Dr Corinna Freund Principal Market Infrastructure Expert ECB

Dr. Corinna Freund Principal Market Infrastructure Expert ECB Oversight Division Effective Oversight of FMIs: What next for FMI resolution regimes? Cambridge, 11 September 2019

Rubric Overview 1. The case for FMI resolution 2. Main elements of effective FMI resolution regimes 3. Open issues and challenges going forward What next for FMI resolution regimes? 2 www. ecb. europa. eu ©

Rubric 1. The case for FMI resolution What next for FMI resolution regimes? 3 www. ecb. europa. eu ©

Rubric 1. The case for FMI resolution Potential FMI lifecycle and risk mitigants • Going concern - Business-as-usual up to extreme but plausible stressed market conditions - Covered by PFMI requirements for ongoing risk management of FMIs • Recovery - Extreme market conditions (beyond extreme but plausible) - Covered by PFMI requirements for any FMI to maintain an effective and comprehensive plan to recover from any threat to its viability and financial strength so that it can continue to provide its critical services - Without intervention or support of public authorities • Resolution - Situations where recovery has failed or is likely to fail, or may compromise financial stability - Intervention by resolution authority with the objective to preserve continuity of critical functions without exposing taxpayer to loss - Covered by FSB Key Attributes of Effective Resolution Regimes of Financial Resolution and related follow-up guidance Effective Oversight of FMIs – What next for FMI resolution regimes? 4 www. ecb. europa. eu ©

Rubric 1. The case for FMI resolution Importance of FMI resolution • Given the risk concentration in FMIs, a disorderly FMI failure would likely lead to severe financial disruptions for: - FMI participants (that are often also participants in other FMIs and providers of systemically relevant financial services) - Any other FMIs to which the failing FMI is linked - Ultimately, the financial system more broadly • These systemic risk implications could be particular severe as, given the oligopolistic nature of FMI services, there would often not be a promptly available substitute for the failing FMI • Objectives of FMI resolution: - Minimize market disruption and contagion risk through continuity of critical services - Stem erosion of market confidence through predictable arrangements and credible intervention of public authorities - Pre-empt moral hazard in terms of potential reliance on public bail-out - Ensure due consideration of cross-border financial risk implications Effective Oversight of FMIs - What next for FMI resolution regimes? 5 www. ecb. europa. eu ©

Rubric 2. Main elements of effective FMI resolution regimes What next for FMI resolution regimes? 6 www. ecb. europa. eu ©

Rubric 2. Main elements of effective FMI resolution regimes 2. 1 Basic framework for all FMIs • FSB Key Attributes of Effective Resolution Regimes (KA) (2011): • “Any financial institution that could be systemically significant or critical if it fails should be subject to a resolution regime that has the attributes set out in this document” • FMIs should be subject to resolution regimes that apply the objectives and provisions of the KA in a manner as appropriate to FMIs and their critical role in financial markets • FMIs within the scope of the KA include systemically important payment systems, central securities depositories (CSDs), securities settlement systems (SSSs), central counterparties (CCPs), and trade repositories (TRs) • FMI Annex (2014): • Guidance on the practical implementation of the KA for systemically important FMIs (as a new annex to the KA) • Covers both resolution of FMIs and FMI support in resolution of FMI participants (i. e. to ensure continued access to critical FMI services for participants that are systemically important banks and that are in resolution) Effective Oversight of FMIs - What next for FMI resolution regimes? 7 www. ecb. europa. eu ©

Rubric 2. Main elements of effective FMI resolution regimes Key elements to ensure effective FMI resolution (1) Substantive area Specific guidance for FMIs Resolution objectives • Continuity and timely completion of payment, settlement, clearing and recording functions • Continuous access of participants to securities or cash accounts and collateral • Avoid disruption of links between FMI in resolution and other FMI • Continuous processing of – and access to – data held in TRs Resolution authority What next for FMI resolution regimes? • Explicit mandate for pursuing financial stability and maintaining continuity of critical FMI functions without taxpayer loss • Dedicated FMI expertise, close cooperation with FMI supervisor • Close cooperation with central banks for FMIs settling through central bank accounts 8 www. ecb. europa. eu ©

Rubric 2. Main elements of effective FMI resolution regimes [Please select] Key elements to ensure effective FMI resolution (2) Substantive area Specific guidance for FMIs Entry into resolution Should be possible if • Recovery measures are exhausted and have failed to return the FMI to viability • Relevant authorities determine that recovery measures are unlikely to succeed or are likely to compromise financial stability Resolution tools • Enforce implementation of FMI rules and procedures (re. participant obligations for loss/position allocation • Write down (fully or partially) FMI equity • Write down or convert unsecured debt into equity • Reduce value of gains payable to participants (i. e. variation margin gains haircutting) • Write down initial margin (where not bankruptcy remote and where consistent with FMI rules) • Terminate or close out contracts • Transfer of critical functions to 3 rd party or bridge entity What next for FMI resolution regimes? 9 www. ecb. europa. eu ©

Rubric 2. Main elements of effective FMI resolution regimes Key elements to ensure effective FMI resolution (3) Substantive area Specific guidance for FMIs Conditions for writing down variation or initial margin • Prefunded resources exhausted • Rules-based loss allocation measures implemented (or suspended for financial stability reasons) • Respect for hierarchy of claims and rules of FMIs • Applies to IM only to the extent that can be used to cover losses of other participants under rules of FMI or in insolvency No-creditor-worse-off principle • Creditors have right to compensation where they would not receive at a minimum what they would have received in a liquidation of the FMI under the applicable insolvency regime • Insolvency counterfactual should assume the full application of the FMI’s rules and procedures for loss allocation • Equity should absorb losses first in resolution What next for FMI resolution regimes? 10 www. ecb. europa. eu ©

Rubric 2. Main elements of effective FMI resolution regimes Key elements to ensure effective FMI resolution (4) Substantive area Specific guidance for FMIs Resolution funding Jurisdictions should have in place appropriate arrangements and powers to provide temporary funding to facilitate resolution and to recover any resulting losses to public funds from the FMI, unsecured creditors (incl. FMI participants) or, if necessary, financial sector participants more widely Cooperation, coordination and information-sharing • Crisis management groups (CMGs) shall be maintained for all FMIs that are systemically relevant in more than one jurisdiction • CMGs shall include home resolution authority, authorities that participate in cooperation arrangements in line with Responsibility E and other authorities of jurisdictions material to the FMI’s resolution • CMGs should be based on written agreement • FMI resolution plan and resolvability assessment should be developed in coordination within CMGs What next for FMI resolution regimes? 11 www. ecb. europa. eu ©

Rubric 2. Main elements of effective FMI resolution regimes 2. 2 Additional work for CCPs • In line with the existing arrangements for banks, the FSB has established a dedicated working structure to monitor the implementation of the Key Attributes for FMIs and to assist in the potential development of further sector-specific guidance as needed (FMI Cross-Border Crisis Management Group, fmi. CBCM) • Given the high degree of financial risk concentration in CCPs, the fmi. CBCM has focused so far on CCP resolution • The focus on CCP resolution is in line with the FSB objective to ensure that mandatory central clearing is coupled with robust safeguards for global clearing (“four safeguards”) and the related “CCP work plan” launched by global standard-setting bodies in 2015 • In parallel to the fmi. CBCM’s work, CMGs have been established or are in the process of being established for 13 CCPs identified as systemically relevant for more than one jurisdiction What next for FMI resolution regimes? 12 www. ecb. europa. eu ©

Rubric 2. Main elements of effective FMI resolution regimes [Please select] FSB “Guidance on Central Counterparty Resolution and Resolution Planning”, July 2017 Key elements further elaborating on KA and FMI annex: • Resolution should focus on financial stability and continuity of critical functions in all relevant jurisdictions and maintain incentives for central clearing, default management and recovery • Further details on tools for loss and position allocation in the case of CCPs, especially on tools to re-establish matched book • Need for dedicated resolution powers for default and non-default related scenarios • Possible clearing member compensation for contributions beyond rulebook • Entry into resolution: Potential triggers and cooperation of relevant authorities • Role of equity in resolution: Need for transparency at which point in resolution it would be written down • NCWO safeguard: Alternative approaches on insolvency counterfactual • Prudent assumptions re. adequacy of financial resources in resolution • Minimum contents of CCP resolution plan • Potential changes in CCPs in response to resolvability assessments • Membership and cooperation within CMGs • Cross-border effectiveness and enforcement of resolution issues What next for FMI resolution regimes? 13 www. ecb. europa. eu ©

Rubric 3. Open issues and challenges going forward What next for FMI resolution regimes?

Rubric 3. Open issues and challenges going forward • Delays in resolution planning for major global CCPs - Partly due to lack of legislative progress particularly in the EU - Ambitious FSB milestones essential to foster further progress • Need for further clarity on how to ensure robust level playing field for financial resources for CCP resolution - Different benchmarks when assessing adequacy of CCPs’ financial resources in recovery and resolution - Quantitative analysis only starting to be developed - Objective to ensure robust buffers on top of recovery resources without aiming at full risk coverage - Expected further guidance in 2020 • Conceptualization of non-default scenarios - Important issue in view of limited prefunded resources - Requires clear scenario development already in recovery - Potential further guidance will build on parallel work of CPMI-IOSCO What next for FMI resolution regimes? 15 www. ecb. europa. eu ©

Rubric 3. Open issues and challenges going forward • Fundamental tension between role of CCP equity as primary loss absorbing resource under the Key Attributes and its small size and subordinate function in CCP rulebooks - Practical approach will likely differ across jurisdictions but should be transparent ex ante • Need for enhanced cooperation of resolution authorities with CCP supervisors/overseers and banking supervisors - Blurred boundaries between recovery and resolution (as resolution would typically commence before recovery would be exhausted and resolution tools essentially rely on rulebook provisions) - Given the role of clearing members in absorbing most losses in CCP recovery and resolution, it is critical to conduct an assessment of the credibility of funding arrangements in cooperation with CCP supervisors • Conceptual and data-sharing challenges in planning in view of cross-CCP interdependencies What next for FMI resolution regimes? 16 resolution www. ecb. europa. eu ©