Committee on Payment and Settlement Systems Technical Committee of the International Organization of Securities Commissions Principles for financial market infrastructures Consultative report March 2011 Copies of publications are available from: Bank for International Settlements Communications CH-4002 Basel, Switzerland E-mail: publications@bis.org Fax: +41 61 280 9100 and +41 61 280 8100 This publication is available on the BIS website ( www.bis.org ) and the IOSCO website (www.iosco.org ). © Bank for International Settlements and International Organization of Securities Commissions 2011. All rights reserved. Brief excerpts may be reproduced or translated provided the source is stated. ISBN 92-9197-868-X (online) This report is being issued now for public consultation. Comments should be sent by 29 July 2011 to both the CPSS secretariat (cpss@bis.org) and the IOSCO secretariat (fmi@iosco.org). The comments will be published on the websites of the BIS and IOSCO unless commentators have requested otherwise. A cover note to the report, published simultaneously and also available on the BIS and IOSCO websites, provides background information on why the report has been issued and sets out some specific topics on which comments are particularly requested. Contents Abbreviations iii Overview of principles and responsibilities 1 1.0. Introduction 5 Background 5 FMIs: definition, organisation, and function 7 Public policy objectives: safety and efficiency 10 Scope of the principles for FMIs 11 Implementation and use of the principles and responsibilities 15 Organisation of the report 15 2.0. Overview of key risks in financial market infrastructures 16 Systemic risk 16 Legal risk 16 Credit risk 17 Liquidity risk 17 General business risk 17 Custody and investment risk 17 Operational risk 18 3.0. Principles for financial market infrastructures 19 General organisation 19 Principle 1: Legal basis 19 Principle 2: Governance 23 Principle 3: Framework for the comprehensive management of risks 28 Credit and liquidity risk management 30 Principle 4: Credit risk 30 Principle 5: Collateral 37 Principle 6: Margin 40 Principle 7: Liquidity risk 46 Settlement 52 Principle 8: Settlement finality 52 Principle 9: Money settlements 54 Principle 10: Physical deliveries 56 Central securities depositories and exchange-of-value settlement systems 58 Principle 11: Central securities depositories 58 Principle 12: Exchange-of-value settlement systems 61 Default management 63 CPSS-IOSCO - Consultative report on Principles for financial market infrastructures - March 2011 i Principle 13: Participant-default rules and procedures 63 Principle 14: Segregation and portability 66 General business and operational risk management 70 Principle 15: General business risk 70 Principle 16: Custody and investment risk 74 Principle 17: Operational risk 75 Access 81 Principle 18: Access and participation requirements 81 Principle 19: Tiered participation arrangements 84 Principle 20: FMI links 86 Efficiency 92 Principle 21: Efficiency and effectiveness 92 Principle 22: Communications procedures and standards 94 Transparency 96 Principle 23: Disclosure of rules and key procedures 96 Principle 24: Disclosure of market data 98 4.0. Responsibilities of central banks, market regulators, and other relevant authorities for financial market infrastructures 101 Responsibility A: Regulation, supervision, and oversight of FMIs 101 Responsibility B: Regulatory, supervisory, and oversight powers and resources 102 Responsibility C: Disclosure of policies with respect to FMIs 103 Responsibility D: Application of the principles for FMIs 104 Responsibility E: Cooperation with other authorities 105 Annex A: Mapping of existing standards to proposed standards 108 Annex B: Mapping of proposed standards to existing standards 109 Annex C: Selected RSSS marketwide recommendations 110 Annex D: Matrix of applicability of key considerations to specific types of FMIs 117 Annex E: Guidance for CCPs that clear OTC derivatives 128 Annex F: Oversight expectations applicable to critical service providers 134 Annex G: Bibliography 136 Annex H: Glossary 137 ii CPSS-IOSCO - Consultative report on Principles for financial market infrastructures - March 2011 CPSS-IOSCO - Consultative report on Principles for financial market infrastructures - March 2011 iii Abbreviations BCBS Basel Committee on Banking Supervision CCP Central counterparty CGFS Committee on the Global Financial System CPSIPS Core principles for systemically important payment systems CPSS Committee on Payment and Settlement Systems CSD Central securities depository DNS Deferred net settlement DvD Delivery versus delivery DvP Delivery versus payment FMI Financial market infrastructure FSB Financial Stability Board ICSD International central securities depository IOSCO International Organization of Securities Commissions IT Information technology Lamfalussy Report Report of the Committee on Interbank Netting Schemes of the central banks of the Group of Ten countries LVPS Large-value payment system OTC Over the counter PvP Payment versus payment RCCP Recommendations for central counterparties Repo Repurchase agreement RSSS Recommendations for securities settlement systems RTGS Real-time gross settlement SSS Securities settlement system STP Straight-through processing TR Trade repository Overview of principles and responsibilities Principles for financial market infrastructures General organisation Principle 1: Legal basis An FMI should have a well-founded, clear, transparent, and enforceable legal basis for each aspect of its activities in all relevant jurisdictions. Principle 2: Governance An FMI should have governance arrangements that are clear and transparent, promote the safety and efficiency of the FMI, 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 An FMI 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 An FMI should effectively measure, monitor, and manage its credit risk from participants and from its payment, clearing, and settlement processes. An FMI should maintain sufficient financial resources to cover its credit exposure to each participant fully with a high degree of confidence. A CCP should also maintain additional financial resources to cover a wide range of potential stress scenarios that should include, but not be limited to, the default of the [one/ two] participant[s] and [its/their] affiliates that would potentially cause the largest aggregate credit exposure[s] in extreme but plausible market conditions. Principle 5: Collateral An FMI that requires collateral to manage its or its participants’ credit risk should accept collateral with low credit, liquidity, and market risk. An FMI should also set and enforce appropriately conservative haircuts and concentration limits. Principle 6: Margin A CCP 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 An FMI should effectively measure, monitor, and manage its liquidity risk. An FMI should maintain sufficient liquid resources to effect same-day and, where appropriate, intraday 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 [one/two] participant[s] and [its/their] affiliates that would generate the largest aggregate liquidity need in extreme but plausible market conditions. CPSS-IOSCO - Consultative report on Principles for financial market infrastructures - March 2011 1 Settlement Principle 8: Settlement finality An FMI should provide clear and certain final settlement, at a minimum, by the end of the value date. Where necessary or preferable, an FMI should provide final settlement intraday or in real time. Principle 9: Money settlements An FMI should conduct its money settlements in central bank money where practical and available. If central bank money is not used, an FMI should minimise and strictly control the credit and liquidity risk arising from the use of commercial bank money. Principle 10: Physical deliveries An FMI 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 CSD 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 CSD should maintain securities in an immobilised or dematerialised form for their transfer by book entry. Principle 12: Exchange-of-value settlement systems If an FMI 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 An FMI should have effective and clearly defined rules and procedures to manage a participant default that ensure that the FMI can take timely action to contain losses and liquidity pressures, and continue to meet its obligations. Principle 14: Segregation and portability A CCP should have rules and procedures that enable the segregation and portability of positions and collateral belonging to customers of a participant. General business and operational risk management Principle 15: General business risk An FMI should identify, monitor, and manage its general business risk and hold sufficiently liquid net assets funded by equity to cover potential general business losses so that it can continue providing services as a going concern. This amount should at all times be sufficient to ensure an orderly wind-down or reorganisation of the FMI’s critical operations and services over an appropriate time period. 2 CPSS-IOSCO - Consultative report on Principles for financial market infrastructures - March 2011 [...]... to them CPSS-IOSCO - Consultative report on Principles for financial market infrastructures - March 2011 5 1.4 The CPSS, in January 2001, published the Core principles for systemically important payment systems (CPSIPS), which provided 10 principles for the safe and efficient design and operation of systemically important payment systems These principles drew extensively from the Report of the Committee... 24 Disclosure of market data ● ● * The applicability of certain principles for CSDs and SSSs will vary with the design of the FMI FMI resolution 1.23 The focus of this report and its principles is to ensure that FMIs operate as smoothly as possible in normal circumstances and in times of market stress While the resolution or CPSS-IOSCO - Consultative report on Principles for financial market infrastructures... disruption 18 CPSS-IOSCO - Consultative report on Principles for financial market infrastructures - March 2011 3.0 Principles for financial market infrastructures General organisation The foundation of an FMI’s risk-management framework includes its authority, structure, rights, and responsibilities The following set of principles provides guidance on (a) the legal basis for the FMI’s activities, (b)... market participants with some degree of protection against losses from counterparty defaults Such arrangements typically are organised and managed by the CSD of the market or by some other market operator A guarantee typically is viewed as desirable or even necessary where market rules or other features make it practically impossible for market 8 CPSS-IOSCO - Consultative report on Principles for financial. .. requirement to CPSS-IOSCO - Consultative report on Principles for financial market infrastructures - March 2011 11 help contain risks and provide for a level playing field The principles are designed to be applied holistically because of the significant interaction between principles; principles should be applied as a set and not as stand-alone principles Some principles build upon others and some complement... safety and efficiency of FMIs 4 CPSS-IOSCO - Consultative report on Principles for financial market infrastructures - March 2011 1.0 Introduction 1.1 Financial market infrastructures (FMIs) that facilitate the recording, clearing, and settlement of monetary and other financial transactions can strengthen the markets they serve and play a critical role in fostering financial stability; however, if not properly... analytical work include CPSS, Market structure developments in the clearing industry: implications for financial stability, September 2010, and CPSS, Strengthening repo clearing and settlement arrangements, September 2010 6 CPSS-IOSCO - Consultative report on Principles for financial market infrastructures - March 2011 recommendations 6 and 12, this report contains focused principles on the risk management... these principles should achieve a strong and balanced approach to interoperability 14 CPSS-IOSCO - Consultative report on Principles for financial market infrastructures - March 2011 Implementation and use of the principles and responsibilities 1.27 FMIs that are subject to these principles should apply them on an ongoing basis in the operation of their business This includes when reviewing their performance,... by the board The reporting lines for risk management should be clear and separate from those for other operations of 28 26 Such committees would normally be composed mainly of, and, if possible, led by, independent or nonexecutive directors CPSS-IOSCO - Consultative report on Principles for financial market infrastructures - March 2011 the FMI, and there should be an additional direct reporting line... by the Financial Stability Board (formerly called the Financial Stability Forum) and international financial institutions 2 In general, the principles in this report are not addressed to other types of market infrastructures, such as trading exchanges, trade execution facilities, or multilateral trade-compression systems; however, relevant authorities may decide to apply some or all of these principles . - Consultative report on Principles for financial market infrastructures - March 2011 CPSS-IOSCO - Consultative report on Principles for financial market. Consultative report on Principles for financial market infrastructures - March 2011 3 4 CPSS-IOSCO - Consultative report on Principles for financial market