NOTICE. OF 2018 FINANCIAL SERVICES BOARD

Transcription

1 NOTICE. OF 2018 FINANCIAL SERVICES BOARD FINANCIAL MARKETS ACT, 2012 (ACT NO. 19 OF 2012) DRAFT GUIDELINES ON RECOVERY PLANS FOR MARKET INFRASTRUCTURES I, Dube Phineas Tshidi, the Registrar of Securities Services, under section 6(3)(k), of the Financial Markets Act, 2012 (Act No. 19 of 2012), hereby invite comments concerning the proposed guidelines on recovery plans for market infrastructures. DP TSHIDI REGISTRAR OF SECURITIES SERVICES Page 1 of 31

2 GUIDELINES ON RECOVERY PLANS FOR MARKET INFRASTRUCTURES 1. DEFINITIONS In these guidelines, the Act means the Financial Markets Act, 2012 (Act No. 19 of 2012) and any word or expression to which a meaning has been assigned in the Act has the meaning so assigned to it; and unless the context otherwise indicates- group of companies has the meaning ascribed to it Regulation Act, 2017(Act No. 9 of 2017); in the Financial Sector matched book means a risk management technique for central counterparties to ensure that they have equal valued liabilities and assets with equal maturities; systemically important financial institution has the meaning ascribed to it in the Financial Sector Regulation Act, 2017 (Act No. 9 of 2017). 2. THE PURPOSE The purpose of these guidelines is to provide guidance to market infrastructures regarding the development of recovery plans. 3. INTRODUCTION 3.1 In terms of the Act, market infrastructures must implement arrangements to efficiently and effectively manage the material risks associated with the operation thereof. 3.2 According to the Principles for Financial Market Infrastructures issued by the Committee on Payment and Settlement Systems 1 and the Technical Committee of the International Organization of Securities Commissions in April 2012 all financial market infrastructures should have comprehensive and effective recovery plans because the disorderly failure of such a market infrastructure could lead to severe systemic 1 The Committee on Payment and Settlement Systems (CPSS) changed its name to the Committee on Payments and Market Infrastructures (CPMI) on 1 September Please note that references to reports published before that date use the Committee s old name. Page 2 of 31

3 disruptions. 2 Recovery planning is inherently integrated into risk management and concerns those aspects of risk management and contingency planning which address the extreme circumstances that could threaten the market infrastructure s viability and financial strength. The absence of a recovery plan thus constitutes non-compliance with the Principles for Financial Market infrastructures. 3.3 Recovery involves the ability of a market infrastructure to recover from a threat to its viability and financial strength so that it can continue to provide its critical functions. The term critical refers to the importance of the function to the market infrastructure s participants and other market infrastructures, and to the smooth functioning of the markets the market infrastructure serves and, in particular, the maintenance of financial stability without requiring the use of resolution powers by authorities. 4. BACKGROUND 4.1 In terms of the Principles for Financial Market Infrastructures, exchanges are not included in the definition of financial market infrastructure. A financial market infrastructure refers to systemically important payment systems, central securities depositories, securities settlement systems, central counterparties and trade repositories. These infrastructures facilitate the clearing, settlement, and recording of monetary and other financial transactions, such as payments, securities, and derivatives contracts (including derivatives contracts for commodities). 4.2 However, the Act defines market infrastructure as the following: market infrastructure means each of the following- (a) (b) (c) (d) (e) a licensed central counterparty; a licensed central securities depository; a licensed clearing house; a licensed exchange; a licensed trade repository; 2 Key Consideration 3.4: An FMI should identify scenarios that may potentially prevent it from being able to provide its critical operations and services as a going concern and assess the effectiveness of a full range of options for recovery or orderly wind-down. An FMI should prepare appropriate plans for its recovery or orderly wind-down based on the results of that assessment. Where applicable, an FMI should also provide relevant authorities with the information needed for purposes of resolution planning. Page 3 of 31

4 4.3 The Act also provides for external market infrastructure which means each of the following: (a) an external central counterparty; (b) an external central securities depository; (c) an external clearing house; (d) an external exchange; (e) an external trade repository; 4.4 Furthermore, in terms of the Financial Sector Regulation Act, a market infrastructure may be designated as a systemically important financial institution in the Republic of South Africa and it is therefore the intention to include exchanges in this notice. 5. RECOVERY GUIDANCE 5.1 Recovery planning is not intended as a substitute for robust day-to-day risk management. Rather, it serves to extend and strengthen a market infrastructure s riskmanagement framework, enhancing the resilience of the market infrastructure and bolstering confidence in the market infrastructure s ability to function effectively even under extreme market conditions and operating environments. 5.2 A market infrastructure must prepare a recovery plan which includes the following: (a) (b) (c) (d) (e) Critical functions; stress scenarios (including idiosyncratic stress events as well as systemic stress events); triggers for recovery options; governance arrangements; and a communication plan as well as substantive descriptions of recovery tools, structural weaknesses and market infrastructure links. Page 4 of 31

5 5.3 Critical functions A market infrastructure must demonstrate that critical functions (payment, clearing, settlement, and recording of monetary and other financial transactions) will continue to be provided effectively and efficiently throughout the recovery process A market infrastructure must be able to identify critical functions it provides. The purpose of identifying critical functions is to focus the recovery plan on the market infrastructure s ability to continue to provide those functions on an on-going basis The degree of criticality of a market infrastructure s function is likely to be high if there are no, or only a small number of, alternative service providers. Factors related to the substitutability of a function could include: (a) (b) (c) The size of an infrastructure s market share; the existence of alternative providers that have the capacity to absorb the number of customers and transactions the market infrastructure maintains; and the market infrastructure participants capability to transfer positions to the alternative providers Furthermore, the criticality of the market infrastructure s function may be high if significantly interconnected with other market participants, both in terms of breadth and depth, thereby increasing the likelihood of contagion if the function were to be discontinued. Potential factors to consider when determining a market infrastructure s interconnectedness are the following: (a) (b) What functions it provides to other entities, and which of those functions are critical for other entities to function The failure of a market infrastructure to provide a critical function would be likely to have a material negative impact on participants or third parties, which could lead to contagion and undermine general confidence in the markets the market infrastructure serves. Such negative impacts are dependent on the degree of substitutability of the function as mentioned above. Page 5 of 31

6 5.3.6 If a market infrastructure provides services ancillary to its critical functions, it should determine whether the recovery plan needs to provide for the continuity of these services. 5.4 Stress scenarios A market infrastructure must identify scenarios under which its ability to continue to provide critical functions will be materially impaired. Typically two to four stress scenarios for recovery planning purposes are used with at least one systemic or market-wide scenario and at least one idiosyncratic or firm-specific scenario. These scenarios may include credit losses or liquidity shortfalls created by a participant default, a wide range of general business losses, or the realisation of investment losses (from financial assets the financial market infrastructure holds at third parties). A market infrastructure must include the risk associated with the failure of a third party to perform its critical functions (for example, the failure of a settlement bank or other service provider). A financial market infrastructure can achieve compliance by implementing appropriate recovery measures and periodic testing of backup facilities where necessary with regards to the function, service or activity that has been outsourced When a market infrastructure is part of a group of companies it may be at risk due to circumstances affecting other entities in the group. When the market infrastructure has links with other market infrastructures, it may be at risk from failures occurred from those market infrastructures. The underlying assumptions must be such that the scenarios are sufficiently severe. Both idiosyncratic 3 and systematic stress scenarios should be considered, taking into account the potential impact of domestic and crossborder contagion in crises, as well as simultaneous crises in several significant markets. 5.5 Triggers for Recovery The aim of triggers in recovery planning is to enable market infrastructures to maintain or restore financial strength and viability before regulatory authorities see the need to intervene or enforce recovery measures. Such triggers are generally understood as a 3 Unsystematic risk, also referred to as Idiosyncratic risk, is the risk that is endemic to a particular asset such as a stock and not a whole investment portfolio. Being the opposite of systematic risk (the overall risk that affects all assets like fluctuations in the stock market or interest rates), Idiosyncratic risk can be mitigated through diversification in an investment portfolio. Page 6 of 31

7 pre-identified point in time, situation or marker, which requires the market infrastructure to notify senior management or its board, and its supervisory authority that a triggering event has occurred. A market infrastructure must define the criteria (both quantitative and qualitative) that will trigger the implementation of part or all of the recovery options. For each stress scenario, a market infrastructure must identify the triggers that would move them from their pre-recovery risk management activities (e.g. those found in a central counterparty s default waterfall) to recovery. These triggers must be both qualified and, where relevant, quantified to demonstrate a point at which recovery plans will be implemented without ambiguity or delay While the boundary between pre-recovery risk-management activities and recovery can be clear (for example, when pre-funded resources are fully depleted), judgment may be needed in some cases. When this boundary is not clear, a market infrastructure must include how the market infrastructure will make decisions in its recovery plans This includes detailing in advance the communication plans of the market infrastructure, as well as the escalation process associated with its decision-making procedures. A market infrastructure must also specify the decision-makers responsible for each step of the escalation process to ensure that there is adequate time for recovery tools to be implemented, if required. More generally, it is important to identify and place the triggers for recovery early enough in a stress scenario to allow for sufficient time to implement recovery tools It is important to identify the moment when recovery should commence beforehand. Triggers placed too late in a scenario will impede the effective roll-out of these tools and hamper recovery efforts In some cases the triggers will be obvious. For example, in the case of participant default, the recovery plan will be triggered when the market infrastructure has exhausted the pre-funded financial resources or the liquidity arrangements it has in Page 7 of 31

8 place to deal with such default-related shortfalls or when it has become unlikely that the pre-funded financial resources or liquidity arrangements will be sufficient In other cases, judgment may be needed regarding how to devise appropriate triggers. For example, chronic or extraordinary losses from general business risks that threaten to impair the market infrastructure s capital may indicate that the scale of a problem has become sufficiently serious that the recovery plan may need to be implemented These triggers should lead to a pre-determined information-sharing and escalation process within the market infrastructure s senior management and its controlling body and to careful consideration of what action should be taken. The triggers should occur early enough to provide sufficient time for the plan to be implemented. Implementation will typically take place after discussion with the relevant authorities The development and the use of triggers and stress scenarios for recovery plans must be subject to strong risk governance processes in a market infrastructure, including review by the controlling body. 5.6 Governance Arrangements A market infrastructure must have robust governance arrangements, which include a clear organisational structure with well-defined, transparent and consistent lines of responsibility, effective processes to identify, manage, monitor and report the risks they are or might be exposed to, adequate internal control mechanisms, including sound administration and accounting procedures, and remuneration policies and practices that are consistent with and promote sound and effective risk management. The arrangements, processes and mechanisms referred to above should be comprehensive and proportionate to the nature, scale and complexity of the risks inherent in the business model and the organisation s activities. 5.7 Recovery options A market infrastructure s recovery options must specify the following: (i) measures that are within the direct control of the market infrastructure; Page 8 of 31

9 (ii) (iii) (iv) (v) steps and estimated time needed to implement each recovery option, the underlying assumptions for each recovery option, as well as the circumstances which could render the option unavailable, where the execution of any recovery option is dependent on other entities or stakeholders; the potential effectiveness and feasibility of each recovery option. This should take into account the impact, time, ease of execution and any associated risks that may arise from implementing the recovery option; the potential hurdles, challenges and constraints that it may face for each recovery option. These should be documented in the recovery plan, along with the measures that the market infrastructure intends to take to address these impediments; and the impact/potential impact of implementing multiple recovery options at the same time. 5.8 Communication plan In addition, as part of the recovery plan, a market infrastructure must implement a communication plan outlining how it intends to communicate within and outside the institution. The communication plan must cover the following: (i) (ii) Internal communication, in particular to staff; and external communication, in particular to shareholders, resolution or supervisory authorities, counterparties (e.g. authorised users and central securities depository participants), other market infrastructures, investors, and the public in general, as appropriate. In particular, the plan will explain how any potentially negative market reaction could be managed The recovery plan must also include an analysis of how the communication and disclosure plan would be implemented for each recovery tool, providing an assessment of the potential impact on the business and on the financial stability in general A market infrastructure must develop solid communications protocols with the Financial Services Board in the event that recovery is triggered which should also include an escalation process and the associated communication procedures. Such a Page 9 of 31

10 process must define the associated timelines, objectives and key messages of each communication step, as well as the decision-makers who are responsible for it. 5.9 Recovery tools A market infrastructure is required under the Principles for Financial Market Infrastructures to have recovery tools that allow it to allocate fully any uncovered losses and liquidity shortfalls caused by participant default. Moreover, a market infrastructure must be in a position to allocate losses or to implement an orderly winddown following losses that are not related to participant default. Additionally, an appropriate set of tools should meet the market infrastructure s recovery objectives. Market infrastructures can be exposed to legal, credit, liquidity, general business, custody, investment and operational risks. However, not all market infrastructures are exposed to these risks equally or in the same manner Characteristics of recovery tools The appropriateness of a given recovery tool or set of tools will vary based on particular market infrastructures and their individual circumstances. In some cases, a single recovery tool may be sufficient to achieve recovery of the market infrastructure however, in many cases, a market infrastructure will probably need to use a combination of tools to achieve such an outcome. The following characteristics will assist a market infrastructure evaluate the strengths and weaknesses of tools so that it can choose the set most appropriate for each relevant recovery scenario, including the sequence in which they should be used. (i) Comprehensive The set of tools should address comprehensively any uncovered credit loss or liquidity shortfall, ensure re-establishment of a matched book and enable replenishment of the market infrastructure s financial resources, including its own capital, in order to continue to provide critical services. The set of tools should be flexible enough to apply to a wide range of scenarios and should take account of the market infrastructure s ongoing risk management as well as the event that has triggered the use of recovery tools. Page 10 of 31

11 (ii) Effective Each tool should be reliable, timely, and have a strong legal basis. There should be a high degree of certainty that the market infrastructure will be able to implement each tool in all relevant circumstances, including in times of stress. Furthermore, a market infrastructure should take into account the extent to which participants, owners and third parties would have sufficient resources to meet their potential obligations when considering the reliability of a tool or set of tools. The tools should provide the market infrastructure with the required resources in a timely manner. When developing recovery tools, a market infrastructure should consider the trade-offs between tools that require new resources to be collected from participants (e.g. cash calls) and those that do not (e.g. variation margin haircutting). Lastly, tools should be consistent with the market infrastructure s rules, membership agreements, contracts, and the regulatory and legal frameworks in all relevant jurisdictions. (iii) Transparent, measurable, manageable and controllable The tools should be transparent and designed to allow those who would bear losses and liquidity shortfalls to measure, manage and control their potential losses and liquidity shortfall. A loss or liquidity shortfall is measurable to the extent that those who bear it are able to understand clearly how it would be allocated to them and what the potential size of their allocation would be under each default scenario. A loss or liquidity shortfall is manageable to the extent that those who bear it are able to absorb it without endangering their own financial viability. A loss or liquidity shortfall is controllable to the extent that those who bear it are able to affect by their behaviour the extent of their exposure to it. (iv) Create appropriate incentives The recovery tools should create appropriate incentives for a market infrastructure s owners, direct and indirect participants and, where relevant, other stakeholders to: (a) (b) (c) Control the amount of risk that they bring to or incur in the system; monitor the market infrastructure s risk-taking and risk management activities; and assist in the market infrastructure s default management process. Page 11 of 31

12 In line with Principle 3 of the Principles for Financial Market Infrastructures, a market infrastructure should create incentives for direct and indirect participants to manage and contain risks they pose to the market infrastructure. Any involvement by participants in loss or liquidity shortfall sharing may provide some incentive for them to reduce the risks created by their own positions and activity. Using recovery tools where participants losses or liquidity shortfalls in recovery are proportionate to their activity at the market infrastructure is a way to provide such incentives. Moreover, allocating losses or liquidity shortfalls in a way that is likely to mean that they are borne solely by direct participants could discourage direct participation in the market infrastructure, which in itself may carry potential risks. (v) Minimise negative impact The tools should be designed to minimise the negative impact on direct and indirect participants and the financial system more broadly. The use of particular recovery tools by a market infrastructure in certain stress scenarios may have particularly serious consequences for participants, markets and financial stability more broadly. Accordingly, the recovery tools should be developed in a way that minimises any negative impact to the broader financial system to the greatest extent possible. A market infrastructure should endeavour to develop a set of tools, including the sequence in which they would be used, that exhibits these characteristics to the greatest extent possible. However, because no set of tools may fully satisfy all the characteristics, a market infrastructure will need to determine which set achieves the best trade-off Specific recovery tools for market infrastructures There are different types of recovery tools with different purposes that might be applied by a market infrastructure individually, in combination or in sequence. Market infrastructures may implement the following tools: (i) Tools to allocate uncovered losses caused by participant default Cash calls on participants ( assessment power ) Page 12 of 31

13 There may be circumstances in a default or recovery scenario where a market infrastructure s prefunded financial resources will not be sufficient to address all losses. The market infrastructure needs to address such remaining losses which could be through rules requiring direct participants to commit in providing additional resources, typically in the form of cash, in order to meet a shortfall. This process is often referred to as an assessment power, and typically applies to cases of participant default. Position-based loss allocation tools Position-based recovery tools may take various forms, including steps that involve borrowing funds owed to participants (e.g. rules-based loans, swaps, or repos to address liquidity shortfalls); steps that decrease the amounts of payments owed on outstanding contracts (e.g. variation margin haircuts or reduced pay-outs to address credit losses and liquidity shortfalls); and steps that decrease outstanding gross or net positions (e.g. tear-up or forced allocations of contracts to address credit losses and liquidity shortfalls). Variation margin haircutting by central counterparties An important example of a position-based loss allocation recovery tool is variation margin haircutting by central counterparties. When haircutting variation margin, the central counterparty reduces pro rata the amount which is due to pay to participants with in-the-money (net) positions, while continuing to collect in full from those participants with out-of-the-money (net) positions. Initial margin haircutting by central counterparties Initial margin is provided to cover the obligations of the participant who posted it. (ii) Tools to address uncovered liquidity shortfalls Obtain liquidity from third-party institutions A financial market infrastructure may have arrangements in place with third-party institutions, including affiliated entities, to address uncovered liquidity shortfalls. Such tools may vary in their degree of reliability and be similar to forms of liquidity. Forms of liquidity that would qualify as supplementary liquidity may be useful in some scenarios, such as those where a financial market infrastructure or market conditions are not highly stressed. However, these less reliable forms of liquidity may not represent sufficient tools to address uncovered shortfalls in extreme but plausible market conditions. Hence, a recovery plan that contains Page 13 of 31

14 such tools should also contain tools that will be effective in highly stressed environments. Obtain liquidity from non-defaulting participants Tools to obtain liquidity from non-defaulting participants form an important category of recovery tools for financial market infrastructures. Obtaining liquidity only from participants who are owed funds by the financial market infrastructure, could take the form of rules requiring such participants to provide a collateralised loan, a repo or a swap transaction. This tool has the following advantages: (a) As it would not require pay-ins from participants, it could be executed immediately and does not entail performance risk, and thus is reliable and timely; (b) the tool is easiest to execute before outgoing payments have begun and is transparent as all terms and conditions should be clearly established under the financial market infrastructure s rules; (c) the size of potential obligations is measurable and controllable because it is based on the participant s position; and (d) finally, participants are incentivised to monitor the financial market infrastructure s liquidity risk management as well as their own individual liquidity risks in the system and to plan for their obligations should they materialise. (iii) Tools to replenish financial resources A market infrastructure will need to replenish its financial resources once uncovered losses caused by participant default have been allocated in order to be able to continue providing critical services. The market infrastructure may either collect resources from its participants by means of cash calls and/or it may need to raise additional equity capital. Cash calls on participants ( assessment power ) Ex-ante assessment powers are one way to replenish resources. Depending on the rules of the market infrastructure, where assessment powers are capped, it may be the case that use of such assessment powers to obtain resources to Page 14 of 31

15 meet existing defaults would reduce the amount of contributions that can be assessed to replenish mutualised default resources (default fund) that would be required for ongoing operations. (iv) Tools to allocate losses not related to participant default A market infrastructure will need to cover losses relating to general business, custody and investment, or operational risks which may cause a market infrastructure to experience recurring losses. A market infrastructure may need to recapitalise or have put in place explicit insurance or indemnity agreements. Investment risk A market infrastructure must have recovery tools in place to deal with a scenario where the viability of the market infrastructure is at risk because of losses that are not related to a participant default. Such losses might arise from general business, custody and investment risks, and would need to threaten the solvency of the market infrastructure before the recovery tools could be triggered. Insurance or indemnity agreements may be an effective way of addressing the impact of specific business and operational losses. However, the timeliness and reliability of such arrangements would be subject to a number of factors, including the lead-time required for having a claim processed and paid (in particular if there might be a challenge as to the validity of the claim or indemnification). Recapitalisation There may be circumstances in a market infrastructure s recovery process where the market infrastructure needs to obtain resources that exceed those available in the existing capital structure, including cases where the market infrastructure requires such resources to replenish its resources to continue systemically important operations. The market infrastructure should therefore have plans in place to increase their capital; for example, by recapitalisation after extraordinary losses, or capital conservation measures such as suspension of dividends and payments of variable remuneration. Raising capital should be for the market infrastructure to develop ex-ante arrangements with the existing debt holders regarding the bail- Page 15 of 31

16 in 4 of their instruments. Converting debt into equity under a bail-in scenario may be an appropriate tool for the market infrastructure. (v) Tools for central counterparties to re-establish a matched book After a participant defaults, a central counterparty will need to re-establish a matched book of obligations, stemming further losses. The central counterparty may enter into liquidating or risk-neutralising transactions to mitigate the market risk of the defaulter s positions, or may auction portions or the defaulters entire portfolio to surviving participants. If the central counterparty is unable to offset the defaulter s positions, within the central counterparty s recovery resources, through voluntary means, it may need to take action through involuntary means (albeit based on ex-ante agreements), such as forced-allocation or tear-up. Incentivise acceptance of unmatched contracts To deal with a defaulter s outstanding positions, a central counterparty should auction these to direct participants or to third parties who could clear such positions through direct participants. The central counterparty s rules could provide incentives for successful bidders on unmatched contracts. The method of allocation of losses among participants could be set out ex-ante to provide incentives for competitive bidding, for example juniorising (that is, using first) the mutualised default fund contributions of participants (if these have not been exhausted in meeting losses caused by a default) that are not successful bidders in auctions of unmatched contracts. Forced allocation of contracts To the extent the central counterparty has positions remaining that it cannot allocate through voluntary means at a price within the central counterparty s available resources, it could forcibly allocate those positions to non-defaulting participants at a price determined by the central counterparty. The method of allocation should be set out ex-ante, for example focusing on direct participants that hold positions related to or opposite the unmatched positions, or allocating more positions to participants who have made fewer successful bids in the voluntary auctions. 4 Borrower's creditors are forced to bear some of the burden by having a portion of their debt written off Page 16 of 31

17 Contract termination: tear up The central counterparty could terminate some or all open positions in order to return to a matched book and stem further losses. A price would be established upon termination. Contractual versus voluntary tools to achieve a matched book In order for a recovery plan to be comprehensive, it should include contractual tools pursuant to which the central counterparty may, on a mandatory basis, reestablish a matched book. Such mandatory tools necessarily involve either disruption to netting sets, compulsory allocation of unmatched positions or full tear up. (vi) Tools to address structural weaknesses Recovery concerns financial shortfalls that pose a threat to the market infrastructure s viability and financial strength. However, in most cases the market infrastructure will not only need to recover from the financial shortfall itself but will also need to identify and address the underlying cause of the problem if it is to continue operating as a going concern. The recovery action taken will depend on the specific stress scenario that led to the problem. If the financial problem that triggers recovery is on-going business losses, the market infrastructure may need to restructure its business to correct the underlying problem. Mechanisms to address structural weaknesses include the following: a) Revising risk management frameworks; b) replacing management; c) revising business strategy (including cost or fee structures); d) restructuring services provided; e) selling business units; f) merging with another market infrastructure; g) reducing risks (for example, changes in investment or custody policy); and h) taking measures to reduce complexity and interconnectedness. Page 17 of 31

18 In order to be prepared to address structural weaknesses that could lead to a financial shortfall that requires the implementation of the recovery plan, a market infrastructure should carry out a strategic analysis. This strategic analysis may include identifying and preparing for potential material impediments to timely execute tools to address structural weaknesses and describe the process for determining the value and marketability of material business lines that the market infrastructure may wish to sell. If a market infrastructure wants to sell a part of its business, it must identify and address legal, regulatory or information technology-related obstacles that would make it difficult to execute the sale in a timely manner (i.e. within the period for which it has liquid net assets funded by equity). For example, a market infrastructure may need to obtain approvals from authorities or make sure that it can continue to use an information technology system that is shared with a business line that may be sold. Where the business line involves a critical service, it is essential that the plan ensures the continuity of provision of that service. 6 ANNUAL REVIEW OF RECOVERY PLAN 6.1 A market infrastructure must review and, if necessary, update its recovery plan on an annual basis. The recovery plan must be subject to approval by the market infrastructure s controlling body. In addition to the annual review, the market infrastructure should also under the following circumstances, review its recovery plan: (a) (b) (c) If there is a significant change to market conditions or to a market infrastructure s business model, corporate structure, services provided, risk exposures or any other element of the firm that could have a relevant impact on the recovery plan; if a market infrastructure encounters a severe stress situation that requires appropriate updates to the recovery plan to address the changes in the market infrastructure s environment or lessons learned through the stress period; and if requested by the Authority or the Prudential Authority that the market infrastructure update the recovery plan to address specific concerns or for additional clarity. Page 18 of 31

19 7. CONCLUSION 7.1 Developing and maintaining a recovery plan will have effective business value by sharpening the strategic decision-making by the controlling body and senior management, improving the information and analytical systems on which a market infrastructure bases many of its operations as well as considering activities that have been outsourced.. The plan should rationalise organisational and the legal structure of the entity. The plan will also become a key supervisory tool on which the Registrar will rely on, to ensure that the market infrastructure has a co-ordinated plan for managing extreme stress scenarios with minimum disruption to the economy. Market infrastructures should understand the importance of the guidance, devote adequate and appropriate resources to it, and keep open channels of communication with the regulators on its recovery plans. 8. COMMENCEMENT DATE These guidelines will come into effect six months after the date of the final publication. Page 19 of 31

20 ANNEXURE A Principles for financial market infrastructures General organisation Principle 1: Legal basis A financial market infrastructure should have a well-founded, clear, transparent, and enforceable legal basis for each material aspect of its activities in all relevant jurisdictions. Principle 2: Governance A financial market infrastructure should have governance arrangements that are clear and transparent, promote the safety and efficiency of the financial market infrastructure, and support the stability of the broader financial system, other relevant public interest considerations, and the objectives of relevant stakeholders. Principle 3: Framework for the comprehensive management of risks A financial market infrastructure should have a sound risk-management framework for comprehensively managing legal, credit, liquidity, operational, and other risks. Credit and liquidity risk management Principle 4: Credit risk A financial market infrastructure should effectively measure, monitor, and manage its credit exposures to participants and those arising from its payment, clearing, and settlement processes. A financial market infrastructure should maintain sufficient financial resources to cover its credit exposure to each participant fully with a high degree of confidence. In addition, a central counterparty that is involved in activities with a more complex risk profile or that is systemically important in multiple jurisdictions should maintain additional financial resources sufficient to cover a wide range of potential stress scenarios that should include, but not be limited to, the default of the two participants and their affiliates that would potentially cause the largest aggregate credit exposure to the central counterparty in extreme but plausible market conditions. All other central counterparties should maintain additional financial resources sufficient to cover a wide range of potential stress scenarios that should include, but not be limited to, the default of the participant and its affiliates that Page 20 of 31

21 would potentially cause the largest aggregate credit exposure to the central counterparty in extreme but plausible market conditions. Principle 5: Collateral A financial market infrastructure that requires collateral to manage its or its participants credit exposure should accept collateral with low credit, liquidity, and market risks. A financial market infrastructure should also set and enforce appropriately conservative haircuts and concentration limits. Principle 6: Margin A central counterparty should cover its credit exposures to its participants for all products through an effective margin system that is risk-based and regularly reviewed. Principle 7: Liquidity risk A financial market infrastructure should effectively measure, monitor, and manage its liquidity risk. A market infrastructure should maintain sufficient liquid resources in all relevant currencies to effect same-day and, where appropriate, intraday and multiday settlement of payment obligations with a high degree of confidence under a wide range of potential stress scenarios that should include, but not be limited to, the default of the participant and its affiliates that would generate the largest aggregate liquidity obligation for the financial market infrastructure in extreme but plausible market conditions. Settlement Principle 8: Settlement finality A financial market infrastructure should provide clear and certain final settlement, at a minimum by the end of the value date. Where necessary or preferable, a financial market infrastructure should provide final settlement intraday or in real time. Principle 9: Money settlements A financial market infrastructure should conduct its money settlements in central bank money where practical and available. If central bank money is not used, a financial market Page 21 of 31

22 infrastructure should minimise and strictly control the credit and liquidity risk arising from the use of commercial bank money. Principle 10: Physical deliveries A financial market infrastructure should clearly state its obligations with respect to the delivery of physical instruments or commodities and should identify, monitor, and manage the risks associated with such physical deliveries. Central securities depositories and exchange-of-value settlement systems Principle 11: Central securities depositories A central securities depository should have appropriate rules and procedures to help ensure the integrity of securities issues and minimise and manage the risks associated with the safekeeping and transfer of securities. A central securities depository should maintain securities in an immobilised or dematerialised form for their transfer by book entry. Principle 12: Exchange-of-value settlement systems If a financial market infrastructure settles transactions that involve the settlement of two linked obligations (for example, securities or foreign exchange transactions), it should eliminate principal risk by conditioning the final settlement of one obligation upon the final settlement of the other. Default management Principle 13: Participant-default rules and procedures A financial market infrastructure should have effective and clearly defined rules and procedures to manage a participant default. These rules and procedures should be designed to ensure that the financial market infrastructure can take timely action to contain losses and liquidity pressures and continue to meet its obligations. Page 22 of 31

23 Principle 14: Segregation and portability A central counterparty should have rules and procedures that enable the segregation and portability of positions of a participant s customers and the collateral provided to the CCP with respect to those positions. General business and operational risk management Principle 15: General business risk A financial market infrastructure should identify, monitor, and manage its general business risk and hold sufficient liquid net assets funded by equity to cover potential general business losses so that it can continue operations and services as a going concern if those losses materialise. Further, liquid net assets should at all times be sufficient to ensure a recovery or orderly wind-down of critical operations and services. Principle 16: Custody and investment risks A financial market infrastructure should safeguard its own and its participants assets and minimise the risk of loss on and delay in access to these assets. An financial market infrastructure s investments should be in instruments with minimal credit, market, and liquidity risks. Principle 17: Operational risk A financial market infrastructure should identify the plausible sources of operational risk, both internal and external, and mitigate their impact through the use of appropriate systems, policies, procedures, and controls. Systems should be designed to ensure a high degree of security and operational reliability and should have adequate, scalable capacity. Business continuity management should aim for timely recovery of operations and fulfilment of the financial market infrastructure s obligations, including in the event of a wide-scale or major disruption. Access Principle 18: Access and participation requirements A financial market infrastructure should have objective, risk-based, and publicly disclosed criteria for participation, which permit fair and open access. Page 23 of 31

24 Principle 19: Tiered participation arrangements A financial market infrastructure should identify, monitor, and manage the material risks to the financial market infrastructure arising from tiered participation arrangements. Principle 20: Financial markets infrastructure links A financial market infrastructure that establishes a link with one or more financial market infrastructures should identify, monitor, and manage link-related risks. Efficiency Principle 21: Efficiency and effectiveness A financial market infrastructure should be efficient and effective in meeting the requirements of its participants and the markets it serves. Principle 22: Communication procedures and standards A financial market infrastructure should use, or at a minimum accommodate, relevant internationally accepted communication procedures and standards in order to facilitate efficient payment, clearing, settlement, and recording. Transparency Principle 23: Disclosure of rules, key procedures, and market data A financial market infrastructure should have clear and comprehensive rules and procedures and should provide sufficient information to enable participants to have an accurate understanding of the risks, fees, and other material costs they incur by participating in the financial market infrastructure. All relevant rules and key procedures should be publicly disclosed. Principle 24: Disclosure of market data by trade repositories A trade repository should provide timely and accurate data to relevant authorities and the public in line with their respective needs. Page 24 of 31

25 ANNEXURE B The following example provides suggestions on how a market infrastructure s recovery guidance could be organised. 1. Critical Services Identify critical services, following guidance on factors to consider. 2. Risks faced by the market infrastructures Identify types of risks the market infrastructure is exposed to. 3. Stress Scenarios For each type of risk, identify stress scenarios, further explain where existing risk management tools have become insufficient to cover losses or liquidity shortfalls, thereby necessitating the use of recovery tools. 4. Trigger For each stress scenario, identify the trigger to enter recovery. 5. Recovery Tools Provide an assessment of recovery tools, including how each tool will address uncovered losses, liquidity shortfalls and capital inadequacies. 6. Structural Weakness Identify and address structural weaknesses, including underlying issues that must be addressed to ensure the market infrastructure can remain a going concern post-recovery. The structural weakness can be caused by factors such as poor business strategy (including unsuitable cost or fee structures), poor investment or custody policy, poor organisational structure and internal control, and other internal factors unrelated to participant default (see Recovery Report). Page 25 of 31

26 ANNEXURE C Suggested submission template Individual / Group - Recovery Plan for [Insert Entity / Group Name] Recovery Plan reporting reference date: [insert date]. 1. Executive summary 1.1 Provide a summary of key elements in the recovery plan and material changes. 1.2 List all material changes since the last recovery plan submission. (Leave blank on first submission). 1.3 Description of legal and financial structures. 1.4 Describe the entity / entities covered by the plan. 1.5 Describe the legal and financial structures of the firm (in individual recovery plans) or the group members covered by the plan (in group recovery plans) Include a summary of the core business lines and critical functions. Core business lines means business lines and associated services which represent material sources of revenue, profit or franchise value for a market infrastructure. Critical functions means activities, services or operations the discontinuance of which is likely to lead to the disruption of essential services to the real economy or to disrupt financial stability due to the: (a) (b) (c) (d) (e) Size; market share; external and internal interconnectedness; complexity; or cross-border activities of a market infrastructure, particularly bearing in mind the substitutability of those activities, service or operations. Page 26 of 31

27 2. Governance arrangements 2.1 Describe the market infrastructure s governance arrangements, including the following: How the recovery plan is integrated into the corporate governance of the firm or the group (for example, how the recovery plan was developed); and the firm s or the group s overall risk management framework. 3. Recovery strategy/options 3.1 List and describe recovery options, including: Capital and liquidity actions required to maintain or restore the viability and financial position of the market infrastructure; arrangements and measures to conserve or restore the firm s own funds (in individual recovery plans) or the own funds of each market infrastructure in the group on an individual and consolidated basis (in group recovery plans); and an assessment of the expected timeframe for implementing recovery options. 3.2 Note that when identifying recovery options a market infrastructure should consider a range of severe macro-economic and financial stress scenarios relevant to the market infrastructure s specific conditions. 3.3 Summarise the overall recovery capacity of the market infrastructure or the overall capability of the group to restore its financial position following a significant deterioration. The following should be included: The risks associated with recovery options; an analysis of any material impediments to the effective and timely execution of the recovery plan; and whether and how material impediments could be overcome. 3.4 Describe preparatory measures the market infrastructure has taken, or plans to take, to implement the recovery plan. Page 27 of 31