The Committee on Payment and Settlement Systems (CPSS) and the International Organization of Securities Commissions (IOSCO) have published a consultative report on the recovery of CSDs, CCPs and trade repositories.
The report provides guidance for CSDs, CCPs, settlement systems and trade repositories on how to develop plans to enable them to recover from threats to their viability and financial strength.
The report has been produced in response to comments received on the July 2012 CPSS-IOSCO report on Recovery and resolution of financial market infrastructures (FMI) that requested more guidance on what recovery tools would be appropriate for FMIs.
The report considers recovery tools that fall into five categories: tools to allocate uncovered losses caused by member default; tools to address uncovered liquidity shortfalls; tools to replenish financial resources; tools to allocate losses not related to participant default; and tools for CCPs to re-establish a matched book. For each recovery tool, guidance is provided on the elements that an FMI should consider in its recovery plan and on the tool’s likely effects. The tools propose that additional capital that may be used to meet losses arising from general business, custody and investment, or operational risks. These tools may include ex-ante commitments from existing shareholders or a capacity to raise capital from participants.
CPSS-IOSCO found FMIs and the authorities responsible for their regulation, supervision and oversight should consider carefully the following guidance on recovery planning and recovery tools:
• The recovery plans should identify the FMI’s critical services, the stress scenarios that may prevent it from being able to provide its critical services as a going concern, and the triggers for implementing the recovery plans.
• The recovery plans should include a set of recovery tools that is comprehensive, effective (in terms of reliability, timeliness, and legal basis) and transparent; provides appropriate incentives; and has the least negative systemic impact.
• The recovery plans and the recovery tools should take into account any constraints potentially imposed by domestic or foreign laws or regulations.
• In order to allow effective implementation of recovery plans, recovery tools should, to the maximum extent practicable, be agreed and established as binding ex-ante.
• Even where there is ex-ante agreement that a tool is available, there needs to be an appropriate balance struck between its automatic application in a given situation (which increases transparency and predictability) and discretion by the FMI to use its judgement (which may enable a better decision to be taken about which tools are best given the specific circumstances and in which sequence they should be used).
• FMIs should have in their recovery plans ex-ante, rules-based arrangements that fully allocate through position-based loss allocation any losses caused by participant default that are not otherwise covered.
• FMIs should have in their recovery plans ex-ante, rules-based arrangements that fully allocate any liquidity shortfall caused by participant default that is not covered by available resources. Such arrangements should include, as necessary, rules-based funding from participants to whom funds are owed.
• CCPs should have additional tools in place that allow them to re-establish a matched book, including mechanisms that incentivise a successful auction of unmatched contracts. If such efforts to re-establish a matched book fail, there should be an ex-ante, rules-based arrangement to allow the CCP to achieve a matched book.
The report proposes FMIs should have a plethora of tools to assist their recovery, including:
• Tools for dealing with liquidity shortfalls can be separable from tools to deal with credit losses. Similarly, tools for establishing a matched book can be separable from tools to deal with credit losses.
• FMIs should have tools to replenish financial resources once losses caused by participant default have been allocated. These tools may include collecting resources from its participants by means of cash calls, raising additional equity capital, or replenishing resources by some other means.
• FMIs should have tools to raise additional capital that may be used to meet losses arising from general business, custody and investment, or operational risks. These tools may include ex-ante commitments from existing shareholders or a capacity to raise capital from participants.
• In many cases the FMI will need not only to recover from a financial shortfall but also to identify and correct the underlying cause of the problem. FMIs should have arrangements to address any underlying structural weaknesses.
Comments to the report are due by comments by Oct. 11 2013. After the consultation, it will publish a final version of the report.
The report supplements the latest report on jurisdictions’ progress towards implementing the 24 Principles for financial market infrastructures (the PFMIs), published by CPSS-IOSCO in April 2012 and which includes risk management standards for financial market infrastructures (FMIs) such as central counterparties, payment systems and securities settlement systems, and trade repositories.
Most jurisdictions are in the process of implementing the PFMIs, the report found.
CPSS-IOSCO Publish Recovery Guidelines for CSDs and CCPs
The report provides guidance for CSDs, CCPs, settlement systems and trade repositories on how to develop plans to enable them to recover from threats to their viability and financial strength.