Turn back the clock five years and many thought that large banks were too big to fail. The events of 2008 have reversed this perception and financial institutions and regulators are looking to create stability.
This is one of the reasons the Committee on Payment and Settlement Systems (CPSS) and the Technical Committee of the International Organisation of Securities Commissions (IOSCO) have reviewed and updated standards for Financial Market Infrastructures (FMIs). Such FMIs include Central Securities Depositories (CSDs), as their role gained prominence during the market uncertainty.
According to CPSS IOSCO, FMIs were a ‘source of strength’ during the financial crisis and were generally able to settle obligations when due, giving market participants the confidence to continue transacting.
Principles for Financial Market Infrastructures
No one could predict the crisis and no one will be able to predict what will happen in the future, so to support the goals and mandates of the G-20 and Financial Stability Board, to strengthen the safety and soundness of the financial markets, CPSS IOSCO wanted to ensure FMIs are truly resilient.
The Financial Stability Board’s progress report encourages a regulatory framework to be in place. CPSS IOSCO, which are recognised as international standard-setting bodies by the Financial Stability Board, have undertaken to establish Principles that are in line with the Financial Stability Board’s initiatives to meet the G-20’s commitments.
CPSS IOSCO have published the CPSS IOSCO Principles for financial market infrastructures, which raises the bar on the previous requirements. It provides 24 principles with more detailed guidance by broadening the scope of the standards to cover new risk management topics.
South Africa and Strate adopt new principles
They have also drafted the Disclosure Framework for financial market infrastructures and the Assessment Methodology for the principles for FMIs and the responsibilities of authorities, which have been released for public comment. This is to promote consistent disclosures of information by FMIs and assessments of FMIs by international financial institutions and national authorities.
As a member of the G-20, CPSS and IOSCO, South Africa is adopting the new principles applicable to its FMIs. As the CSD, Strate has constantly endeavored to adhere to and support global efforts that promote the mitigation and management of risk, and strengthen market infrastructures. These include the CPSS IOSCO standards, which harmonise and, where appropriate, strengthen the existing international standards that are systemically important for FMIs.
Strate aims to comply with the 24 principles released by the CPSS IOSCO to the extent that those principles are applicable to Strate as a CSD.
The 24 CPSS IOSCO Principles
Principle 1: requires that an FMI have a strong legal basis for its activities.
Principle 2: requires that an FMI have robust governance arrangements that focus on the safety and efficiency of the FMI, and that support stability. This includes guidance on the roles, responsibilities, and composition of boards of directors.
Principle 3: the framework for the comprehensive management of risks is a new principle that requires an FMI to take an integrated and comprehensive view of its risks, including those it bears from, and poses to, its participants, their customers, and other entities.
Principles 4 through 7: address the management of the credit and liquidity risks that arise from an FMI’s payment, clearing and settlement processes. CPSS IOSCO says that unlike previous international standards, this report distinguishes between credit and liquidity risks and provides separate principles to address the management of these risks.
Principles 8 through 10: address settlement risk, which is the risk that settlement will not take place as expected.
Principle 11: requires that a CSD maintain securities in an immobilised or dematerialised form for their transfer by book entry. It consolidates and harmonises previous guidance regarding the unique risks faced by these types of FMIs associated with their function and design. While the nature and scope of activities performed by CSDs vary based on jurisdiction and market practices, CSDs play a critical role in the protection of securities and help ensure the integrity of securities issues and transactions.
Principle 12: relates to exchange-of-value settlement systems, which play a critical role in mitigating principal risk. Principle 12 requires these systems to eliminate principal risk by ensuring that the final settlement of one obligation occurs if and only if the final settlement of the linked obligation also occurs.
Principle 13: for participant-default rules and procedures; requires all FMIs to have effective and clearly defined rules and procedures to manage the default of a participant.
Principle 14: refers to segregation and portability – a new principle specific to CCPs. The principle requires that a CCP have rules and procedures that enable the segregation and portability of the positions of a participant’s customers and the collateral provided to the CCP with respect to those positions.
Principles 15, 16 and 17: General business risk, custody and investment risks, and operational risk are addressed respectively.
Principles 18, 19 and 20: address the need for fair and open access to an FMI as well as management of risks posed by alternative access arrangements.
Principles 21 and 22: address issues related to efficiency.
Principles 23 and 24: address transparency and require that relevant information be provided to an FMI’s participants, authorities and the public to inform sound decision making and foster confidence in the markets the FMI serves.