INTERNATIONAL: IOSCO Report on CCP’s Recovery Planning and Liquidity Stress Testing

Thursday May 10 2018

In April 2012, the Committee on Payments and Market Infrastructures (CPMI) and the International Organization of Securities Commissions (IOSCO) published the Principles for financial market infrastructures (PFMI). The PFMI set expectations for the design and operation of financial markets infrastructures (FMIs) to enhance their safety and efficiency and, more broadly, to limit systemic risk and foster transparency and financial stability.

Following the publication of the PFMI, the CPMI and IOSCO agreed to monitor their implementation in 28 CPMI and IOSCO member jurisdictions via a dedicated standing group, the Implementation Monitoring Standing Group (IMSG). The implementation monitoring is being carried out on three levels. Level 3 (L3) peer reviews examine consistency in the outcomes of implementation of the Principles by FMIs and implementation of the Responsibilities by authorities. These assessments are also expected to inform the CPMI and IOSCO about the nature and potential causes of variations in approaches or outcomes, as such variations may be due to challenges and interpretative issues that have emerged in implementing the PFMI.

This report outlines the findings from a follow-up assessment to the initial L3 assessment Report on the financial risk management and recovery practices of 10 derivatives CCPs published by the CPMI and IOSCO in August 2016.

Overall, participating CCPs have made progress in implementing arrangements that, collectively, help advance the public policy objectives of the PFMI. In particular areas, as further described below, some CCPs have not implemented practices that are fully consistent with specific standards of the PFMI. These issues were first identified in the August 2016 L3 assessment and, based upon the results of this assessment, remain outstanding in a number of specific instances both for certain derivatives CCPs that participated in the August 2016 L3 assessment (and were urged to remediate such issues by the end of 2016) and for some of the additional nine CCPs that were assessed for the first time under this expanded L3 assessment. The failures of these CCPs to implement practices consistent with specific standards of the PFMI constitute, in certain instances, issues of concern that are serious and warrant immediate attention.

In keeping with their respective responsibilities for regulation, supervision and oversight, authorities are expected to ensure that the PFMI are applied consistently in their respective jurisdictions and implemented by individual CCPs, as noted in Responsibility D of the PFMI. The CPMI and IOSCO have shared the concerns identified in this assessment with the relevant authorities for each particular CCP.

All of the 10 CCPs that were surveyed in the initial L3 assessment have reported changes in their recovery plans in the last 18 months. In particular, the two CCPs that were identified in the previous report as not having any recovery plans in place have made progress in developing their recovery plans but were still in the process of putting in place rules and arrangements to implement the plans as of the effective date of this review.

The CPMI and IOSCO reiterate the importance of developing comprehensive and effective recovery plans, consistent with standards in the PFMI and informed by associated guidance in the revised Recovery Report. To that end, if a CCP has not fully implemented a comprehensive and effective recovery plan, this is a serious issue of concern that should be addressed with the highest priority.

Additionally, certain elements of CCPs’ recovery plans were highlighted as serious issues of concern in the initial L3 assessment. Many of these elements remain in place as of the effective date of this report, namely:

– Some CCPs employ only one capped tool to address uncovered credit losses. Reliance on this tool alone may be insufficient for a CCP to comprehensively allocate uncovered losses. Other tools may be necessary to achieve the outcome expected in Principle 4.

– Some CCPs do not have mandatory rule-based recovery tools to re-establish a matched book, and it is unclear whether reliance by these CCPs on voluntary, market-based tools alone would effectively restore a matched book. These CCPs should have a range of tools available that are sufficient to ensure that the CCP can re-establish a matched book in recovery.

– Although all CCPs have now identified at least one tool for addressing liquidity shortfalls, certain tools identified in this assessment do not appear consistent with the standards in the PFMI.

– A small number of CCPs lacked rules and procedures that indicate processes to replenish any financial resources employed during a participant default in a manner that allows the CCP to continue to operate in a safe and sound manner.

These CCPs should address these remaining serious issues of concern with the highest priority because the lack of such tools or equivalent measures may undermine a CCP’s ability to meet the standards in the PFMI.

While CCPs reported enhancements to several areas of liquidity risk management, limited progress has been made by the participating CCPs over the last 18 months in developing liquidity-specific scenarios in their stress testing framework. Specifically, some participating CCPs do not include in their liquidity stress tests a sufficiently wide range of scenarios that take into account the material liquidity risk posed by the non-performance of entities other than participants (such as settlement banks, nostro agents, custodian banks, liquidity providers, and linked FMIs). The PFMI provide that an FMI should maintain sufficient liquid resources in a wide range of potential stress scenarios. The fact that, following the publication of the initial L3 report, some CCPs continue to lack sufficient liquidity-specific scenarios is a serious issue of concern that should be addressed by the relevant CCPs with the highest priority.

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