (a), (b) or (c) or of a committee of the governing body for the conduct of any regulated activity (as specified under section 22 of the Act) in respect of which the body is exempt from the general prohibition in section 19 of the Act as a result of section 285(2) or (3) of the Act (Exemption for recognised investment exchanges and clearing houses) or any function relating to, or to matters arising out of, the obligations to which the body is subject under or by virtue of the Act. RCH 2 Extent of duty and notice requirements for proposal to make regulatory provisions (currently REC 3.26). 2.1 The duty in section 300B(1) of the Act only applies in respect of a regulatory provision of the description specified in rule 2.2 which is not excluded under rule The specified regulatory provisions are those which (whether considered alone or together with any other regulatory provision) materially: increase disclosure, reporting or corporate governance requirements imposed on any person (whether directly or indirectly); limit access to, or use by, any person (whether directly or indirectly including, without limitation, through an amendment to fees or charges) of the facilities operated by the RCH proposing to make the regulatory provision; or add to the circumstances in which any person (whether directly or indirectly) may be liable to penalties or other sanctions or have liability in damages. 2.3 The duty in section 300B(1) of the Act does not apply to a regulatory provision to the extent that it: is required under EU law or any enactment or rule of law in the United Kingdom; specifies or amends standard terms relating to the provision of clearing services for any derivative; specifies or amends operating procedures which are reasonably consequential on any regulatory provision falling within 2.3.2; is expressed to have effect for no longer than three months and which is made in response to an emergency event (including, without limitation, a war, terrorist attack or labour strike); or does not impose a requirement (including any obligation or burden) on persons affected (directly or indirectly) by it. 2.4 Where the duty in section 300B(1) of the Act applies, a written notice of a proposal by an RCH to make a regulatory provision must: state expressly that it is a notice for the purpose of that section; contain full particulars of the proposed provision; and be accompanied by sufficient supporting information to enable the Bank to assess the purpose and effect of the proposed regulatory provision or, where such information has already been provided to the Bank, refer to such information A UK RCH must provide such additional information in connection with a notice under section 300B(1) of the Act as the Bank may reasonably require. (1) For ease this document is annotated with the FSA numbering although this numbering will not be retained in future.
10 8 of key staff prior to their appointment. This reflects requirements in EMIR (such as article 27) and the existing Recognition Requirements (regulation 17). Since FMIs play an important role in managing risk, including systemic risk, key staff must have the skills, experience and capability to perform their roles with a high degree of competence. The rule would allow supervisory intervention, if judged necessary, prior to an appointment being made. It will be without prejudice to the Bank s ability to reassess the suitability of staff at any point. This rule broadly continues the existing practice applied by the FSA. (1) Rule 2 is designed to help RCHs meet the legal obligation in FSMA concerning reporting of regulatory provisions that might potentially be considered excessive. A requirement may be considered excessive if it is not required by UK or EU law and is not justified as pursuing a reasonable regulatory objective or is disproportionate to the end to be achieved. (2) The Treasury introduced a power in 2006 enabling the regulator to prevent RCHs and RIEs from introducing excessive regulatory provisions (FSMA s.290a and s.300a). The power requires RIEs and RCHs to notify all regulatory provisions to the FSA. The FSA s rule, which the Bank proposes to retain in an amended form, has the effect of narrowing the scope of the requirement so as to provide a more proportionate reporting burden for RCHs. The Bank considers that these rules support effective supervision and hence are compatible with the Bank s financial stability objective. Cost-benefit analysis While the Bank is not required to complete a cost-benefit analysis, the Bank has considered the proportionality of its rule making. In the case of these proposed rules, the Bank considers that the costs of complying with these rules will not be material. The notices under proposed rule 1 are straightforward. Proposed rule 2 clarifies where statutory notices are required and their expected content, and consequently reduces regulatory reporting requirements by limiting the extent of reporting otherwise required under s.300b of FSMA. Questions regarding Section 2 (1) Do you agree with the approach proposed in these rules? (2) Are there further existing FSA notification rules that it would be helpful for the Bank to retain as rules? (3) Do you have any comments on the Bank s drafting of the rules? (1) See the Dear CEO letter issued in December 2009, (2) See FSMA s.300a(3).
11 9 3 Consultation on new rule relating to expert reports on recognised clearing houses Background The Bank will have the power under s.166 of FSMA to instruct RCHs to commission reports from experts (the s.166 power ). This is in line with a current FSA power in respect of authorised firms, and with a power that the Prudential Regulation Authority (PRA) and Financial Conduct Authority (FCA) will in future have in respect of authorised firms. The provision is not currently available to the FSA in respect of recognised bodies. Under the FSA s current power in respect of authorised firms, appointing a skilled person to provide a report on a specific matter involves the FSA sending written notice to the authorised firm concerned and either itself nominating one or more skilled persons, or asking the authorised firm to nominate one or more such persons to conduct the work. The authorised firm then contracts directly with the skilled person to produce the required report. Section 166 has now been amended, so that s.166(3)(b) permits the Bank, or the PRA or FCA (as appropriate) itself to appoint the skilled person to conduct the work and to contract directly with the skilled person. The regulator also has the power to issue a new rule that would allow the regulator, where it appoints the skilled person directly, to levy a fee on the RCH to which the expert report relates in order to recover associated costs. The Bank plans to make such a rule, and is consulting accordingly. Fees owed to the Bank may be recovered as a debt due to the Bank. (1) The Bank of England s approach to the supervision of financial market infrastructures outlines how the Bank plans to use the power to commission expert reports. It will do so where it judges them necessary or useful, for example to diagnose risks, and envisages commissioning them on an occasional basis in response to specific needs as they arise. It will decide on a case-by-case basis whether to commission a report itself or to direct the RCH (2) to do so. Relevant factors in that decision would include the urgency of the review, the use to which it will be put, and the Bank s assessment of the RCH s ability properly to brief and manage the expert producing the report. If the Bank contracts directly with the skilled person, the RCH will be provided with an indication of the anticipated costs before work begins. The Bank will consider responses received from the RCHs in relation to the cost and likely benefit to be derived from the report. The above rule would be made under s.166(9) of FSMA. FSMA requires that the Bank provide an explanation of the purpose of the proposed rules, and an explanation of the reasons for considering that making the proposed rules is compatible with the Bank s financial stability objective. Purpose and financial stability objective The purpose of the proposed rule is to allow the Bank to charge RCHs for the cost of a report where it chooses to commission a report directly from a skilled person rather than instructing the RCH to commission the report. External experts can provide input on technical issues so that the Bank, as supervisor, may benefit from an expert, experienced and independent view. They can also allow the Bank access to additional resource where analysis is needed. Commissioning reports directly from skilled persons rather than via the RCH could in some cases make it easier to ensure the report has the desired focus and that the skilled person is fully independent from the RCH. This will help the Bank to fulfil its financial stability objective. Cost-benefit assessment While the Bank is not required to complete a cost-benefit analysis, the Bank has considered the proportionality of its rule making. There will be costs to producing skilled person reports, and their materiality to the RCH will depend on the nature and complexity of the matter under consideration, the consequent charges made by the skilled person, and how this compares with the revenue and profits of the RCH. In 2011/12, the FSA commissioned 111 reports with a total cost of 31 million and costs per report ranging from just under 3,000 to 3 million. These are charges made by the company or individual producing the skilled person report, and do not include costs associated with any remedial actions required as a result of the report. The commissioning of a report by the Bank, with the cost recovered from the RCH should not in principle result in an increase in the overall cost for the RCH, compared with a scenario in which the RCH commissioned the report directly except to the extent that VAT becomes unrecoverable. (3) The benefits of skilled person reports under s.166 cannot reasonably be estimated ex ante. These benefits might include, for example, identifying flaws and gaps in risk management policies or practices that could endanger the RCH s resilience; catalysing implementation of enhanced systems and controls following an assessment of system and control weaknesses; or informing improvements to governance structures that enhance monitoring, oversight and accountability. These benefits can be significant, but cannot feasibly be quantified before a specific report is commissioned. The Bank considers it appropriate that costs are met by the (1) See Part 4 of Schedule 17A to FSMA. (2) The s.166 powers and this rule also apply to other bodies referred to in s.166(2) such as other members of the RCH s group and a partnership of which the RCH is a member. References to RCHs in this section of the document should be read to include these bodies. (3) RCHs in relation to which an expert report is commissioned could be subject to additional VAT costs (currently up to 20% depending on the RCH s tax circumstances) when the regulators contract directly with skilled persons and seek to recover from the RCH the total fees (including VAT) incurred.
12 10 The proposed rule RCH 3 Fees in respect of expert reports 3.1 This rule applies where the Bank gives notice under section 166(5) of the Act to the person concerned that the Bank has appointed a person under subsection (3)(b) to provide the Bank with a report on a matter. 3.2 Where the Bank notifies the person concerned in writing that the Bank has incurred expenses in relation to the appointment and specifies the amount of those expenses, the person concerned must pay those expenses to the Bank as a fee within 30 days. 3.3 The expenses may include any amount invoiced to the Bank by the appointed person in relation to any work carried out in connection with the matter. RCH to which the additional work relates, rather than by the wider community of firms that contribute towards the cost of supervision. The Bank will consider the expected costs and benefits of commissioning a report under s166 prior to commissioning such a report. To achieve an appropriate balance between cost and benefit, the Bank will, where it contracts directly with the skilled person, utilise a formal procurement process to assess the capabilities of the skilled person and the costs to be incurred and recovered from the RCH. Questions regarding Section 3 (1) Do you agree with the approach proposed in this rule? (2) Do you have any comments on the Bank s drafting of the rule?
13 11 4 Consultation on new rules relating to the introduction of excessive requirements on market participants by approved operators under the uncertificated securities regulations, and to expert reports on approved operators Background The first proposed new rule for approved operators ( Operators ) reflects a new obligation that the Treasury proposes to introduce in the USRs to prevent the introduction of excessive requirements on market participants by Operators. This would be equivalent to an obligation introduced for RIEs and RCHs under the Investment Exchanges and Clearing Houses Act As with the existing RCH provisions discussed in Section 2 of this document, the Bank will be able to make rules that set limits on the reporting requirements by which Operators fulfil this obligation. Absent this proposed rule, Operators would have to report all regulatory provisions to the Bank from the point at which the Bank takes over regulatory responsibility for Operators. The Bank therefore considers it desirable to consult now, notwithstanding that the underpinning legislation has not yet been made. The proposed rule is identical in effect to the relevant part of the equivalent proposed RCH rule (2) and, is based on the rule to which the existing Operator (Euroclear UK and Ireland Limited) is already subject in its capacity as an RCH. The FSA consulted when it first introduced its rules for RCHs and RIEs. In deciding to retain the substance of the FSA s rules, the Bank considered the FSA s experience of using those rules. The Bank is content that the proposed rule is a proportionate means of establishing practical limits within which the proposed new reporting obligations in the USRs can be implemented. The other proposed new rule for Operators under the USRs enables the Bank to recover as a fee costs that it may incur in instructing a skilled person to report on the Operator. This rule operates in the same way as the RCH rule (3) discussed in Section 3 of this consultation document, and that section should be read for details of the purpose, costs and benefits of such a rule. The Treasury s proposed changes to the USRs are still in preparation, but were outlined in general terms in the earlier Treasury consultation documents and draft legislation has been published. (1) Should these changes not, however, be introduced as anticipated, these rules will also not be introduced. Questions regarding Section 4 (1) Do you agree with the approach proposed in these rules? (2) Do you have any comments on the Bank s drafting of the rules? (1) The proposed operator rules USR 1 Extent of duty to notify proposal to make regulatory provision. 1.1 The duty in paragraph 3(1) of Schedule 2 to the Uncertificated Securities Regulations 2001 (as amended) (1) (in this rule the duty ) only applies in respect of a regulatory provision of a description specified in rule 1.2 which is not excluded under rule The specified regulatory provisions are those which (whether considered alone or together with any other regulatory provision) materially: increase disclosure, reporting or corporate governance requirements imposed on any person (whether directly or indirectly); limit access to, or use by, any person (whether directly or indirectly including, without limitation, through an amendment to fees or charges) of the facilities operated by the Operator proposing to make the regulatory provision; or add to the circumstances in which any person (whether directly or indirectly) may be liable to penalties or other sanctions or have liability in damages. 1.3 The duty does not apply to a regulatory provision to the extent that it: is required under EU law or any enactment or rule of law in the United Kingdom; specifies or amends standard terms relating to the provision of clearing services for any derivative; specifies or amends operating procedures which are reasonably consequential on any regulatory provision falling within 1.3.2; is expressed to have effect for no longer than three months and which is made by in response to an emergency event (including, without limitation, a war, terrorist attack or labour strike); or
14 does not impose a requirement (including any obligation or burden) on persons affected (directly or indirectly) by it. 1.4 Where the duty applies, a written notice of a proposal by the Operator to make a regulatory provision must: state expressly that it is a notice for the purpose of that regulation; contain full particulars of the proposed provision; and be accompanied by sufficient supporting information to enable the Bank to assess the purpose and effect of the proposed regulatory provision or, where such information has already been provided to the Bank, refer to such information. 1.5 A UK RCH must provide such additional information in connection with a notice under paragraph 3(1) of Schedule 2 to the Uncertificated Securities Regulations 2001 (as amended) as the Bank may reasonably require. USR 2 Fees in respect of expert reports. 2.1 This rule applies where the Bank gives notice under regulation 11A(4) to the Operator concerned that the Bank has appointed a person under regulation 11A(2)(b) to provide the Bank with a report on a matter. 2.2 Where the Bank notifies the Operator in writing that the Bank has incurred expenses in relation to the appointment and specifies the amount of those expenses, the Operator must pay those expenses to the Bank as a fee within 30 days. 2.3 The expenses may include any amount invoiced to the Bank by the appointed person in relation to any work carried out in connection with the matter. (1) These draft rules have been prepared on the basis of the provisions in the draft Uncertificated Securities (Amendment) Regulations 2013.