The Bank Of England’s Annual Report On FMIs: A Stocktake And Detail On The Future Approach On FMI Supervision – Financial Services

On 19 December 2022 the Bank of England
(“BoE“) published its annual report on Financial
Market Infrastructures’ (“FMIs“)
supervision which sketches the BoE’s work undertaken during
2021/22 and sets out its supervisory approach for 2022/23
(“Report“).

There are two main themes cutting through the Report which are
relevant to firms:

• Lessons Learnt for firms from the 2021/22
  reporting period (where available); and




• New Rules: BoE prepares firms for upcoming
  regulatory developments, also in light of the new general
  rulemaking powers under the Financial Services and Markets Bill
  (“FSMB”) currently before the UK
  Parliament with respect to central securities depositories
  (“CSDs“) and central counterparties
  (“CCPs“).

BoE focuses on four key areas: operational resilience, CCP
resilience and recovery, innovation in payments and recognition and
supervision of cross-border CCPs and CSDs.

Overall, the BoE is maintaining the same focus in relation to
FMI supervision as during the latest reporting period. The
BoE’s emphasis is being placed on enhancing operational
resilience whilst ensuring that this does not impede innovation.
The main game changer for the upcoming year is expected to be the
enactment of the FSMB that will equip the BoE with additional
rulemaking powers.

The rest of this blog post provides more details on the content
of the Report.

Operational resilience

Lessons Learnt:

• 2022 was a year that put FMIs under significant market shocks
  due to the pandemic and the war in Ukraine. Nevertheless, FMIs have
  proven resilient to these extraordinary market conditions.




• The suspension of nickel trading for a week by the London Metal
  Exchange (“LME“) due to the extreme
  market volatility and the build up of large derivative exposures
  (many of which to be cleared by LME Clear) forced the BoE to look
  into LME Clear’s governance and risk management framework to
  extract any lessons learnt.




• The settlement system outage that Euroclear UK and
  International (“EUI“) suffered (the
  second since 2020) forced BoE to take enforcement action and to use
  its supervisory tools to maintain the resilience in EUI.
  Specifically, the BoE made use of its power under Section 166 of
  the Financial Services and Markets Act 2000 to require EUI to
  appoint a skilled person responsible for assessing whether the
  relevant lessons learnt from the first outage back in 2020 had been
  appropriately implemented and whether any additional steps to
  improve IT resilience need to be taken.

New Rules:

• The BoE together with the Financial Conduct Authority
  (“FCA“) and Prudential Regulation
  Authority published a joint Discussion Paper in July 2022 to present
  the potential measures by way of which supervisory authorities
  could use the proposed new powers under the FSMB in respect of
  improving the resilience of services outsourced to critical third
  parties (“CTPs“) by firms and FMIs.
  These measures are build on three pillars according to the FSMB:
  

  • Identifying CTPs and recommending them to HMT for formal
    designation;

  
  

  • Setting minimum resilience standards for designated CTPs in
    respect of material services provided to firms and FMIs; and

  
  

  • Tools for testing the resilience of material services that CTPs
    provide to firms and FMIs.

The BoE will continue to work to incorporate the new rules into
its supervisory framework.

• The FSMB will introduce a high-level Senior Managers and
  Certification Regime framework for CCPs and CSDs. The BoE is
  expected to develop a policy in that respect in conjunction with
  the HMT.




• The BoE will continue to undertake thematic and firm-specific
  deep dive reviews across the FMIs.




• The BoE will ensure that FMIs comply with their obligation to
  implement the BoE’s latest policy requirement for operational resilience
  by 2025.

CCP resilience and recovery

Lessons Learnt:

• In October 2022, the BoE published the results of its first public CCP
  supervisory stress test (a) exploring the credit and liquidity
  resilience of the three UK CCPs as well as (b) performing a reverse
  stress test to understand what would be required to deplete
  CCPs’ financial resources and (c) analysing the impact of the
  stress test scenario on CCP’s clearing members and their
  clients. Results varied per CCP though none of the UK CCPs
  experienced full depletion of prefunded financial resources or
  negative liquidity balance.

New Rules:

• Rules on CCP margin will primarily derive from the work of the
  joint BCBS-CPMI-IOSCO group which is co-chaired by the BoE.
  Following the publication of the final report on margining
  practices in September 2022, further international work is expected
  on liquidity preparedness and data gaps in regulatory
  reporting.




• As set out in the BoE’s policy statement in relation to the
  discontinuation of the USD Libor benchmark at the end of Q2 2023,
  USD Libor referencing contracts will be removed from the clearing
  obligation on 24 April 2023.




• The BoE intends to publish a framework document for CCP
  supervisory stress testing, which will set out the BoE’s
  framework for CCP supervisory stress testing and guide the design
  of each of the BoE’s annual stress testing exercises. This new
  framework will be developed on the basis of the BoE’s Discussion Paper on Supervisory Stress Testing
  of Central Counterparties together with the lessons learned from
  the first CCP stress testing exercise.




• The BoE will also start preparing its second CCP stress
  testing.




• New CCP resolution and pre-resolution rules will be introduced
  under the FSMB, which will largely mimic banking resolution rules
  in line with international standards.

Innovation in payments

New Rules:

• Significant work has been done by CPMI-IOSCO in relation to the
  design of stablecoin arrangements confirming that the Principles for FMIs apply
  to systemically important stablecoin arrangements that transfer
  stablecoins. In addition, this guidance by CPMI-IOSCO addresses
  issues of governance, risk management, settlement finality and
  money settlements, as well as considerations related to the
  classification of a stablecoin arrangement as systemically
  important. The rules set out in the FSMB are consistent with the
  abovementioned guidance.




• The BoE’s regulatory framework for systemic stablecoins
  will follow the proposed FSB’s “Global
  Stablecoin” (“GSC“) arrangements
  which in turn are expected to be finalised by July 2023. The
  revised framework requires GSC arrangements to provide a robust
  legal claim, guarantee timely redemption at par into fiat and
  maintain effective stabilisation mechanisms, as well as to be
  subject to appropriate prudential requirements.




• The new stablecoin regime in the UK will be combined with a
  Special Administrative Regime for stablecoins which will be a
  bespoke insolvency framework for systemic payment and settlement
  systems.




• New rules are likely to be introduced in respect of wholesale
  cash distribution network in the UK. In line with the BoE consultation on this matter, any firm
  recognised as systemic by HMT would be brought into the scope of
  the BoE’ prudential supervision. The above notwithstanding,
  currently it appears that no firm in the wholesale cash sector
  would meet the criteria for systemic recognition.




• The BoE is working together with HMT and the FCA to develop an
  FMI Sandbox which should be ready for launch by the end of 2023.
  Participating firms will have the possibility to test and adopt new
  technologies that are currently not supported by the existing
  legislation.

Recognition and supervision of cross-border CCPs and CSDs

New Rules:

• The BoE is expected to start implementing its recently
  introduced policy regime for incoming FMIs. Therefore,
  the BoE is expected to proceed with the recognition of incoming
  CCPs and CSDs where the requirements for recognition are met
  prioritising for firms that may pose a risk to UK financial
  stability. These requirements entail a decision by HMT that the
  relevant jurisdiction’s regulatory framework is equivalent and
  that appropriate and proportionate supervisory cooperation and
  information sharing is being agreed with the incoming FMI’s
  home authority. In this context, the BoE is also aiming to enter
  into the necessary Memoranda of Understanding with overseas
  authorities to support recognition.




• Alongside the recognition process, incoming FMIs may obtain
  protection from certain insolvency challenges under the Settlement
  Finality Regulations.

The content of this article is intended to provide a general
guide to the subject matter. Specialist advice should be sought
about your specific circumstances.