The Association for Financial Markets in Europe (AFME) has commented on the European Commissions consultation paper on a recovery and resolution regime for CSDs and CCPs. The trade association said it strongly supports the efforts of the European Commission to enhance the mechanisms for dealing with the failure of these systemically important financial market infrastructures (FMIs).
While at a high level, there can be key common features for CCP and CSD recovery and resolution regimes, we would suggest that detailed regimes would need to be tailored to the specific type of FMI, said AFME.
Many aspects of the proposed EU bank recovery and resolution framework are appropriate to be replicated for an FMI recovery and resolution framework, said AFME. The framework, however, would need some features that are specific to CCPs and CSDs. For example, details surrounding resolution triggers would need to be tailored to specific types of FMIs. In the event that a CSD is also a credit institution (therefore an ICSD), the FMI framework alone should apply to the recovery and resolution of the CSD entity of the FMI only, to ensure that requirements and efforts are not duplicated and features of the framework that are CSD specific can apply to the CSD part of the FMI only.
The Consultation Paper highlights that ordinary insolvency law would be unsatisfactory in managing the failure of a systemic financial institution and we are unaware of harmonization in insolvency law at this point in time.
AFME identified some key scenarios or events that can lead to resolution of a CCP, including: the default of one or more clearing members; severe operational issues; severe operational issues of related entities (e.g. exchangebased failures); severe losses on the CCPs investments; and severe liquidity issues.
The association noted that it is impossible to identify in advance all possible scenarios. Any recovery and resolution regime should be able to manage a wide range of different scenarios, said AFME. We do, however, have some comments relating both to the risks incurred by CCPs and CSDs, and to the design of appropriate recovery and resolution regimes.
We note that the services of European FMIs are being provided in an increasingly crossborder context, notably as a result of legislative initiatives such as CSDR andEMIR, but also as a result of infrastructure initiatives such as TARGET2Securities.
We do believe that there are issues with, and inconsistencies between, nationaltranspositions of the Settlement Finality Directive. We note that in the context of theTARGET2Securities project there is discussion on this question.
On regulatory obligations, namely legal and regulatory risk, AFME said that regulatory regimes for CCPs and CSDs should concentrate on their core services, on the safety and soundness of the legal entity, and in general should not impose on the FMI regulatory duties and obligations that affect outside parties (such as the underlying trading parties and their trading relationship, or the relationship between participants in the FMI and their clients). With respect to the preparation of recovery and resolution plans, however, AFME said regulators should consider the potential spill over effects of even a shortterm disruption to the continued functioning of an FMI, including a decrease in value to financial assets held in custody, direct losses on participants and their customers, and a reduction in credit generally.
Commenting on whether the general objective for the resolution of CCPs/CSDs should be continuity of critical service, AFME said: The disorderly failure of an FMI can lead to severe systemic disruptions, if the failure causes markets to cease to operate effectively. Ensuring that the critical operations and services of an FMI continue as expected in a financial crisis is therefore central to the recovery plans they formulate and the resolution regime that applies to them. An FMIs recovery plan should be sufficiently comprehensive and robust such that it can effectively address all stress scenarios prior to the point of failure, or likely failure, at which point resolution actions would kick in as a last resort. Even then, ensuring continuity of service should not mean preserving the entity but rather the services being provided when a firm is no longer operationally viable, regulatory intervention should not be aimed at its rescue, but at its orderly resolution.
Although we recognize the general objective under recovery and resolution of maintaining critical service, current insolvency procedures are generally designed primarily to protect creditors. The change of emphasis to maintenance of critical service may therefore disadvantage some creditors who would have been favored by existing insolvency procedures, and care may be needed to control the extent of this effect.
Industry sources have expressed concern with the suggestion that the maintenance of critical operations and keeping things going takes precedence over paying out creditors in a default situation, who would ordinarily get fixed charge over the assets. They might then say dont bother lending money to these institutions because while the maintenance of critical operations is important, will I get my money back? Under Chapter 11 in the US there is a moratorium on the payment of creditors where directors of a firm declare themselves solvent. This may result in a situation where a liquidator or third party is appointed so that a firm would be solvent not just under the guise of the directors. We need similar measures like this in Europe.
The European Commission is using the consultation responses to provide guidance in preparing formal Commission proposals, which could be adopted in 2013.
(JDC)