The Bank of England’s annual supervision of financial market infrastructures (FMI) report this week laid out plans for the future supervision of systematically important FMIs.
“As a global financial centre, the smooth and safe operation of UK FMIs is vital for international markets,” said deputy governor for financial stability, Sir Jon Cunliffe. “The Bank’s supervision of FMIs is essential for financial stability by ensuring that their risk management and resilience frameworks enable them to carry out their vital functions in normal times and during periods of stress.
“Our supervisory approach will evolve to ensure the UK maintains a coherent, agile, and internationally respected approach to financial services regulation that promotes financial stability.
The bank regulates three broad categories of FMI: payment systems, central securities depositories (CSDs) and central counterparties (CCPs). Currently, it supervises one CSD (Euroclear UK & International) and three CCPs (ICE Clear Europe, London Clearing House (LCH) and the London Metals Exchange); along with payment platforms including Bacs, CHAPS, LINK, Visa Europe and Mastercad Europe, among others.
The role of FMIs is to simplify complex networks of counterparty exposures, making financial transactions more efficient and secure. Their central role in the financial system means that maintaining their operational and financial resilience is of crucial importance to financial stability.
However, FMIs can be exposed to multiple sources of disruption, including from other market participants and service providers, as well as their own operations, which can give rise to both financial and operational risks. “FMIs must be financially and operationally resilient in order to be able to absorb, rather than amplify, shocks,” stressed the Bank of England.
Market volatility over the past year has demonstrated the importance of the resilience of FMIs for financial stability in the UK and abroad, and the latest report outlines how the central bank has stepped up its supervision of these entities in response to the challenging times.
This includes a new agenda on CCP resilience and recovery, an updated policy on the recognition and supervision of overseas CCPs and CSDs that want to provide services in the UK, and targeted enhancements to supervisory frameworks – with new requirements on FMI operational resilience including consultations to reflect an increased reliance on outsourcing. Also this year, the Bank published its first public supervisory stress rest of UK CCPs, which (reassuringly) confirmed their resilience to market stress scenarios calibrated to be of equal or greater severity than the worst historical market stresses.
“The BofE’s annual report reinforces the increasing importance of interconnection between FMIs across Europe,” said Javier Hernani, head of securities services at SIX Group, speaking exclusively to Global Custodian’s sister publication, The TRADE.
“What market participants crave is a far greater array of choice when it comes to clearing services. For instance, if an international trading firm is opening a new euro clearing account, they need to have direct access to the domestic CSDs. Providing connectivity like this is paramount to ensuring the financial stability that the BofE has outlined.”
Going forward, the UK’s Future Regulatory Framework (currently before Parliament) is likely to step up supervisory attention, as it grants the Bank of England sole rulemaking power over CCPs and CSDs operating in the UK.