Recovery and resolution of financial market infrastructures - - PowerPoint PPT Presentation

Recovery and resolution of financial market infrastructures

Presentation for Session 7 of the Financial Safety Net Conference 2015 Stockholm, May 2015 Klaus Löber, Head, CPMI Secretariat

This presentation does not necessarily express the views of the CPMI or BIS

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FMI risk management, recovery and resolution

Resolution is an alternative regime to insolvency to enable authorities to restore, restructure or wind- down an FMI without severe systemic disruption and without exposing taxpayers to loss. Risk management is the “everyday” management

• f risk by the FMI, including dealing with

anticipated problems Recovery for an FMI is the extreme end of risk management – dealing with the most extreme financial threats that could threaten its survival Responsibility of the FMI, overseen by the central bank etc Responsibility of the resolution authority

Covered by the CPMI-IOSCO PFMI (2012) Covered in more detail by the CPMI- IOSCO report on FMI recovery (2014) Covered by the FSB’s “Key attributes of effective resolution regimes”, including an FMI-specific annex (2014) Risk management Recovery Resolution

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Banks and FMIs are different

Development of the concepts of recovery and resolution driven by bank failures – the desire to avoid “too big to fail”. But FMIs are very different:



FMIs are a critical service



Often there is no alternative So closing an FMI is usually not a realistic option



FMIs’ balance sheets are typically very different from banks’ (usually not designed to bear substantial risk themselves)



They are required to have comprehensive risk management (ie the PFMI)



They regularly already have arrangements to share losses (with their participants, as part of the FMI’s rules) So the sorts of tools for bank recovery and resolution aren’t necessarily useful for FMIs

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Emphasis on recovery

 The importance of FMIs, and the lack of alternatives, means

the emphasis has to be on recovery

 Nevertheless, there is no guarantee that FMI recovery plans

will work. If they fail, resolution will be needed. Triggers for resolution:

• recovery plan has failed (but that may be too late)
• recovery plan was not implemented in a timely way
• authorities decide that plan will fail or compromise financial

stability  Even then, the key difference is that it is the authorities trying

to recover the FMI rather than the FMI itself trying to do it

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Tools for recovery and resolution

Recovery and resolution are about the ability of an FMI to cope with even the most extreme financial problems Participant default Investment and custody risk Business risk Operational risk Legal risk Financial consequences Funds or collateral from participants FMI’s capital Taxpayer funds Third party funds

(eg insurance)

Who bears the loss is a largely a matter of fairness and effectiveness

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Focus on CCPs and participant default

 Problem can be an outright loss. Or it can be a liquidity

shortage

 Initially, the FMI will typically use existing (pre-funded) financial

resources to cover a loss. And pre-arranged liquidity facilities to turn those resources into cash if necessary. This is “normal” risk management

 But if the problem is too big, those resources and/or facilities

may not be enough. This is when the FMI needs a recovery plan, about how it is going to cope in these circumstances

 Risks vary in size and how much they can be predicted and/or

• controlled. They thus vary in how likely it is that the

resources/facilities run out and the recovery plan needs to be

• activated. But there’s always some likelihood

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Criteria for judging recovery tools

 Comprehensive  Effective  Transparent and manageable/controllable  Create appropriate incentives  Minimise negative impact

Need a set of tools But still likely to involve trade-offs In practice the range of adequate tools is quite limited

Recovery tools: example for a CCP

There are a range of tools a CCP could use if a default were to be so extreme that the waterfall didn’t cover it. For recovery:

• To deal with uncovered losses

Tools such as cash calls (participants provide additional resources to the CCP) or variation margin “haircutting” (reducing the CCP’s liabilities to participants)

• To deal with uncovered liquidity shortfalls

Similar tools may also be used to cover liquidity shortfalls

The CCP will also need to:

• Re-establish the CCP’s matched book

If voluntary methods (eg auctions, CCP purchases of offsetting positions, incentives to participants to accept unmatched contracts) don’t work, involuntary tools may be needed (eg forced allocation of contracts or contract tear-up)

• Replenish financial resources and capital

Cash calls can also be used to replenish participants’ contributions. Ex-ante arrangements with existing owners, voluntary arrangements with participants, or bail-in of debt (where applicable) can be used to recapitalise. Similar tools are likely to be key in resolution too

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Outstanding issues

 FMI recovery (CPMI-IOSCO)

• Assess the current position of CCP recovery planning,

possibly as part of its implementation monitoring work

• Possibility of more granular standards for CCP recovery

 FMI resolution (FSB)

• Stocktake of existing CCP resolution regimes and resolution

planning

• Minimum standards for resolution planning (building on

Key Attributes)

• Assess the need for additional capital and liquidity

resources in resolution