N-9-1  As regards the global regulatory standards for CSDs and SSSs, following the publication of the Principles for Financial Market Infrastructures (PFMIs) in April 2012 (see para 9.38 et seq of the main work), the relevant standard setting bodies CPMI¹ and International Organization of Securities Commissions (IOSCO) initiated the process of monitoring jurisdictions’ progress towards adopting the legislation and other policies to implement the PFMIs, including assessing the consistency of implementation measures in each jurisdiction with the PFMIs and consistency of outcomes across jurisdictions.²

N-9-2  The findings of this monitoring exercise, which revealed some instances of inconsistent implementation or differences of interpretation, in addition to considerations regarding the provision of expanded guidance on some key policy areas have led to a number of supplementary documents by CPMI and IOSCO, most notably in the areas of financial market infrastructure (FMI) cyber resilience and FMI recovery. These do not create additional standards for FMIs but provide guidance on how FMIs can observe the existing requirements laid down in the PFMIs.

N-9-3  Cyber security has become a topic of critical importance for FMIs and the broader financial sector. Disruptions in one FMI may spread to a multitude of other connected entities. Furthermore, cyber threats tend to be cross-jurisdictional in nature, posing challenges for risk mitigation efforts conducted solely at national or single-institution level. Given the critical role of FMIs, the CPMI analysed the relevance of cyber security issues for FMIs and their overseers within the context of the PFMIs.³ The CPMI noted that while cyber resilience has increasingly become a top priority within FMIs, there are differences as to the form and maturity of FMIs’ approaches to cyber resilience. Approaches frequently attempt to combine different factors, such as people, technology, processes, and communication. Furthermore, a variety of preventive, detective, and recovery measures may be deployed to cope with different forms of threats, ranging from threats to confidentiality and availability of services to integrity of data.

N-9-4  In November 2014, CPMI and IOSCO released a consultative paper concerning guidance on cyber resilience for financial market infrastructures.⁴ The consultative guidance aims to contribute to the ongoing efforts of industry and authorities to enhance the FMIs’ ability to pre-empt cyber attacks, to respond rapidly and effectively to them, and achieve faster and safer target recovery objectives if they succeed. In doing so, the proposed guidance sets out the kind of measures that FMIs should undertake to enhance their cyber resilience capabilities in order to limit the risks that cyber threats pose to FMIs and thereby to financial stability. It also provides authorities with a set of internationally agreed guidelines to support consistent and effective oversight and supervision of FMIs in the area of cyber risk. The guidance builds on and is supplemental to the PFMIs, primarily in the context of governance (Principle 2), the framework for the comprehensive management of risks (Principle 3), settlement finality (Principle 8), operational risk (Principle 17), and FMI links (Principle 20).

N-9-5  The proposed guidance highlights a number of key considerations that are deemed central to an efficient cyber resilience framework. As for any type of operational risk, the ability of an FMI to resume operations quickly and safely after a successful cyber attack is paramount. This entails rigorous planning and pre-established processes. FMIs should make use of good-quality threat intelligence and rigorous testing and have an established process of continuous improvements. CPMI and IOSCO consider that board and senior management attention is critical to a successful cyber resilience strategy. A further key element of the guidance is the emphasis on cooperation and information-sharing, as cyber resilience is not achievable by an FMI in isolation; rather it is a market-wide collective endeavour. When finalized, the cyber guidance will not establish additional standards for FMIs beyond those already set out in the PFMIs.

N-9-6  Following the consultative report of July 2012⁵ (see para 9.84 of the main work) and taking into account comments received,²⁸ CPMI and IOSCO have been looking further at the appropriate framework for FMI recovery and the requirements for recovery planning by FMIs. The resulting final report by CPMI and IOSCO on FMI recovery⁶ supplements the PFMIs in this respect by providing guidance on how FMIs can observe the requirements laid down in Principle 3 of the PFMIs to have effective recovery plans. Given the criticality of clearing and settlement functions performed by FMIs, particular emphasis is given to maintaining or restoring the viability of a FMI as opposed to its winding-down.

N-9-7  The report provides guidance on the recovery planning process and the content of recovery plans. It provides an overview of tools that an FMI may include in its recovery plan,⁷ including a discussion of scenarios that may trigger the use of recovery tools and characteristics of appropriate recovery tools in the context of such scenarios (including tools to allocate uncovered losses caused by participant default; tools to address uncovered liquidity shortfalls; tools to replenish financial resources; or tools to allocate losses not related to participant default). Some or all of these tools may be used, also taking into account regulatory guidance in that respect, in different combinations or sequences by different FMIs and under different scenarios.

N-9-8  The basic principle is that an FMI should have a set of recovery tools that is comprehensive and effective in allowing the FMI, where relevant, to allocate any uncovered losses and cover any liquidity shortfalls. The set of tools should include plausible means of addressing unbalanced positions and replenishing financial resources, including the FMI’s own capital, in order to continue to provide critical services. Each tool should be effective in the sense of being timely, reliable, and having a strong legal basis. The tools should be transparent and designed to allow those who would bear losses and liquidity shortfalls to measure, manage, and control their potential exposure. They should create appropriate incentives for the FMI’s owners, participants, and other relevant stakeholders to control the amount of risk that they bring to or incur in the system, monitor the FMI’s risk-taking and risk-management activities, and assist in the FMI’s default management process. Finally, the tools should also be designed to minimize the negative impact on direct and indirect participants and the financial system more broadly.

N-9-9  Recovery and resolution of FMIs are close interrelated, with the set of tools and resources that are available strongly overlapping or even being identical. Thus, CPMI and IOSCO being the relevant bodies for regulatory standards on FMI recovery and the FSB being responsible for global guidance on resolution of FMIs, closely coordinate their approaches in this regard. When the FSB adopted the Key Attributes of Effective Resolution Regimes for Financial Institutions in 2011, it was agreed to develop further guidance on their implementation, taking into account in particular sector-specific considerations, such as for insurance or financial market infrastructures, to promote effective and consistent implementation across jurisdictions. Consequently, in October 2014, the FSB published a revision of the Key Attributes⁸ including sector-specific guidance that sets out how the Key Attributes should be applied for insurers, FMIs, and the protection of client assets in resolution. The newly adopted guidance documents have been incorporated as annexes into the 2014 version of the Key Attributes. Specifically, the Annex on FMI resolution was published simultaneously with the CPMI-IOSCO report on FMI recovery (see para N-9-6) to provide a comprehensive set of guidance on recovery and resolution for systemically important FMIs.

N-9-10  The FMI Annex⁹ supplements the Key Attributesand follows the basic parameters already contained in the FSB consultative document on the Key Attributes Assessment Methodology (see para 9.81 of the main work). It contains guidance elements for the resolution of FMIs and is complemented by an additional section on the resolution of FMI participants.¹⁰ While the key objective for FMIs remains to ensure continuity of critical FMI functions without exposing taxpayers to loss from solvency support, there may be instances where restoring the ability of the FMI to perform those functions as a going concern is not possible and instead it is necessary to ensure the performance of those functions by another entity or arrangement coupled with the orderly wind-down of the FMI in resolution.¹¹ This requires FMIs to be subject to resolution regimes that apply the objectives and provisions of the Key Attributes in a manner as appropriate to FMIs and their critical role in financial markets.

N-9-11  Key issues in the FMI Annex include the continuity of the process for settlement and application of the relevant finality rules; tools for the application of margin haircuts and contract tear-ups, the continuity and timely completion of critical payment, clearing and settlement functions, and the settlement of obligations due to participants and to any linked FMI and the non-application of moratoria in that respect; and the temporary stay on early termination rights. The FMI Annex further addresses the issue of the powers of resolution authorities, appropriate resolution strategies and plans, as well as guidance on access to information and information-sharing.

N-9-12  The 2014 revision of the FSB Key Attributes also includes an Annex on client asset protection in resolution.¹² This Annex follows the proposed FSB guidance of 2013 on client asset protection in resolution (see para 9.98 of the main work) and further builds on the IOSCO report on Recommendations Regarding the Protection of Client Assets of January 2014.¹³ It is meant to provide guidance on the interpretation and implementation of the FSB Key Attributes relating to elements in resolution regimes that are necessary to resolve a financial firm that directly or indirectly holds client assets.¹⁴ Given the variations in national regimes, the Annex specifies outcomes¹⁵ rather than prescribing methods or mandatory rules by which those outcomes should be achieved.

N-9-13  The new Annex stipulates that there should be effective arrangements such as segregation mechanisms,¹⁶ information systems, and controls,¹⁷ to identify quickly which assets are client assets and to ascertain the nature of claims and entitlements of individual clients to those assets, including with respect to client assets held in a holding chain. The clients should be informed on these arrangements and their consequences. Moreover, the transfer powers under the Key Attributes 3.2 (vi) and (vii) and 3.3 No. 4 should extend to the transfer of client assets.¹⁸

N-9-14  The annex confirms earlier FSB considerations on rehypothecation and re-use of client assets (see para 9.102 of the main work). Where a firm lends client securities as agent, it should keep adequate records of outstanding transactions, including counterparties, contract terms, legal documentation, collateral details, and location of collateral.¹⁹ Further, to the extent that rehypothecation and re-use of client securities by the firm or third parties acting as principal is permitted by a jurisdiction, such techniques should be governed by clear frameworks, and transactions should be adequately recorded.²⁰ In any case, there should be adequate disclosure to clients of the effects of such transactions on the protection of their assets and the nature of their legal claims in resolution.

N-9-15  Finally, the new Annex reiterates (see para 9.103 of the main work) that jurisdictions should have clear rules in place on how losses are shared between clients in the event of shortfalls in a pool of client assets, and that there should be clarity as regards the role of investor protection schemes and other guarantee schemes or funds supporting the transfer of client assets and addressing shortfalls. To support the effective exercise of transfer powers, resolution authorities should have the power to require changes to a firm’s business practices, information management systems, and contractual arrangements relating to the holding and protection of client assets.²¹

N-9-16  Cross-border recognition of resolution actions in relevant foreign jurisdictions is critical for an orderly and successful resolution process. This holds true in particular for certain resolution tools, namely temporary restrictions or stays on early termination and cross-default rights in financial contracts; and the ‘bail-in’ of debt instruments that are governed by the laws of a jurisdiction other than that of the issuing entity. In the absence of global harmonization of the relevant laws, e.g. through an international instrument such as a model law or a convention, alternative measures have to be pursued to enhance the degree of certainty for the cross-border effectiveness of these resolution tools.

N-9-17  In order to enhance the cross-border recognition of resolution actions and remove impediments to cross-border resolution, the FSB decided to develop alternative policy proposals on how legal certainty in cross-border resolution can be further enhanced, focusing on contractual recognition clauses in financial contracts. Following a public consultation in September 2014²² on a set of policy measures and guidance consisting of elements that jurisdictions should consider including in their statutory cross-border recognition frameworks to facilitate effective cross-border resolution and on contractual approaches to cross-border recognition, in November 2015, the FSB released its final Principles for Cross-border Effectiveness of Resolution Actions.²³

N-9-18  These Principles set out statutory and contractual mechanisms that jurisdictions should consider including in their legal frameworks to give cross-border effect to resolution actions in accordance with the FSB Key Attributes.²⁴ While emphasizing the importance of implementing comprehensive statutory frameworks, these Principles are aimed to support contractual approaches to cross-border recognition, which the FSB considers critical pending the adoption of such statutory frameworks and which may also complement such regimes once they are in place. The guidance focuses on the resolution of banks; however, many of the legal issues and principles may be relevant to other types of financial institutions as well as to financial market infrastructures.

N-9-19  Whilst the Principles stress that jurisdictions should consider the development of statutory frameworks and legal processes that would enable to give prompt effect to foreign resolution actions,²⁵ following the principle of equal treatment of creditors, they also recommend authorities to require, or provide incentives for, firms to adopt, where appropriate, contractual approaches to fill the gap until statutory approaches have been fully implemented and to complement such approaches by reinforcing the legal certainty and predictability of cross-border recognition under statutory frameworks that are in place.²⁶

N-9-20  The FSB conducted its activities on the principles in close interaction with the industry, which worked in parallel to establish contractual solutions to enforcing stays in resolution. Examples for such contractual clauses are the 2015 ISDA Universal Resolution Stay Protocol²⁷ or the 2016 Loan Market Association (LMA) bail-in clauses.²⁸ Normally, adherence to these contractual provisions is voluntary and they are only binding between the parties that have adhered or agreed to them. However, relevant industry associations are strongly encouraging and some authorities even require the use of such contractual provisions in financial transactions.

N-9-21  As regards repos and securities lending, following up on its2013 policy framework for addressing shadow banking risks in securities lending and repos,²⁹ the FSB has conducted further activities to specify some of the recommendations for addressing financial stability risks in this area. This led to further regulatory guidance in the area of enhanced transparency and collateral valuation.

N-9-22  In respect of transparency and disclosure requirements, following a public consultation,³⁰ in November 2015 the FSB issued final standards and processes defining the data elements for repos, securities lending, and margin lending that authorities will be asked to report as aggregates to the FSB for financial stability purposes.³¹ These standards and processes describe data architecture issues related to the data collection and transmission from the reporting entity to the national/regional authority and then from the national/regional to the global level. To ensure consistency and to derive meaningful global aggregates, six recommendations to national/regional authorities are set out.³² The FSB intends to complement these standards with detailed operational arrangements in order to initiate the official global data collection and aggregation at the end of 2018.

N-9-23  With regard to collateral valuation, in November 2015, the FSB released a document on Transforming Shadow Banking into Resilient Market-based Finance: Regulatory Framework for Haircuts on Non-centrally Cleared Securities Financing Transactions,³³ which contains the finalized framework for applying numerical haircuts on certain non-centrally cleared securities financing transactions. The framework aims to address financial stability risks in securities financing transactions as identified in the FSB report on a Policy Framework for Addressing Shadow Banking Risks in Securities Lending and Repos of August 2013,³⁴ which contained a set of policy recommendations (see paras 9.116–22 of the main work), including inter aliaminimum regulatory standards for collateral valuation and management.³⁵ The final framework builds on a consultative FSB document of October 2014,³⁶ taking also into account the responses received during the consultation period.³⁷

N-9-24  Consistent with the 2014 consultative report, the final framework includes recommendations on (i) qualitative standards for methodologies used by market participants that provide securities financing to calculate haircuts on the collateral received; and (ii) a framework of numerical haircut floors for non-centrally cleared securities financing transactions. The numerical haircut floors set upper limits on the amount that non-banks can borrow against different categories of collateral other than government securities. The framework also includes an implementation approach for applying the numerical haircut floors to non-bank-to-non-bank transactions; details of an enhanced monitoring of implementation of the framework through the FSB; and technical guidance on the implementation of the framework.

N-9-25  Compared to the 2014 consultative report and based on the assessment of consultative responses received, the FSB extended the scope of the numerical haircut floors to non-bank-to-non-bank transactions to limit regulatory arbitrage and prevent the build-up of excessive leverage and liquidity mismatch in the non-bank financial system. Further, as regulatory measures in jurisdictions to implement numerical haircut floors may take some time, the FSB extended the originally foreseen implementation date by one year to the end of 2018.

N-9-26  Finally, as part of this framework, the FSB recommended that the Basel Committee on Banking Supervision (BCBS) incorporates the haircut floors into the capital requirements for non-centrally cleared SFTs by setting significantly higher capital requirements for transactions with haircuts traded below the haircut floors. Taking up this recommendation, in November 2015, the BCBS issued a consultative document on haircut floors for non-centrally cleared SFTs.³⁸ The objective of the BCBS proposal is to create incentives for banks to set their collateral haircuts above the floors rather than hold more capital.

N-9-27  The movement of securities and the settlement of transactions for collateral management purposes rely on existing clearing and settlement infrastructure. Motivated by expected increases in demand for collateral stemming from regulatory changes and a greater preference for secured transactions, collateral management service providers have been adapting their services with the aim to enhance efficiency and enable market participants to meet collateral demands with existing and available securities. In a report published in September 2014,³⁹ the CPMI analysed the existing range of collateral management services as well as what innovation is under way to respond to the higher demands for collateral.

N-9-28  The report identifies a number of benefits resulting from the innovations, furnishing customers with better tools to monitor their securities holdings and increase efficiencies in the deployment of those securities. At the same time, it highlights that proposed services may lead to increased complexity and potential settlement-related risks by creating extensive networks of interconnections among financial market infrastructures and custodian banks active in providing collateral management services. The CPMI notes that both the public and the private sector need to understand, monitor, and appropriately manage the associated risks, as innovations in collateral management services are introduced and as partnerships and operational connections are established, implemented, and used.