Impact of the new Principles on Financial Market Infrastructures

Transcription

1 Impact of the new rinciples on Financial Market Infrastructures Workshop on payments systems oversight Kingston, Jamaica 5 December 2012 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-IOSCO The new principles for Financial Market Infrastructures (FMIs) Other related CSS initiatives Assessment methodology and disclosure framework Recovery and resolution of FMIs OTC Derivatives 2

3 Financial Market Infrastructures (FMIs) Facilitate recording, clearing and settlement of monetary and other financial transactions Strengthen the markets they serve Mitigate systemic risk FMIs play a critical role in fostering financial stability On the other hand, FMIs also concentrate risk not the least through interdependencies. If this risk is not properly managed, FMIs can be sources of: Credit losses Liquidity and collateral dislocations Financial shocks FMIs could be major channels through which shocks are transmitted across domestic and international financial markets 3

4 Experience during the financial crisis FMIs generally proved resilient to the crisis due to the efforts of last 20 years No materialisation of systemic risk in FMIs Global efforts towards intraday finality were 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 Severe lack of transparency in the OTC derivatives market and absence of infrastructure to mitigate risk Insufficient (cross-border) information flow Shortcomings in default and liquidity risk management 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 implementation and whether it is sufficient to improve transparency in the derivatives markets, mitigate systemic risk, and protect against market abuse Standard setting bodies should strengthen their risk management standards 5

6 Key international standards Financial Stability Board Macroeconomic policy and data transparency 1 Monetary and financial policy transparency IMF 2 Fiscal policy transparency IMF 3 Data dissemination IMF Financial regulation and supervision 4 Banking supervision BCBS 5 Securities regulation IOSCO 6 Insurance supervision IAIS Institutional and market infrastructure 7 Crisis resolution and deposit insurance BCBS/IADI 8 Insolvency World Bank 9 Corporate governance OECD 10 Accounting and auditing IASB/IAASB 11 ayment, clearing and settlement CSS/IOSCO 12 Market integrity (money laundering etc) FATF 6

7 Role of CSS and IOSCO CSS and CSS-IOSCO standards are increasingly becoming the foundation of FMI related oversight and regulatory activities CSS is recognised by the FSB as one of the relevant standard setting bodies (SSBs). The FMIs are among the key standards for sound financial systems 7

8 International standards for payment, clearing and settlement systems Old standards CSS Core principles for systemically important payment systems (CSIS)(2001) CSS-IOSCO Recommendations for securities settlement systems (RSSS) (2001) CSS-IOSCO Recommendations for central counterparties (RCC) (2004) New standards CSS-IOSCO rinciples for financial market infrastructures (FMI) (2011) 8

9 New rinciples for the Financial Market Infrastructures: Replace former three standards with one single, comprehensive set of principles for all FMIs: CSIS (2001), RSSS (2001), RCC (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 9

10 Development of the FMIs A comprehensive review of the old standards was launched in February 2010 to support G-20 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 10

11 Status of the principles CSS and IOSCO members should strive to adopt the principles in the FMI by the end of 2012 and put them into effect as soon as possible; FMIs are expected to observe the principles as soon as possible Binding on members of relevant committees (CSS, IOSCO, FSB) - not directly legally binding but they enjoy the status of soft law because of: power of the arguments they contain membership of the committees (increased legitimacy thanks to wider membership of CSS) Domestic regulation frequently based on them (sometimes the basis of legislation too by way of incorporation) 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) Basis of assessments by IMF and World Bank for financial sector assessment programmes (FSAs) 11

12 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 12

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

14 FMIs covered by the FMIs FMIs are sophisticated multilateral arrangements among participating financial institutions that handle significant transaction volumes and sizable monetary values FMIs facilitate the recording, clearing and settling payments, securities, derivatives, or other financial transactions These FMIs are regarded as systemically important because of the critical roles in the markets they serve: Systemically important (large value and retail) payment systems (SIS) Central counterparties (CC) Central securities depositories (CSD) and Securities settlement systems (SSS) Trade repositories (TR) (newly included) 14

15 General organisation Credit and liquidity risk Settlement CSDs and Exchange Value Settlements Default Management General business and operational risk management Access Efficiency Transparency 15

16 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 16

17 Key differences between old and new standards Unifies the set of standards for payment systems that are systemically important, CSDs, SSSs, CCs, and TRs (a new type of FMI) Focuses requirements on its safety and efficiency to limit systemic risk and foster transparency and financial stability Introduces more-demanding requirements and provides greater guidance when compared with previous standards Addresses a number of important issues across several principles financial resources recovery or orderly wind down fair and open access tiered participation arrangements interdependencies, including interoperability 17

18 rinciple 4: Credit risk rinciple 7: Liquidity risk New requirement Distinction between current exposures and FEs Full coverage of all 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 Does the FMI have enough collateral? How to estimate potential future losses? What stress scenarios? Normal versus extreme condition: 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? 18

19 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 19

20 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 arising from the FMI s CS processes, 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 20

21 CC requirements Cover exposures to each participant fully with a high degree of confidence This means that a CC must collect margin or maintain other resources with values equal to or greater than the current and potential future exposure to each participant CCs generally collect variation margin (cash) to cover current exposure and initial margin (cash and securities) to cover potential future exposure High degree of confidence is defined (in principle 6 on margin) as the 99% confidence level (single-tailed) of the estimated distribution of future exposure In addition, collect additional resources to cover the default of one or two participants and their affiliates in extreme but plausible market conditions Intended to cover a subset of tail risk (or beyond the 99 confidence level) CCs generally collect additional collateral as margin or as contributions to a mutualized pool of resources Document supporting rationale for and have appropriate governance arrangements relating to the amount of total financial resources held 21

22 Cover 1 or cover 2 for extreme but plausible Whether a CC maintains sufficient resources to cover one or cover two depends on the risk profile of its activities and its systemic importance Activities with a more-complex risk profile include clearing financial instruments that are characterized by discrete jump-to-default price changes or that are highly correlated with potential participant defaults Determinants of systemic importance in specific jurisdictions include consideration of location of the participants aggregate volume/volume of transactions that originate in each jurisdiction proportion of its total volume/value of transactions that originate in each jurisdiction range of currencies in which the instruments it clears are cleared or settled any links it has with FMIs located in other jurisdictions extent to which it clears instruments that are subject to mandatory clearing obligations in multiple jurisdictions 22

23 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 23

24 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 backtesting, 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 wrong-way risk be avoided? 24

25 Initial margin requirements Initial margin is collateral collected to cover potential changes in the value of each participant s position (that is, potential future exposure) over the appropriate close-out period in the event the participant defaults Meet an established single-tailed confidence level of at least 99% with respect to the estimated distribution of future exposure (at the portfolio, sub-portfolio, or product level) Have an initial margining system that takes into account the product characteristics such as complexity, close-out period length, price volatility and correlation, jump-todefault risk, and hedging strategies Use an appropriate close-out period that considers anticipated close-out times in stressed market conditions and an appropriate historical period for each product type Identify and mitigate any credit exposure that may give rise to specific wrong-way risk Address procyclicality by adopting a forward looking and relatively stable and conservative margin requirements 25

26 Variation margin requirements Variation margin is funds that are collected or paid out to reflect current exposures resulting from actual changes in market prices Collect variation margin daily (and intraday where appropriate) to mitigate current exposure Have the authority and operational capacity to make scheduled and unscheduled intraday variation margin calls and payments Have highly reliable price information for marking positions to market; sources of price information include market third-party pricing services CC valuation models participants 26

27 Testing margin coverage Backtesting is an ex-post comparison of actual outcomes with outcomes derived from the margin model erformed daily The CC should have clear procedures to deal with instances where the model did not perform as expected and determine whether a recalibration is warranted Backtesting does not evaluate effectiveness against forward-looking risks Sensitivity analysis tests how the margin coverage might be affected by a wide set of scenarios designed to reflect potential market conditions erformed at least monthly Scenarios should include both historical and hypothetical situations Validation of the margin methodology should be conducted at least annually by qualified and independent individuals 27

28 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 28

29 rinciple urpose Key discussion points rinciple 14: Segregation and portability rotect indirect participants; Increased importance following mandatory clearing What model of segregation, at the level of CC or participant? Other equivalent models? What form of portability (relevant for capital requirements)? rinciple 15: Business risk rinciple 19: Tiered participation 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 types of non-default related business risks? What ongoing quantitative requirement (at least 6 months)? What liquid composition? How far down the chain of tiering? FMIs as quasi-regulators? 29

30 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 A CC should protect 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 In certain jurisdictions, a cash market CC may have alternative approaches to protecting customers For example, laws that subject participants to explicit and comprehensive financial responsibility or customer protection requirements 30

31 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 31

32 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 32

33 rinciple rinciple 3: Comprehensive risk management rinciple 18: Access and participation requirements rinciple 20: FMI links Responsibility E: Cooperation between authorities 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 Strengthening the need for cross-border cooperation between authorities 33

34 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 34

35 Key requirements by FMI type CSD-CSD Links CC-CC Links TR Links Cover fully all extensions of credit between CSDs with highquality collateral lace limits on extensions of credit between CSDs rohibit provisional transfers of securities between linked CSDs, or prohibit retransfer of provisionally transferred securities prior to the transfer becoming final Ensure the link arrangement provides protection for the rights of participants Robust reconciliation procedures are needed to ensure accurate records Manage risks associated with the use of an intermediary to access another CSD Identify and manage potential spillover effects from linked CCs Cover current and potential future exposures to the linked CC and its participants fully with a high degree of confidence Financial resources used to cover inter-cc current exposures should be prefunded with highly liquid assets that exhibit low credit risk Financial resources provided by one linked CC to another should be ring fenced from other resources and should be at the bottom of the waterfall Losses in a particular financial product should be contained to those participants clearing the products Linked CCs should consider harmonizing their risk-management frameworks Carefully assess additional operational risks related to links to ensure scalability and reliability of IT and related resources Ensure that changes in a linked FMI will not inhibit the smooth functioning of the link, risk-management arrangements, and nondiscriminatory access to the link Note: Links to payment systems are not addressed by this principle, but rather by principle 9 on money settlements. 35

36 Assessment Methodology rovides guidance for assessing observance of the 24 principles and 5 responsibilities defined in the FMI rovides guidance for determining the scope of an assessment, gathering facts, developing conclusions, and assigning a rating of observance for each principle Intended primarily for external assessors at the international level, such as the World Bank and the International Monetary Fund May also be used by national authorities, either as written or as an input to their own methodologies Intended to promote objectivity and comparability across the assessments of observance in different jurisdictions Consultative period on the Assessment Methodology ended June

37 Disclosure Framework Outlines basic information that an FMI should disclose to increase transparency of its governance, risk-management, and operations in order to provide participants, authorities, and the public with a comprehensive understanding of the FMI and to facilitate comparisons across FMIs The FMI s organization, markets served, and key metrics Any recent changes to the FMI s design and services The FMI s approach to or method for observing each of the applicable principles in the FMI rinciple 23 of the FMI requires FMIs to complete the Disclosure Framework on a regular basis and disclose their answers publicly repared in connection with the Assessment Methodology to ensure a consistent framework for disclosure and assessment Consultative period on the Disclosure Framework ended June

38 FMI related follow-up December 2012 End 2012/early 2013 ublication of final Assessment methodology and disclosure framework Starting of monitoring of implementation by CSS-IOSCO: Reviews are considered to be carried out in three levels, assessing (i) whether a jurisdiction has completed the process of adopting the required legislation and other policies; (ii) whether the content of new legislation and policies is complete and consistent; and (iii) whether there is consistency in the outcomes of implementation 38

39 FMI related follow-up work Recovery and resolution of FMIs - Following the work undertaken by the FSB in respect of resolution and recovery regimes for financial institutions - Outlines the issues to be taken into account for different types of FMIs when putting in place effective recovery plans and resolution regimes consistent with the FSB rinciples and Key Attributes - CSS-IOSCO consultative report published in July

40 OTCD related follow-up work OTCD Data reporting and aggregation requirements Laying out minimum data reporting requirements and standardised formats, and the methodology and mechanism for data aggregation on a global basis CSS-IOSCO paper outlining considerations for data requirements for Trade Repositories published in January 2012 Legal Entity Identifier Establishing a scheme for the issuance of unique legal entity identifiers FSB report published in June 2012 Access by authorities to trade repository data Guidance on the level of access by authorities having different mandates (supervision, oversight, financial stability, etc.) to data stored in TRs CSS-IOSCO task force to prepare further guidance 40

41 OTCD related follow-up work Capital requirements for bank exposures to central counterparties Introducing the interim framework for determining capital requirements for bank exposures to CCs via additions and amendments to Basel II (indicating that a FMIs compliant CCs will receive a preferential capital treatment) BCBS document published in July 2012 Margining requirements for non-centrally-cleared derivatives Laying out a set of high-level principles on margining practices and treatment of collateral, and proposing margin requirements for noncentrally-cleared derivatives with the objectives of reducing systemic risk and promoting central clearing BCBS-IOSCO consultative paper published in June 2012 Coordination of OTCD related regulatory activities Aiming to address gaps and overlaps of standard setting bodies 41

42 What is next? Globalisation and regional integration Consolidation Innovation Interdependencies Continued and enhanced global cooperation among authorities is essential in promoting global financial stability 42