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1
Importance of the oversight function for
financial market infrastructures: General
framework and objectives
Workshop on payments systems oversight
Kingston, Jamaica
5 December 2012
Klaus Löber
CPSS Secretariat
Bank for International Settlements
1 * Views expressed are those of the author and not necessarily those of the BIS
2
Outline
The role of the Committee on Payment and Settlement Systems
(CPSS)
Concept: What is oversight?
Purpose: Why is oversight performed?
Scope: What should be overseen?
Method: How should it be done?
3
The Committee on Payment and Settlement Systems (CPSS)
Central bank membership (24)
Canada Sweden ECB Russia Japan
USA UK Germany Turkey Korea
Mexico Switzerland Netherlands India China
Brazil Belgium Saudi Arabia Hong Kong
France South Africa Singapore
Italy Australia
The CPSS serves as a forum for central banks to monitor and
analyse developments in the field of FMIs and to set common policies
and recommendations
From G10 (1990) to G10-plus (late 1990s) to approximately G20 (2009)
Originally reported to G10 Governors, now reports to “Global Economy”
Governors (also approximately G20)
Secretariat based at the BIS in Basel, Switzerland
Part of the “Basel process” (also including BCBS, FSB, IAIS, IADI, …)
4
Role of the committee
Two key functions:
Standard Setting (including setting common policies and
recommendations)
eg. Principles for financial market infrastructures (2012)
Settlement risk in foreign exchange transactions (1996)
Central bank oversight of payment and settlement systems (2005)
Descriptive/Analytical (sharing information, carrying out analysis,
discussing issues, increasing mutual understanding …)
eg. Role of central bank money in payment systems (2003)
New developments in large value payment systems (2005)
The interdependencies of payment and settlement systems (2008)
Innovations in retail payments (2012)
5
What is oversight?
“Oversight of payment and settlement systems is a central
bank function whereby the objectives of safety and efficiency
are promoted by monitoring existing and planned systems,
assessing them against the objectives and, where necessary,
inducing change.”
Oversight of payment and settlement systems, BIS, 2005
6
Two “old” CPSS definitions
A central bank task, principally intended to promote the
smooth functioning of payment systems and to protect the
financial system from possible “domino effects” which may
occur when one or more participants in the payment system
incur credit or liquidity problems. Payment systems oversight
aims at a given system (e.g. a funds transfer system) rather
than individual participants
Glossary of terms, BIS, March 2003
A public policy activity principally intended to promote the
safety and efficiency of payment systems and in particular to
reduce systemic risk
Core principles, BIS, January 2001
7
A form of “regulation”
FINANCIAL SYSTEM
INSTITUTIONS
SUPERVISION
INFRASTRUCTURES
OVERSIGHT
MARKETS
SURVEILLANCE
All can be described as “regulatory” activities in a very
broad sense of “involvement” by the authorities
8
Monitor
Assess
Induce change
Policy
(setting)
Oversight is a “regulatory” activity:
“Regulating” infrastructures, not their participants
9
Focus on risks
Market Risk
Liquidity Risk
Operational Risk
Systemic Risk
FX Settlement
Risk
Legal Risk
Credit Risk
Risks
10
Oversight process
Enforcement
Collecting and
assessing relevant
information
Formulation of the
oversight policy stance
• Monitoring and
analysing relevant
developments
(legal, technical,
business environment)
and risks
Setting standards
(binding or non-
binding)
Formulating policy
framework
Regular oversight activities
Ad-hoc assessments
• Collection of data/information
• Identification of potential weaknesses
• Recommendations to operators
Inducing change
• Binding legal instruments
• Informal tools (e.g. moral
suasion)
• Voluntary agreements
• Cooperation with other
authorities
Oversight is an iterative process
11
Financial Market Infrastructures (FMIs)
Facilitate recording, clearing and settlement of monetary and other financial
transactions
Strengthen the markets they serve
Mitigate systemic risk
FMIs play a critical role in fostering financial stability
On the other hand, FMIs also concentrate risk – not the least through
interdependencies.
if this risk is not properly managed, FMIs can be sources of:
Credit losses
Liquidity and collateral dislocations
Financial shocks
FMIs could be major channels through which shocks are transmitted
across domestic and international financial markets
International standards for FMIs have been established over the years to
address these risks
12
Criticality of safety and effciiency of FMIs for financial
markets, because of the impact of:
• Intransparency and inefficiencies
• Market failures
• Concentration and lack of substitutability
• Network effects and interdependencies
• Systemic risk
However, some implications:
• Primary responsibility of FMIs for their activities
• Moral hazard
• Financial costs
Why is oversight carried out?
13
Who should perform oversight? – a “central bank
function”
Central bank advantages:
Expertise and experience
Operator and user perspective
Relevance for financial and monetary stability
Relevance for lender-of-last-resort role
But some implications:
• Regulatory overlap with other authorities (supervisors,
competition authorities, etc.)
• Potential conflicts of interest
• Reputational risk
14
Central bank rationale
Ensure the safety and
efficiency of financial market
infrastructure
Contribute to financial
stability
Contribute to the smooth
implementation of
monetary policy
Maintain the public
confidence in the currency
15
Main public policy objectives in view of limiting systemic risk and
fostering transparency and financial stability (see PFMIs):
Safety
Robust management of risks such as: legal, credit, liquidity, general
business, operational risks etc.
Efficiency
Best use of resources by financial market infrastructures and their
participants in view of performing effectively their functions and the
wider market they serve
Public policy objectives
16
Scope of oversight - which “systems”?
PFMIs:
Systemically relevant payment systems (large value vs. retail)
Central securities depositories and securities settlement systems
Central counterparties
Trade repositories
What about:
Critical service providers?
Other retail payment systems?
Payments instruments/schemes?
Quasi-systems (correspondent banks and custodians)?
17
1974 1989
Herstatt
G-10 Committee
on Payment and
Settlement
Systems
G-10 Ad hoc
Committee on
Interbank
Netting
Schemes
(Lamfalussy)
1990
(Allsopp)
Report on
Settlement
Risks in FX
CPSS Core
Principles
for SIPS
1996
CLS
2002 2001 1980
G-10 Group
of Experts
on Payment
Systems
1985 1991 1992 2004
CPSS Report
on Oversight
Development and scope of the oversight role
1999
CPSS/IOSCO
Recommen-
dations for SSS
CPSS/IOSCO
Recommen-
dations for
CCPs
2005 2003 2007 2008
CPSS-IOSCO
guidance on OTC
derivatives
FX settle-
ment risk
Interdepen-
dencies
Lehman
2009 2011 2012
CPSS-IOSCO
PFMIs
18
Large-Value Payment Systems
Backbone of the financial markets
RTGS or DNS, multicurrency: CLS
Retail Payment Systems
used for the bulk of payments between individuals and corporates
may have a role with respect to the safety and efficiency of the
financial system and citizens’ confidence in the currency
may be systemically relevant (PFMIs)
Policy issues for central banks in retail payments (BIS, 2003)
“Each central bank should examine developments in its markets … in order to form a view on whether [policy] issues arise. Where such issues are judged to arise, [central banks] may decide to take action …”
19
Clearing and settlement infrastructure –
CSDs, SSSs and CCPs
Embedded payment arrangements
Central banks have a strong interest in CCPs and SSSs due to
their relevance for financial stability, monetary policy and the
smooth operation of payments systems
Frequent need to cooperate with other competent authorities
(e.g. securities regulators), at national or cross-border level
20
Trade repositories (TRs)
TRs are data warehouses that record trade-related data, and which
are connected to CCPs by a relationship of data feed
TRs not comparable with CCPs in terms of systemic risk
implications, but their safety, resilience and efficiency is significant
from a financial stability perspective in view of the reliance of a
large number of market participants, public authorities and market
infrastructures on the availability and accuracy of the data
Need for a framework for the operation of trade repositories (i.a.
access/participation, disclosure of data, protection of data, legal
certainty/status of registered contracts)
21
Payment instruments
Arrangements rather than system
Non-cash payment instruments (means to transfer (retail) funds
between accounts), e.g. cards, credit transfer schemes, e-money
schemes, mobile payments, remittance services, cheques
Essential part of payment infrastructure
Low risks, but important for both maintaining confidence in the
currency and promoting an efficient economy
Frequently focus on security
22
Third-party service providers
provide key services to FMIs
critical for the functioning of the financial markets (e.g. SWIFT)
Annex F to the PFMIs
• Risk identification and manadement
• Information security
• Reliability and resilience
• Technilogy planning
• Communication with users
23
Quasi-systems –
Correspondent banks and custodian banks
key components of an economy’s payment and settlement arrangements
potential for strong concentration, giving rise to possible financial and operational risks
B
Central bank
or FMI
C
A
D
24
A question of “territory”
Large value payment system
Efficiency Risk
= central bank
overseer
= consumer
protection agency
= banking
supervisor
RTGS
CLS
Bank’s capital
and liquidity
Bank charges
Retail payment system
Securities settlement system
Central counterparty
Quasi system
Individual institutions (eg banks)
Direct debit conditions
= securities
regulator
How to conduct oversight - PFMI Responsibilities A - E
• Responsibility A: FMIs should be subject to appropriate and effective
regulation, supervision, and oversight by a relevant authority
• Responsibility B: Authorities should have the powers and resources
to carry out effectively their responsibilities in regulating, supervising,
and overseeing FMIs
• Responsibility C: Authorities should clearly define and disclose their
regulatory, supervisory, and oversight policies with respect to FMIs
• Responsibility D: Authorities should adopt and consistently apply the
PFMI
• Responsibility E: Relevant authorities should cooperate, both
domestically and internationally, as appropriate, in promoting the
safety and efficiency of FMIs
25
26
Central bank oversight of payment and settlement
systems, CPSS, May 2005
Described how CPSS central banks currently do oversight
Set out five general principles for oversight (GOPs):
GOP A: Transparency
GOP B: Use of international standards
GOP C: Effective powers and capacity
GOP D: Consistency
GOP E: Cooperation with other authorities
Set out five additional principles for international cooperative
oversight (eg for CLS, SWIFT)
26
27
Evolution of the central bank responsibilities in
the new principles
CSIPS RSSS RCCP GOP
Responsibility A: A 18 15 B
Responsibility B: C 18 15 C
Responsibility C: A 18 15 A
Responsibility D: B, C – – D
Responsibility E: D 18 15 E
27
28
Responsibility A: Regulation, supervision and
oversight of FMIs
• Authorities should clearly define and publicly disclose the criteria used
to identify FMIs that should be subject to regulation, supervision, and
oversight
• FMIs that have been identified using these criteria should be
regulated, supervised, and overseen by a central bank, market
regulator, or other relevant authority
Typically requires setting out responsibilities, objectives and criteria
for determining who the standards apply to
Necessity to clarify roles in case of multiple authorities
29
Responsibility B: Regulatory, supervisory and
oversight powers and resources
• Authorities should have powers or other authority consistent with their
relevant responsibilities, including:
• ability to obtain timely information
• ability to induce change or enforce corrective action
• Authorities should have sufficient resources to fulfil their responsibilities
Powers could be statutory or non-statuotory
Safeguards to ensure confidentiality
Who has to provide information (e.g. outsourcees)?
Adequate funding, qualified and experienced personel - complexity
Organisational structure - separation of functions?
30
Formal responsibilities
Should the central bank have statutory responsibilities and powers, i.e. set
out in law, explicitly and perhaps in some detail?
Possible advantages
transparency
binding effects
Possible disadvantages
less flexibility to adapt
Enforcement tools
• Formal legal instruments (guidelines, regulations, instructions)
• Sanctions (financial, criminal, closure of systems)
• Informal tools (e.g. moral suasion)
• Cooperation with other authorities
• Voluntary agreements
Are non-binding instruments enough?
31
Responsibility C: Disclosure of policies with respect
to FMIs
• Authorities should clearly define their policies with respect to FMIs,
which include the authorities’ objectives, roles, and regulations
• Authorities should publicly disclose their relevant policies with respect to
the regulation, supervision, and oversight of FMIs
Transparency supports consistency, accountability and effectiveness
Typically involves a public document setting out the policies (see
responsibility A)
32
PFMI Responsibility C is silent about this
Advantages:
– Useful information to help markets to make its own judgment
– A useful oversight “power” for the central bank
– Promotes central bank accountability
Disadvantages:
– Confidentiality of information
– Competition issues
– May create adverse effects on market confidence
Transparency of assessments?
33
Responsibility D: Application of the principles for
FMIs
• Authorities should adopt the PFMIs
• Authorities should ensure that these principles are, at a minimum,
applied to all systemically important PSs, CSDs, SSSs, CCPs, and TRs
• Authorities should apply these principles consistently within and across
jurisdictions, including across borders, and to each type of FMI covered
by the principles
Commitment by CPSS and IOSCO members to apply PFMIs
Minimum scope
Consistency of application (also to central bank operated FMIs)
34
Consistency
Important where systems are in competition with each other
Central banks should indicate criteria for “comparability”
(e.g. types of instruments, value, types of participants, risk
attributes)
Consistency also needed where a central bank operates a
system itself to avoid competition issues and conflict of
interests (e.g. by organisational separation)
35
Responsibility E: Cooperation with other authorities
• Relevant authorities should cooperate with each other in fulfilling their
respective mandates with respect to FMIs
• both domestically and internationally
• to foster efficient and effective communication and consultation in
order to support each other
• Cooperation needs to be effective in normal circumstances
• Cooperation should be adequately flexible to facilitate effective
communication, consultation, or coordination, as appropriate, during
periods of market stress, crisis situations, and the potential recovery,
wind-down, or resolution of an FMI
36
Responsibility E: Cooperation with other authorities
• Cooperation may take a variety of forms. The form, degree of
formalization and intensity of cooperation should promote the efficiency
and effectiveness of the cooperation, and should be appropriate to the
nature and scope of each authority’s responsibility for the supervision or
oversight of the FMI and commensurate with the FMI’s systemic
importance in the cooperating authorities’ various jurisdictions.
Cooperative arrangements should be managed to ensure the efficiency
and effectiveness of the cooperation with respect to the number of
authorities participating in such arrangements
MoUs
Formal colleges
Information sharing arrangements
37
Between central banks
in the context of cooperative oversight of cross-
border and multicurrency systems
Between central banks at international level (I.e.
CPSS)
to define and implement oversight requirements
for global infrastructures
With securities regulators at international level (e.g
CPSS-IOSCO)
to define common standards
With other regulators (MoUs, colleges)
to reconcile the “infrastructure” and the
“institution” perspective
With financial stability authorities
to foster the macroprudential perspective on
systemic risks
With resolution authorities
to ensure safe and effective resolution of FMIs
Co-operation
• align conflicting objectives
• promote consistency of oversight requirements and approaches and avoid duplication and overlaps
• access to comprehensive and timely information on factors that may impact on the safety and resilience of infrastructures
• clarification of responsibilities and procedures for cooperation among authorities during crisis situations
Aim to:
38
Responsibility E: Cooperation with other authorities
• If an authority has identified an actual or proposed operation of a cross-
border or multicurrency FMI in its jurisdiction, the authority should, as
soon as it is practicable, inform other relevant authorities that may have
an interest in the FMI’s observance of the CPSS-IOSCO Principles for
financial market infrastructures
Notification duty (in advance where possible)
39
Responsibility E: Cooperation with other authorities
• When assessing an FMI’s payment and settlement arrangements and
its related liquidity risk-management procedures in any currency for
which the FMI’s settlements are systemically important against the
principles, the authority or authorities with primary responsibility with
respect to the FMI should consider the views of the central banks of
issue. If a central bank of issue is required under its responsibilities to
conduct its own assessment of these arrangements and procedures, the
central bank should consider the views of the authority or authorities
with primary responsibility with respect to the FMI
Role of the central bank of issue for settlement and liquidity
arrangement in its currency
Duty to consider, not to jointly agree
What can be done in case of disagreement (e.g. discourage of use of
FMI)?
40
Responsibility E: Cooperation with other authorities
• For an FMI where cooperative arrangements are appropriate, at least
one authority should accept responsibility for establishing efficient and
effective cooperation among all relevant authorities. In international
cooperative arrangements where no other authority accepts this
responsibility, the presumption is the authority or authorities with primary
responsibility in the FMI’s home jurisdiction should accept this
responsibility
• At least one authority should ensure that the FMI is periodically
assessed against the principles and should, in developing these
assessments, consult with other authorities that conduct the supervision
or oversight of the FMI and for which the FMI is systemically important
appoint an authority with primary responsibility
consider appropriate cooperative arrangements
assessment of the system as a whole by that authority, in consultation
with the other authorities
41
Cooperative oversight and the concept of lead overseer
Basis: “Lamfalussy principles” for cooperative oversight of cross-border and
multicurrency netting and settlement systems
– One central bank (the lead overseer) assumes primary oversight
responsibility
– The lead overseer consults the (most representative) other central banks
with a valid interest
– The settlement procedures are overseen jointly by the lead overseer and
the central banks of issue of relevant currencies
– Central banks involved in cooperative oversight undertake efforts to reach
consensus
42
Responsibility E: Cooperation with other authorities
• Relevant authorities should provide advance notification, where
practicable and otherwise as soon as possible thereafter, regarding
pending material regulatory changes and adverse events with respect to
the FMI that may significantly affect another authority’s regulatory,
supervisory, or oversight interests
• Relevant authorities should coordinate to ensure timely access to trade
data recorded in a TR
cf. the work being conducted by the CPSS and IOSCO on access to
data by competent authorities
43
Challenges for oversight
• Market infrastructure changes:
increased attention of overseers to the clearing and settlement
infrastructures or security of payments
• Developing oversight framework:
evolving legal and regulatory environment, i.e new legislation and
international standards
• Need for co-operation and sharing of information:
between central banks, securities regulators, supervisors and other
relevant authorities for emerging cross-border and global FMIs