Committee on Payment andSettlement Systems
Technical Committee of theInternational Organization of
Securities Commissions

Principles for financial
market infrastructures

April 2012

This publication is available on the BIS website (www.bis.org) and the IOSCO website(www.iosco.org).

© Bank for International Settlements and International Organization of Securities Commissions
2012. All rights reserved. Brief excerpts may be reproduced or translated provided the source isstated.

ISBN 92-9131-108-1 (print)
ISBN 92-9197-108-1 (online)

Contents

Abbreviations ......................................................................................................................... iii
Overview of principles and responsibilities ............................................................................. 1
1.0. Introduction ................................................................................................................... 5
Background .................................................................................................................. 5
FMIs: definition, organisation, and function ................................................................... 7
Public policy objectives: safety and efficiency ............................................................. 10
Scope of the principles for FMIs.................................................................................. 12
Scope of the responsibilities of central banks, market regulators, and otherrelevant authorities for financial market infrastructures ...................................... 16
Implementation, use, and assessments of observance of the principles andresponsibilities ................................................................................................... 16
Organisation of the report ........................................................................................... 17
2.0. Overview of key risks in financial market infrastructures ............................................. 18
Systemic risk .............................................................................................................. 18
Legal risk .................................................................................................................... 18
Credit risk ................................................................................................................... 19
Liquidity risk ................................................................................................................ 19
General business risk ................................................................................................. 19
Custody and investment risks ..................................................................................... 19
Operational risk .......................................................................................................... 20
3.0. Principles for financial market infrastructures .............................................................. 21
General organisation............................................................................................................ 21
Principle 1: Legal basis ............................................................................................... 21
Principle 2: Governance.............................................................................................. 26
Principle 3: Framework for the comprehensive management of risks.......................... 32
Credit and liquidity risk management ................................................................................... 36
Principle 4: Credit risk ................................................................................................. 36
Principle 5: Collateral .................................................................................................. 46
Principle 6: Margin ...................................................................................................... 50
Principle 7: Liquidity risk ............................................................................................. 57
Settlement ........................................................................................................................... 64
Principle 8: Settlement finality ..................................................................................... 64
Principle 9: Money settlements ................................................................................... 67
Principle 10: Physical deliveries .................................................................................. 70
Central securities depositories and exchange-of-value settlement systems ......................... 72
Principle 11: Central securities depositories................................................................ 72

CPSS-IOSCO – Principles for financial market infrastructures – April 2012iPrinciple 12: Exchange-of-value settlement systems .................................................. 76
Default management ............................................................................................................ 78
Principle 13: Participant-default rules and procedures ................................................ 78
Principle 14: Segregation and portability ..................................................................... 82
General business and operational risk management ............................................................ 88
Principle 15: General business risk ............................................................................. 88
Principle 16: Custody and investment risks ................................................................. 92
Principle 17: Operational risk ...................................................................................... 94
Access ............................................................................................................................... 101
Principle 18: Access and participation requirements ................................................. 101
Principle 19: Tiered participation arrangements ........................................................ 105
Principle 20: FMI links ............................................................................................... 109
Efficiency ........................................................................................................................... 116
Principle 21: Efficiency and effectiveness ................................................................. 116
Principle 22: Communication procedures and standards .......................................... 119
Transparency ..................................................................................................................... 121
Principle 23: Disclosure of rules, key procedures, and market data .......................... 121
Principle 24: Disclosure of market data by trade repositories .................................... 124
4.0

Responsibilities of central banks, market regulators, and other relevant
authorities for financial market infrastructures ........................................................... 126
Responsibility A: Regulation, supervision, and oversight of FMIs .............................. 126
Responsibility B: Regulatory, supervisory, and oversight powers and resources ...... 128
Responsibility C: Disclosure of policies with respect to FMIs .................................... 130
Responsibility D: Application of the principles for FMIs ............................................. 131
Responsibility E: Cooperation with other authorities.................................................. 133

Annex A: Mapping of CPSIPS, RSSS, and RCCP standards to the principles in thisreport ........................................................................................................................ 138
Annex B: Mapping of the principles in this report to CPSIPS, RSSS, RCCP, and otherguidance ................................................................................................................... 140
Annex C: Selected RSSS marketwide recommendations................................................... 141
Annex D: Summary of designs of payment systems, SSSs, and CCPs.............................. 148
Annex E: Matrix of applicability of key considerations to specific types of FMIs ................. 158
Annex F: Oversight expectations applicable to critical service providers ............................ 170
Annex G: Bibliography ....................................................................................................... 172
Annex H: Glossary ............................................................................................................. 174
Annex I: Members of the CPSS-IOSCO review of standards ............................................. 180

ii

CPSS-IOSCO – Principles for financial market infrastructures – April 2012

Abbreviations

ACH

Automated clearing house

BCBS

Basel Committee on Banking Supervision

CCP

Central counterparty

CGFS

Committee on the Global Financial System

CPSIPS

Core principles for systemically important payment systems

CPSS

Committee on Payment and Settlement Systems

CSD

Central securities depository

DNS

Deferred net settlement

DvD

Delivery versus delivery

DvP

Delivery versus payment

FMI

Financial market infrastructure

FSB

Financial Stability Board

ICSD

International central securities depository

IOSCO

International Organization of Securities Commissions

IT

Information technology

Lamfalussy Report

Report of the Committee on Interbank Netting Schemes of thecentral banks of the Group of Ten countries

LEI

Legal entity identifier

LVPS

Large-value payment system

OTC

Over the counter

PS

Payment system

PvP

Payment versus payment

RCCP

Recommendations for central counterparties

Repo

Repurchase agreement

RSSS

Recommendations for securities settlement systems

RTGS

Real-time gross settlement

SSS

Securities settlement system

TR

Trade repository

CPSS-IOSCO – Principles for financial market infrastructures – April 2012iii

Overview of principles and responsibilities

Principles for financial market infrastructures
General organisation
Principle 1: Legal basis
An FMI should have a well-founded, clear, transparent, and enforceable legal basis for eachmaterial aspect of its activities in all relevant jurisdictions.
Principle 2: Governance
An FMI should have governance arrangements that are clear and transparent, promote thesafety and efficiency of the FMI, and support the stability of the broader financial system,other relevant public interest considerations, and the objectives of relevant stakeholders.
Principle 3: Framework for the comprehensive management of risks
An FMI should have a sound risk-management framework for comprehensively managing
legal, credit, liquidity, operational, and other risks.
Credit and liquidity risk management
Principle 4: Credit risk
An FMI should effectively measure, monitor, and manage its credit exposures to participants
and those arising from its payment, clearing, and settlement processes. An FMI should
maintain sufficient financial resources to cover its credit exposure to each participant fully
with a high degree of confidence. In addition, a CCP that is involved in activities with a morecomplex risk profile or that is systemically important in multiple jurisdictions should maintainadditional financial resources sufficient to cover a wide range of potential stress scenariosthat should include, but not be limited to, the default of the two participants and their affiliatesthat would potentially cause the largest aggregate credit exposure to the CCP in extreme but
plausible market conditions. All other CCPs should maintain additional financial resources
sufficient to cover a wide range of potential stress scenarios that should include, but not belimited to, the default of the participant and its affiliates that would potentially cause thelargest aggregate credit exposure to the CCP in extreme but plausible market conditions.
Principle 5: Collateral
An FMI that requires collateral to manage its or its participants’ credit exposure should
accept collateral with low credit, liquidity, and market risks. An FMI should also set andenforce appropriately conservative haircuts and concentration limits.
Principle 6: Margin
A CCP should cover its credit exposures to its participants for all products through aneffective margin system that is risk-based and regularly reviewed.
Principle 7: Liquidity risk
An FMI should effectively measure, monitor, and manage its liquidity risk. An FMI should
maintain sufficient liquid resources in all relevant currencies to effect same-day and, whereappropriate, intraday and multiday settlement of payment obligations with a high degree of

CPSS-IOSCO – Principles for financial market infrastructures – April 20121

confidence under a wide range of potential stress scenarios that should include, but not belimited to, the default of the participant and its affiliates that would generate the largest
aggregate liquidity obligation for the FMI in extreme but plausible market conditions.
Settlement
Principle 8: Settlement finality
An FMI should provide clear and certain final settlement, at a minimum by the end of thevalue date. Where necessary or preferable, an FMI should provide final settlement intraday
or in real time.
Principle 9: Money settlements
An FMI should conduct its money settlements in central bank money where practical andavailable. If central bank money is not used, an FMI should minimise and strictly control thecredit and liquidity risk arising from the use of commercial bank money.
Principle 10: Physical deliveries
An FMI should clearly state its obligations with respect to the delivery of physical instruments
or commodities and should identify, monitor, and manage the risks associated with suchphysical deliveries.
Central securities depositories and exchange-of-value settlement systems
Principle 11: Central securities depositories
A CSD should have appropriate rules and procedures to help ensure the integrity of
securities issues and minimise and manage the risks associated with the safekeeping andtransfer of securities. A CSD should maintain securities in an immobilised or dematerialised
form for their transfer by book entry.
Principle 12: Exchange-of-value settlement systems
If an FMI settles transactions that involve the settlement of two linked obligations (forexample, securities or foreign exchange transactions), it should eliminate principal risk byconditioning the final settlement of one obligation upon the final settlement of the other.
Default management
Principle 13: Participant-default rules and procedures
An FMI should have effective and clearly defined rules and procedures to manage aparticipant default. These rules and procedures should be designed to ensure that the FMI
can take timely action to contain losses and liquidity pressures and continue to meet its
obligations.
Principle 14: Segregation and portability
A CCP should have rules and procedures that enable the segregation and portability ofpositions of a participant’s customers and the collateral provided to the CCP with respect tothose positions.

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CPSS-IOSCO – Principles for financial market infrastructures – April 2012

General business and operational risk management
Principle 15: General business risk
An FMI should identify, monitor, and manage its general business risk and hold sufficientliquid net assets funded by equity to cover potential general business losses so that it cancontinue operations and services as a going concern if those losses materialise. Further,liquid net assets should at all times be sufficient to ensure a recovery or orderly wind-down ofcritical operations and services.
Principle 16: Custody and investment risks
An FMI should safeguard its own and its participants’ assets and minimise the risk of loss on
and delay in access to these assets. An FMI’s investments should be in instruments withminimal credit, market, and liquidity risks.
Principle 17: Operational risk
An FMI should identify the plausible sources of operational risk, both internal and external,
and mitigate their impact through the use of appropriate systems, policies, procedures, andcontrols. Systems should be designed to ensure a high degree of security and operationalreliability and should have adequate, scalable capacity. Business continuity management
should aim for timely recovery of operations and fulfilment of the FMI’s obligations, includingin the event of a wide-scale or major disruption.
AccessPrinciple 18: Access and participation requirements
An FMI should have objective, risk-based, and publicly disclosed criteria for participation,
which permit fair and open access.
Principle 19: Tiered participation arrangements
An FMI should identify, monitor, and manage the material risks to the FMI arising from tiered
participation arrangements.
Principle 20: FMI links
An FMI that establishes a link with one or more FMIs should identify, monitor, and manage
link-related risks.
Efficiency
Principle 21: Efficiency and effectiveness
An FMI should be efficient and effective in meeting the requirements of its participants andthe markets it serves.
Principle 22: Communication procedures and standards
An FMI should use, or at a minimum accommodate, relevant internationally accepted
communication procedures and standards in order to facilitate efficient payment, clearing,
settlement, and recording.

CPSS-IOSCO – Principles for financial market infrastructures – April 20123

Transparency
Principle 23: Disclosure of rules, key procedures, and market data
An FMI should have clear and comprehensive rules and procedures and should provide
sufficient information to enable participants to have an accurate understanding of the risks,
fees, and other material costs they incur by participating in the FMI. All relevant rules and key
procedures should be publicly disclosed.
Principle 24: Disclosure of market data by trade repositories
A TR should provide timely and accurate data to relevant authorities and the public in linewith their respective needs.
Responsibilities of central banks, market regulators, and other relevant authorities forfinancial market infrastructures
Responsibility A: Regulation, supervision, and oversight of FMIs
FMIs should be subject to appropriate and effective regulation, supervision, and oversight bya central bank, market regulator, or other relevant authority.
Responsibility B: Regulatory, supervisory, and oversight powers and resources
Central banks, market regulators, and other relevant authorities should have the powers andresources to carry out effectively their responsibilities in regulating, supervising, andoverseeing FMIs.
Responsibility C: Disclosure of policies with respect to FMIs
Central banks, market regulators, and other relevant authorities should clearly define anddisclose their regulatory, supervisory, and oversight policies with respect to FMIs.
Responsibility D: Application of the principles for FMIs
Central banks, market regulators, and other relevant authorities should adopt the CPSSIOSCO Principles for financial market infrastructures and apply them consistently.
Responsibility E: Cooperation with other authorities
Central banks, market regulators, and other relevant authorities should cooperate with eachother, both domestically and internationally, as appropriate, in promoting the safety andefficiency of FMIs.

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CPSS-IOSCO – Principles for financial market infrastructures – April 2012

1.0.

Introduction

1.1.
Financial market infrastructures (FMIs) that facilitate the clearing, settlement, andrecording of monetary and other financial transactions can strengthen the markets they serveand play a critical role in fostering financial stability. However, if not properly managed, they
can pose significant risks to the financial system and be a potential source of contagion,
particularly in periods of market stress. Although FMIs performed well during the recent
financial crisis, events highlighted important lessons for effective risk management. Theselessons, along with the experience of implementing the existing international standards, led
the Committee on Payment and Settlement Systems (CPSS) and the Technical Committeeof the International Organization of Securities Commissions (IOSCO) to review and update
the standards for FMIs. 1 This review was also conducted in support of the Financial Stability
Board (FSB) initiative to strengthen core financial infrastructures and markets. All CPSS andIOSCO members intend to adopt and apply the updated standards to the relevant FMIs in
their jurisdictions to the fullest extent possible.
1.2.
The standards in this report harmonise and, where appropriate, strengthen theexisting international standards for payment systems (PS) that are systemically important,central securities depositories (CSDs), securities settlement systems (SSSs), and central
counterparties (CCPs). The revised standards also incorporate additional guidance for overthe-counter (OTC) derivatives CCPs and trade repositories (TRs). In general, thesestandards are expressed as broad principles in recognition of FMIs’ differing organisations,functions, and designs, and the different ways to achieve a particular result. In some cases,
the principles also incorporate a specific minimum requirement (such as in the credit,
liquidity, and general business risk principles) to ensure a common base level of risk
management across FMIs and countries. In addition to standards for FMIs, the reportoutlines the general responsibilities of central banks, market regulators, and other relevant
authorities for FMIs in implementing these standards.
Background
1.3.
FMIs play a critical role in the financial system and the broader economy. For the
purposes of this report, the term FMI refers to systemically important payment systems,
CSDs, SSSs, CCPs, and TRs. 2 These infrastructures facilitate the clearing, settlement, andrecording of monetary and other financial transactions, such as payments, securities, andderivatives contracts (including derivatives contracts for commodities). While safe andefficient FMIs contribute to maintaining and promoting financial stability and economic
growth, FMIs also concentrate risk. If not properly managed, FMIs can be sources offinancial shocks, such as liquidity dislocations and credit losses, or a major channel throughwhich these shocks are transmitted across domestic and international financial markets. To

1

In this report, the term "standards" is used as a generic term to cover all normative statements such as
standards, principles, recommendations, and responsibilities. The use of this term is consistent with the pastpractice of indicating that the principles and responsibilities set out in this report are, or are expected to be,part of the body of international standards and codes recognised by the Financial Stability Board (formerly
called the Financial Stability Forum) and international financial institutions.

2

In some cases, exchanges or other market infrastructures may own or operate entities or functions that
perform centralised clearing and settlement processes that are covered by the principles in the report. In
general, however, the principles in this report are not addressed to market infrastructures such as tradingexchanges, trade execution facilities, or multilateral trade-compression systems; nonetheless, relevant
authorities may decide to apply some or all of these principles to types of infrastructures not formally coveredby this report.

CPSS-IOSCO – Principles for financial market infrastructures – April 20125

address these risks, the CPSS and the Technical Committee of IOSCO have established,over the years, international risk-management standards for payment systems that aresystemically important, CSDs, SSSs, and CCPs.
1.4.
The CPSS, in January 2001, published the Core principles for systemicallyimportant payment systems (CPSIPS), which provided 10 principles for the safe and efficientdesign and operation of systemically important payment systems. These principles drew
extensively from the Report of the Committee on Interbank Netting Schemes of the central
banks of the Group of Ten countries (also known as the Lamfalussy Report), which was
published in November 1990. The CPSIPS were followed by the Recommendations forsecurities settlement systems (RSSS), which were published jointly by the CPSS and theTechnical Committee of IOSCO in November 2001. This report identified
19 recommendations for promoting the safety and efficiency of SSSs. 3 The accompanying
Assessment methodology for 'Recommendations for securities settlement systems' wassubsequently published in November 2002.
1.5.
In November 2004, building upon the recommendations established in the RSSS,
the CPSS and the Technical Committee of IOSCO published the Recommendations forcentral counterparties (RCCP). The RCCP provided 15 recommendations that addressed the
major types of risks faced by CCPs. A methodology for assessing a CCP’s observance ofeach recommendation was included in the report. In January 2009, the CPSS and theTechnical Committee of IOSCO established a working group to provide guidance on theapplication of these recommendations to CCPs that clear OTC derivatives products and todevelop a set of considerations for TRs in designing and operating their systems. The reportsof this working group, Guidance on the application of 2004 CPSS-IOSCO recommendations
for central counterparties to OTC derivatives CCPs and Considerations for trade repositories
in OTC derivatives markets, were issued as consultative reports in May 2010. The feedback
received from the consultative process on these reports has been incorporated into thisreport.
1.6.
In February 2010, the CPSS and the Technical Committee of IOSCO launched acomprehensive review of the three existing sets of standards for FMIs – the CPSIPS, RSSS,and RCCP – in support of the FSB’s broader efforts to strengthen core financial
infrastructures and markets by ensuring that gaps in international standards are identified
and addressed. 4 The CPSS and the Technical Committee of IOSCO also identified thereview as an opportunity to harmonise and, where appropriate, strengthen the three sets ofstandards. The lessons from the recent financial crisis, the experience of using the existing
international standards, and recent policy and analytical work by the CPSS, the TechnicalCommittee of IOSCO, the Basel Committee on Banking Supervision (BCBS), and others
were incorporated into the review. This report, containing a unified set of standards, is theresult of that review. The standards in Section 3 of this report replace the CPSIPS, RSSS,and RCCP standards insofar as they are directed specifically to FMIs. Mappings of the newstandards to the CPSIPS, RSSS, and RCCP standards are provided in Annexes A and B.
1.7.
A full reconsideration of the marketwide recommendations from the RSSS was notundertaken as part of this review. Those recommendations remain in effect. Specifically,
RSSS Recommendation 2 on trade confirmation, RSSS Recommendation 3 on settlement
cycles, RSSS Recommendation 4 on central counterparties, RSSS Recommendation 5 on

3

The definition of the term “securities settlement system” in the RSSS is the full set of institutionalarrangements for confirmation, clearance, and settlement of securities trades and safekeeping of securities.
This definition differs from the definition of SSS in this report, which is more narrowly defined (seeparagraph 1.12).

4

The CPSIPS, RSSS, and RCCP are currently included in the FSB’s Key Standards for Sound Financial
Systems.

6

CPSS-IOSCO – Principles for financial market infrastructures – April 2012

securities lending, RSSS Recommendation 6 on central securities depositories, and RSSS
Recommendation 12 on protection of customers’ securities remain in effect. These
recommendations are provided in Annex C for reference. In addition to keeping RSSS
Recommendations 6 and 12, this report contains focused principles on the risk managementof CSDs (see Principle 11) and on the segregation and portability of assets and positions
held by a CCP (see Principle 14). The CPSS and Technical Committee of IOSCO may
conduct a full review of the marketwide standards in the future.
FMIs: definition, organisation, and function
1.8.
For the purposes of this report, an FMI is defined as a multilateral system among
participating institutions, including the operator of the system, used for the purposes ofclearing, settling, or recording payments, securities, derivatives, or other financialtransactions. 5 FMIs typically establish a set of common rules and procedures for allparticipants, a technical infrastructure, and a specialised risk-management framework
appropriate to the risks they incur. FMIs provide participants with centralised clearing,
settlement, and recording of financial transactions among themselves or between each ofthem and a central party to allow for greater efficiency and reduced costs and risks. Throughthe centralisation of specific activities, FMIs also allow participants to manage their risks
more efficiently and effectively, and, in some instances, eliminate certain risks. FMIs can also
promote increased transparency in particular markets. Some FMIs are critical to helping
central banks conduct monetary policy and maintain financial stability. 6
1.9.
FMIs can differ significantly in organisation, function, and design. FMIs can belegally organised in a variety of forms, including associations of financial institutions, nonbank clearing corporations, and specialised banking organisations. FMIs may be owned andoperated by a central bank or by the private sector. FMIs may also operate as for-profit or
not-for-profit entities. Depending on organisational form, FMIs can be subject to different
licensing and regulatory schemes within and across jurisdictions. For example, bank andnon-bank FMIs are often regulated differently. For the purposes of this report, the definitionof an FMI includes five key types of FMIs: payment systems, CSDs, SSSs, CCPs, and TRs.
There can be significant variation in design among FMIs with the same function. For
example, some FMIs use real-time settlement, while others may use deferred settlement.
Some FMIs settle individual transactions while others settle batches of transactions. Annex Dprovides greater detail on different designs for payment systems, SSSs, and CCPs.

5

The general analytical approach of this report is to consider FMIs as multilateral systems, inclusive of their
participants, as stated in the definition of FMI. In market parlance, however, the term FMI may be used to refer
only to a legal or functional entity that is set up to carry out centralised, multilateral payment, clearing,
settlement, or recording activities and, in some contexts, may exclude the participants that use the system.
This difference in terminology or usage may introduce ambiguity at certain points in the report. To address thisissue, the report may refer to an FMI and its participants, or to an FMI including its participants, to emphasize
the coverage of a principle or other text where this is not clear from the context. The definition of FMIs
excludes bilateral relationships between financial institutions and their customers, such as traditionalcorrespondent banking.

6

Typically, the effective implementation of monetary policy depends on the orderly settlement of transactions
and the efficient distribution of liquidity. For example, many central banks implement monetary policy byinfluencing short-term interest rates through the purchase and sale of certain financial instruments, such as
government securities or foreign exchange, or through collateralised lending. It is important that FMIs be safeand efficient and allow for the reliable transfer of funds and securities between the central bank, its
counterparties, and the other participants in the financial system so that the effect of monetary policy
transactions can be spread widely and quickly throughout the economy.

CPSS-IOSCO – Principles for financial market infrastructures – April 2012

7

Payment systems
1.10.
A payment system is a set of instruments, procedures, and rules for the transfer offunds between or among participants; the system includes the participants and the entity
operating the arrangement. Payment systems are typically based on an agreement between
or among participants and the operator of the arrangement, and the transfer of funds iseffected using an agreed-upon operational infrastructure. A payment system is generally
categorised as either a retail payment system or a large-value payment system (LVPS). A
retail payment system is a funds transfer system that typically handles a large volume ofrelatively low-value payments in such forms as cheques, credit transfers, direct debits, andcard payment transactions. Retail payment systems may be operated either by the private
sector or the public sector, using a multilateral deferred net settlement (DNS) or a real-timegross settlement (RTGS) mechanism. 7 An LVPS is a funds transfer system that typicallyhandles large-value and high-priority payments. In contrast to retail systems, many LVPSs
are operated by central banks, using an RTGS or equivalent mechanism.
Central securities depositories
1.11.
A central securities depository provides securities accounts, central safekeeping
services, and asset services, which may include the administration of corporate actions andredemptions, and plays an important role in helping to ensure the integrity of securities
issues (that is, ensure that securities are not accidentally or fraudulently created or destroyedor their details changed). A CSD can hold securities either in physical form (but immobilised)or in dematerialised form (that is, they exist only as electronic records). The precise activities
of a CSD vary based on jurisdiction and market practices. For example, the activities of a
CSD may vary depending on whether it operates in a jurisdiction with a direct or indirect
holding arrangement or a combination of both. 8 A CSD may maintain the definitive record oflegal ownership for a security; in some cases, however, a separate securities registrar willserve this notary function. 9 In many countries, a CSD also operates a securities settlement
system (as defined in paragraph 1.12), but unless otherwise specified, this report adopts anarrower definition of CSD that does not include securities settlement functions. 10
Securities settlement systems
1.12.
A securities settlement system enables securities to be transferred and settled bybook entry according to a set of predetermined multilateral rules. Such systems allow
transfers of securities either free of payment or against payment. When transfer is against
payment, many systems provide delivery versus payment (DvP), where delivery of the
security occurs if and only if payment occurs. An SSS may be organised to provide additional
securities clearing and settlement functions, such as the confirmation of trade and settlement
instructions. The definition of an SSS in this report is narrower than the one used in the
RSSS, which defined an SSS broadly to include the full set of institutional arrangements forconfirmation, clearance, and settlement of securities trades and safekeeping of securities

7

In some countries, these retail payment systems may be systemically important systems.

8

In a direct holding system, each beneficial or direct owner of the security is known to the CSD or the issuer. In
some countries, the use of direct holding systems is required by law. Alternatively, an indirect holding system
employs a multi-tiered arrangement for the custody and transfer of ownership of securities (or the transfer ofsimilar interests therein) in which investors are identified only at the level of their custodian or intermediary.

9

A securities registrar is an entity that provides the service of preparing and recording accurate, current, andcomplete securities registers for securities issuers.

10

In market practice, CSDs often perform SSS functions. See paragraph 1.22, which discusses the approach ofthis report for entities that perform combined functions of more than one type of FMI, as defined in this report.

8

CPSS-IOSCO – Principles for financial market infrastructures – April 2012

across a securities market. For example, the RSSS definition for SSSs included CSDs andCCPs, as well as commercial bank functions involving securities transfers. In this report,
CSDs and CCPs are treated as separate types of FMIs. As noted above, in many countries,
CSDs also operate an SSS.
Central counterparties
1.13.
A central counterparty interposes itself between counterparties to contracts traded in
one or more financial markets, becoming the buyer to every seller and the seller to every
buyer and thereby ensuring the performance of open contracts. 11 A CCP becomescounterparty to trades with market participants through novation, an open-offer system, or
through an analogous legally binding arrangement. 12 CCPs have the potential to reducesignificantly risks to participants through the multilateral netting of trades and by imposing
more-effective risk controls on all participants. For example, CCPs typically requireparticipants to provide collateral (in the form of initial margin and other financial resources) tocover current and potential future exposures. CCPs may also mutualise certain risks throughdevices such as default funds. As a result of their potential to reduce risks to participants,
CCPs also can reduce systemic risk in the markets they serve. The effectiveness of a CCP’srisk controls and the adequacy of its financial resources are critical to achieving these riskreduction benefits.
Trade repositories
1.14.
A trade repository is an entity that maintains a centralised electronic record(database) of transaction data. 13 TRs have emerged as a new type of FMI and have recently
grown in importance, particularly in the OTC derivatives market. By centralising thecollection, storage, and dissemination of data, a well-designed TR that operates witheffective risk controls can serve an important role in enhancing the transparency oftransaction information to relevant authorities and the public, promoting financial stability,
and supporting the detection and prevention of market abuse. An important function of a TR
is to provide information that supports risk reduction, operational efficiency and effectiveness,and cost savings for both individual entities and the market as a whole. Such entities may
include the principals to a trade, their agents, CCPs, and other service providers offering
complementary services, including central settlement of payment obligations, electronic
novation and affirmation, portfolio compression and reconciliation, and collateral11

In markets where a CCP does not exist, a guarantee arrangement may provide market participants with somedegree of protection against losses from counterparty defaults. Such arrangements typically are organised
and managed by the CSD or SSS for a market or by some other market operator. A guarantee typically isviewed as desirable or even necessary where market rules or other features make it practically impossible formarket participants to manage their counterparty credit risks bilaterally. Guarantee arrangements vary greatly
from simple insurance-based schemes to more-sophisticated structures comparable to a CCP.

12

Through novation, the original contract between the buyer and seller is extinguished and replaced by two newcontracts, one between the CCP and the buyer, and the other between the CCP and the seller. In an openoffer system, a CCP is automatically and immediately interposed in a transaction at the moment the buyer andseller agree on the terms.

13

The functions of a TR may, where permitted by applicable law, also be performed by a payment system, CSD,
or CCP in addition to its core functions. A TR may also provide or support ancillary services such as the
management of trade life-cycle events and downstream trade-processing services based on the records it
maintains.

CPSS-IOSCO – Principles for financial market infrastructures – April 20129

management. 14 Because the data maintained by a TR may be used by a number ofstakeholders, the continuous availability, reliability, and accuracy of such data are critical.
Box 1
Public policy benefits of trade repositories
The primary public policy benefits of a TR, which stem from the centralisation and quality of thedata that a TR maintains, are improved market transparency and the provision of this data to
relevant authorities and the public in line with their respective information needs. Timely and reliable
access to data stored in a TR has the potential to improve significantly the ability of relevant
authorities and the public to identify and evaluate the potential risks posed to the broader financial
system (see Principle 24 on disclosure of market data by TRs). Relevant authorities, in particular,
should have effective and practical access to data stored in a TR, including participant-level data,
which such authorities require to carry out their respective regulatory mandates and legal
responsibilities.
A TR may serve a number of stakeholders that depend on having effective access to TR services,
both to submit and retrieve data. In addition to relevant authorities and the public, otherstakeholders can include exchanges, electronic trading venues, confirmation or matching platforms,
and third-party service providers that use TR data to offer complementary services. It is essential,
therefore, for a TR to design its access policies and terms of use in a manner that supports fair andopen access to its services and data (see Principle 18 on access and participation requirements).
Another important benefit of a TR is its promotion of standardisation through the provision of acommon technical platform that requires consistency in data formats and representations. The
result is a centralised store of transaction data with greater usefulness and reliability than when thedata are dispersed.
Central banks, market regulators, and other relevant authorities for TRs have a responsibility tomutually support each other’s access to data in which they have a material interest as part of theirregulatory, supervisory, and oversight responsibilities, consistent with the G20 Declaration at the152010 Toronto Summit. As market infrastructures continue to evolve, TRs may develop for avariety of products and asset classes both within and across particular jurisdictions, andcooperation among authorities will become increasingly important (see Responsibility E on
cooperation with other authorities). Efforts should be made to remove any legal obstacles or
restrictions to enable appropriate, effective, and practical access to data by relevant authorities,
provided such authorities are subject to appropriate confidentiality safeguards.

Public policy objectives: safety and efficiency
1.15.
The main public policy objectives of the CPSS and the Technical Committee of
IOSCO in setting forth these principles for FMIs are to enhance safety and efficiency inpayment, clearing, settlement, and recording arrangements, and more broadly, to limit

14

For some TRs, participants may agree that an electronic transaction record maintained in the TR provides theofficial economic details of a legally binding contract. This enables trade details to be used for providing
additional services.

15

The Declaration of the G20, 2010 Toronto Summit, annex II, paragraph 25, provides: “We pledged to work in acoordinated manner to accelerate the implementation of over-the-counter (OTC) derivatives regulation andsupervision and to increase transparency and standardization. We reaffirm our commitment to trade allstandardised OTC derivatives contracts on exchanges or electronic trading platforms, where appropriate, andclear through central counterparties (CCPs) by end-2012 at the latest. OTC derivative contracts should bereported to trade repositories (TRs). We will work toward the establishment of CCPs and TRs in line with
global standards and ensure that national regulators and supervisors have access to all relevant information.”
The complete declaration is available at http://www.g20.org.

10

CPSS-IOSCO – Principles for financial market infrastructures – April 2012

systemic risk and foster transparency and financial stability. 16 Poorly designed and operated
FMIs can contribute to and exacerbate systemic crises if the risks of these systems are notadequately managed, and as a result, financial shocks could be passed from one participant
or FMI to others. The effects of such a disruption could extend well beyond the FMIs andtheir participants, threatening the stability of domestic and international financial markets andthe broader economy. In contrast, robust FMIs have been shown to be an important sourceof strength in financial markets, giving market participants the confidence to fulfil their
obligations on time, even in periods of market stress. In relation to CCPs, the objectives ofsafety and efficiency are even more pertinent because national authorities have required or
proposed the mandatory use of centralised clearing in an increasing number of financial
markets.
Achieving the public policy objectives
1.16.
Market forces alone will not necessarily achieve fully the public policy objectives ofsafety and efficiency because FMIs and their participants do not necessarily bear all the risks
and costs associated with their payment, clearing, settlement, and recording activities.
Moreover, the institutional structure of an FMI may not provide strong incentives ormechanisms for safe and efficient design and operation, fair and open access, or theprotection of participant and customer assets. In addition, participants may not consider thefull impact of their actions on other participants, such as the potential costs of delaying
payments or settlements. Overall, an FMI and its participants may generate significant
negative externalities for the entire financial system and real economy if they do notadequately manage their risks. In addition, factors such as economies of scale, barriers toentry, or even legal mandates, may limit competition and confer market power on an FMI,
which could lead to lower levels of service, higher prices, or under-investment in riskmanagement systems. Caution is needed, however, as excessive competition between FMIs
may lead to a competitive lowering of risk standards.
Safety as a public policy objective
1.17.
To ensure their safety and promote financial stability more broadly, FMIs shouldrobustly manage their risks. An FMI should first identify and understand the types of risks
that arise in or are transmitted by the FMI and then determine the sources of these risks.
Once these risks are properly assessed, appropriate and effective mechanisms should be
developed to monitor and manage them. These risks, described in Section 2 of the report,
include (but are not limited to) legal, credit, liquidity, general business, custody, investment,
and operational risks. The principles for FMIs in this report provide guidance to FMIs andauthorities on the identification, monitoring, mitigation, and management of the full range ofthese risks.
Efficiency as a public policy objective
1.18.
An FMI should be not only safe, but also efficient. Efficiency refers generally to theuse of resources by FMIs and their participants in performing their functions. Efficient FMIs
contribute to well-functioning financial markets. An FMI that operates inefficiently may distortfinancial activity and the market structure, affecting not only its participants, but also its

16

These objectives are consistent with the public policy objectives of previous reports by the CPSS and theTechnical Committee of IOSCO. Other objectives, which include anti-money laundering, antiterrorist financing,data privacy, promotion of competition policy, and specific types of investor and consumer protections, canplay important roles in the design of such systems, but these issues are generally beyond the scope of thisand previous reports.

CPSS-IOSCO – Principles for financial market infrastructures – April 201211

participants’ customers. These distortions may lead to lower aggregate levels of efficiency
and safety, as well as increased risks within the broader financial system. In making choices
about design and operation, however, FMIs ultimately should not let other considerations
take precedence over the establishment of prudent risk-management practices.
Scope of the principles for FMIs
1.19.
The principles in this report provide guidance for addressing risks and efficiency in
FMIs. With a few exceptions, the principles do not prescribe a specific tool or arrangement toachieve their requirements and allow for different means to satisfy a particular principle.
Where appropriate, some principles establish a minimum requirement to help contain risks
and provide for a level playing field. The principles are designed to be applied holisticallybecause of the significant interaction between principles; principles should be applied as a
set and not on a stand-alone basis. Some principles build upon others and somecomplement each other. 17 In other instances, the principles reference an important, common
theme. 18 A few principles, such as those on governance and operational risk, include
references to best practices for FMIs, which may evolve and improve over time. FMIs andtheir authorities should consider such best practices, as appropriate. In addition, authorities
have the flexibility to consider imposing higher requirements for FMIs in their jurisdiction
either on the basis of specific risks posed by an FMI or as a general policy.
General applicability of the principles
1.20.
The principles in this report are broadly designed to apply to all systemicallyimportant payment systems, CSDs, SSSs, CCPs, and TRs. FMIs that are determined bynational authorities to be systemically important are expected to observe these principles.
Where they exist, statutory definitions of systemic importance may vary somewhat acrossjurisdictions, but in general a payment system is systemically important if it has the potential
to trigger or transmit systemic disruptions; this includes, among other things, systems thatare the sole payment system in a country or the principal system in terms of the aggregate
value of payments; systems that mainly handle time-critical, high-value payments; andsystems that settle payments used to effect settlement in other systemically important
FMIs. 19 The presumption is that all CSDs, SSSs, CCPs, and TRs are systemically important,at least in the jurisdiction where they are located, typically because of their critical roles in themarkets they serve. If an authority determines that a CSD, SSS, CCP or TR in its jurisdiction
is not systemically important and, therefore, not subject to the principles, the authority should
disclose the name of the FMI and a clear and comprehensive rationale for the determination.
Conversely, an authority may disclose the criteria used to identify which FMIs are considered
as systemically important and may disclose which FMIs it regards as systemically important
against these criteria. These principles are designed to apply to domestic, cross-border, andmulticurrency FMIs. All FMIs are encouraged to observe these principles.

17

For example, in managing financial risk, FMIs should refer to, among other things, the principles on theframework for the comprehensive management of risks, credit risk, collateral, margin, liquidity risk, money
settlements, and exchange-of-value settlement systems. Other relevant principles include legal basis,governance, participant-default rules and procedures, general business risk, custody and investment risks,and operational risk. Failure to apply all of these principles as a set may result in less-than-robust overall risk
management by an FMI.

18

For example, the roles of governance and transparency in managing risk and supporting sound public policy
are addressed in Principles 2 and 23, respectively. Because of the general importance and relevance ofgovernance and transparency, they are also referred to in several other principles.

19

These criteria for systemic importance mirror those outlined in the CPSIPS.

12

CPSS-IOSCO – Principles for financial market infrastructures – April 2012

Specific applicability of principles to different types of FMIs
1.21.
Most principles in this report are applicable to all types of FMIs covered by thereport. However, a few principles are only relevant to specific types of FMIs (see Table 1 forgeneral applicability of principles to specific types of FMIs and Annex E for applicability of
key considerations to specific types of FMIs). For example, because TRs do not face credit
or liquidity risks, the principles on credit and liquidity risks are not applicable to them, while
Principle 24 on disclosure of market data by TRs applies only to TRs. In addition, where aprinciple applies in a specific way to a particular type of FMI, the report tries to provide
appropriate direction. For example, Principle 4 on credit risk provides specific guidance topayment systems, SSSs, and CCPs.
1.22.
The applicability of the principles and key considerations to specific types of FMIs,
as shown in Table 1, is based on the functional definitions of each type of FMI, provided inparagraphs 1.10 to 1.14. In certain cases, however, the same legal entity may perform thefunctions of more than one type of FMI. For example, many CSDs also operate an SSS, andsome payment systems perform certain functions similar to a CCP. In other cases, thedefinition of a particular type of FMI in a particular jurisdiction may differ from the definition ofthat type of FMI in this report. In all cases, the set of principles applicable to an FMI are thosethat address the functions performed by the particular entity.
1.23.
In general, the principles are applicable to FMIs operated by central banks, as wellas those operated by the private sector. Central banks should apply the same standards totheir FMIs as those that are applicable to similar private-sector FMIs. However, there are
exceptional cases where the principles are applied differently to FMIs operated by central
banks due to requirements in relevant law, regulation, or policy. For example, central banks
may have separate public policy objectives and responsibilities for monetary and liquidity
policies that take precedence. Such exceptional cases are referenced in (a) Principle 2 ongovernance, (b) Principle 4 on credit risk, (c) Principle 5 on collateral, (d) Principle 15 on
general business risk, and (e) Principle 18 on access and participation requirements. In
some cases, FMIs operated by central banks may be required by the relevant legislative
framework or by a central bank’s public policy objectives to exceed the requirements of one
or more principles.

CPSS-IOSCO – Principles for financial market infrastructures – April 201213

Table 11
General applicability of principles to specific types of FMIs
Principle

PSs

CSDs

SSSs

CCPs

TRs

1. Legal basis

●

●

●

●

●

2. Governance

●

●

●

●

●

3. Framework for the comprehensive management of
risks

●

●

●

●

●

4. Credit risk

●

●

●

5. Collateral

●

●

●
●

6. Margin
7. Liquidity risk

●

●

●

8. Settlement finality

●

●

●

9. Money settlements

●

●

●

●

●

●

●

●

●

10. Physical deliveries●

11. Central securities depositories●

12. Exchange-of-value settlement systems●

13. Participant-default rules and procedures

●

●

●

14. Segregation and portability
15. General business risk

●

●

●

●

16. Custody and investment risks

●

●

●

●

17. Operational risk

●

●

●

●

●

18. Access and participation requirements

●

●

●

●

●

19. Tiered participation arrangements

●

●

●

●

●

●

●

●

●

20. FMI links●

21. Efficiency and effectiveness

●

●

●

●

●

22. Communication procedures and standards

●

●

●

●

●

23. Disclosure of rules, key procedures, and market data

●

●

●

●

●

24. Disclosure of market data by trade repositories●

1

This table depicts the applicability of the principles to each type of FMI as defined in paragraphs 1.10-1.14. If
an FMI performs the functions of more than one type of FMI, all of the principles that address the actual
functions performed by the particular FMI will apply in practice.

FMI recovery and resolution
1.24.
The focus of this report and its principles is on ensuring that FMIs operate assmoothly as possible in normal circumstances and in times of market stress. Nonetheless, it
is possible that in certain extreme circumstances, and all preventive measures
notwithstanding, an FMI may become non-viable as a going concern or insolvent. Given thesystemic importance of the FMIs to which the principles in this report are addressed, thedisorderly failure of an FMI would likely lead to systemic disruptions to the institutions andmarkets supported by the FMI, to any other FMIs to which the failing FMI is linked, and to thefinancial system more broadly. The negative implications would be particularly severe insituations in which no other FMI could promptly and effectively provide a substitute for thecritical operations and services of the failing FMI.

14

CPSS-IOSCO – Principles for financial market infrastructures – April 2012

1.25.
In the event that an FMI becomes non-viable as a going concern or insolvent, it isimportant that appropriate actions be taken that allow (a) the recovery of the FMI so that its
critical operations and services may be sustained, or (b) the winding down of the non-viable
FMI in an orderly manner, for instance by transferring the FMI’s critical operations andservices to an alternate entity. Depending on the specific situation and the powers and tools
available to authorities in relevant jurisdictions, these actions may be implemented by the
FMI itself, by the relevant authorities, or by a combination of both. The principles in thisreport identify a number of measures that FMIs should take to prepare for and facilitate theimplementation of their own recovery or orderly wind-down plans, if needed. Issues andanalysis related to the potential necessity, design, and implementation of additional official
resolution regimes for FMIs, including the resolution powers and tools that may be useful for
relevant authorities in such regimes, will be the focus of separate CPSS-IOSCO work, which
will build, as far as possible, on the previous work by the FSB on effective resolution regimes
for financial institutions. 20
Access to FMIs
1.26.
Access to an FMI is typically important because of the critical role many FMIs play inthe markets they serve. In general, an FMI should establish appropriate access policies thatprovide fair and open access, while ensuring its own safety and efficiency. Access to CCPs
in particular is even more important in light of the 2009 G20 commitment to centrally clear all
standardised OTC derivatives by the end of 2012. 21 In its November 2011 report, theCommittee on the Global Financial System (CGFS) considered potential implications ofalternative access arrangements, such as access through direct participation in global CCPs,
tiered participation arrangements, establishment of local CCPs, and links between CCPs. 22
The principles in this current report focus on the identification, monitoring, mitigation, andmanagement of risks posed to the FMI by such arrangements and provides guidance on
access and participation requirements (see Principle 18), the management of tiered
participation arrangements (see Principle 19), and FMI links (see Principle 20).
Tiered participation arrangements
1.27.
Tiered participation arrangements occur when some firms (indirect participants) relyon the services provided by other firms (direct participants) to use the FMI’s central payment,
clearing, settlement, or recording facilities. Tiered participation arrangements may allow
wider access to the services of an FMI. The dependencies and risk exposures (including
credit, liquidity, and operational risks) inherent in these tiered arrangements can, however,present risks to the FMI and its smooth functioning, as well as to the participants themselves
and the broader financial markets. These risks may be particularly acute for systems with ahigh degree of tiering. Principle 19 provides guidance on how an FMI should address risks toitself arising from tiered participation arrangements. Additional issues relating to indirect
participants are addressed in (a) Principle 1 on legal basis, (b) Principle 2 on governance,(c) Principle 3 on the framework for the comprehensive management of risks, (d) Principle 13
on participant-default rules and procedures, (e) Principle 14 on segregation and portability,(f) Principle 18 on access and participation requirements, and (g) Principle 23 on disclosureof rules, key procedures, and market data.

20

See FSB, Key attributes of effective resolution regimes for financial institutions, October 2011.

21

See The Declaration of the G20, 2009 Pittsburgh Summit, which is available at http://www.g20.org.

22

See CGFS, The macrofinancial implications of alternative configurations for access to central counterparties in
OTC derivatives markets, November 2011.

CPSS-IOSCO – Principles for financial market infrastructures – April 201215

Interdependencies and interoperability
1.28.
The different forms of interdependencies, including interoperability, are addressed inthis report in various principles, including Principle 20 which explicitly addresses FMI links
and their risk management. In addition, interdependencies are covered in (a) Principle 2 ongovernance, which states that FMIs should consider the interests of the broader markets;(b) Principle 3 on the framework for the comprehensive management of risks, which statesthat FMIs should consider the relevant risks that they bear from and pose to other entities;(c) Principle 17 on operational risk which states that an FMI should identify, monitor, andmanage the risks that other FMIs pose to its operations and the risks its operations pose toother FMIs; (d) Principle 18 on access and participation requirements, which states that FMIs
should provide fair and open access, including to other FMIs; (e) Principle 21 on efficiency
and effectiveness, which states that FMIs should be designed to meet the needs of their
participants; and (f) Principle 22 on communication procedures and standards, which statesthat FMIs should use, or at a minimum accommodate, relevant internationally accepted
communication procedures and standards. The combination of these principles should
achieve a strong and balanced approach to interoperability.
Scope of the responsibilities of central banks, market regulators, and other relevant
authorities for financial market infrastructures
1.29.
Section 4 of this report outlines five responsibilities for central banks, market
regulators, and other relevant authorities for FMIs and provides guidance for consistent andeffective regulation, supervision, and oversight of FMIs. Authorities for FMIs should accept
and be guided by the responsibilities in this report, consistent with relevant national law.
While each individual FMI is responsible for observing these principles, effective regulation,
supervision, and oversight are necessary to ensure observance and induce change.
Authorities should cooperate with each other both domestically and internationally tostrengthen official oversight and supervision and to minimise the potential duplication of effort
and reduce the burden on the FMI and the relevant authorities. These responsibilities are
consistent with international best practices. Other CPSS and IOSCO guidance to authorities
on the regulation, supervision, and oversight of FMIs also may be relevant.
Implementation, use, and assessments of observance of the principles andresponsibilities
1.30.
Relevant authorities should strive to incorporate the principles and the
responsibilities in this report in their legal and regulatory framework by the end of 2012. To
the fullest extent permissible under national statutory regimes, these authorities should seek
to incorporate the principles into their respective activities as soon as possible. FMIs that are
subject to the principles are expected to take appropriate and swift action in order to observe
the principles.
1.31.
FMIs should apply the principles on an ongoing basis in the operation of theirbusiness, including when reviewing their own performance, assessing or proposing newservices, or proposing changes to risk controls. FMIs should communicate the outcome of
their findings as part of their regular dialogue with relevant authorities. FMIs are also
expected to complete the CPSS-IOSCO Disclosure framework for financial market
infrastructures (see also Principle 23 on disclosure of rules, key procedures, and market
data).
1.32.
Central banks, market regulators, and other relevant authorities, consistent with theirrespective responsibilities for regulation, supervision, and oversight of an FMI, are expected
to perform their own assessments of the FMI. If an FMI does not fully observe the principles,
actions should be taken to promote full observance. The summary of the authorities’

16

CPSS-IOSCO – Principles for financial market infrastructures – April 2012assessments should be publicly disclosed, where and to the extent consistent with nationallaw and practice.
1.33.
International financial institutions, such as the International Monetary Fund and theWorld Bank, may also use these principles and responsibilities in promoting the stability of
the financial sector when carrying out assessment programmes for FMIs and relevant
authorities and in providing technical assistance to particular countries.
1.34.
The CPSS-IOSCO Assessment methodology for the principles for FMIs and the
responsibilities of authorities provides guidance for assessing and monitoring observance ofthe principles and responsibilities. This assessment methodology is primarily intended forexternal assessors at the international level, in particular the international financial
institutions. It also provides a baseline for national authorities to assess observance of theprinciples by the FMIs under their oversight or supervision or to self-assess the way they
discharge their own responsibilities as regulators, supervisors, and overseers. National
authorities may use this assessment methodology as written or consider it in thedevelopment of equally effective methodologies for their national oversight or supervision
processes.
1.35.
The CPSS-IOSCO Disclosure framework for financial market infrastructures and the
CPSS-IOSCO Assessment methodology for the principles for FMIs and the responsibilities ofauthorities are published separately.
Organisation of the report
1.36.
This report has four sections. Following this introduction (Section 1), the reportprovides an overview of the key risks in FMIs (Section 2). The principles for FMIs are thendiscussed in detail (Section 3) followed by the responsibilities of central banks, market
regulators, and other relevant authorities for FMIs (Section 4). For each standard, there is alist of key considerations that further explain the headline standard. An accompanying
explanatory note discusses the objective and rationale of the standard and provides
guidance on how the standard can be implemented. Where appropriate, annexes provide
additional information or guidance. In addition, compendium notes, which provide moredetailed notes and additional information on specific topics, are published separately; thesenotes, however, do not represent additional requirements.

CPSS-IOSCO – Principles for financial market infrastructures – April 2012

17

2.0.

Overview of key risks in financial market infrastructures

2.1.
FMIs are generally sophisticated multilateral systems that handle significant
transaction volumes and sizable monetary values. Through the centralisation of certain
activities, FMIs allow participants to manage their risks more effectively and efficiently, and,in some instances, reduce or eliminate certain risks. By performing centralised activities,
however, FMIs concentrate risks and create interdependencies between and among FMIs
and participating institutions. In addition to discussing systemic risk, this section of the reportprovides an overview of specific key risks faced by FMIs. These include legal, credit, liquidity,
general business, custody, investment, and operational risks. Whether an FMI, itsparticipants, or both face a particular form of risk, as well as the degree of risk, will dependon the type of FMI and its design.
Systemic risk
2.2.
Safe and efficient FMIs mitigate systemic risk. FMIs may themselves face systemic
risk, however, because the inability of one or more participants to perform as expected could
cause other participants to be unable to meet their obligations when due. In suchcircumstances, a variety of “knock-on” effects are possible, and an FMI’s inability to complete
settlement could have significant adverse effects on the markets it serves and the broader
economy. These adverse effects, for example, could arise from unwinding or reversing
payments or deliveries; delaying the settlement or close out of guaranteed transactions; orimmediately liquidating collateral, margin, or other assets at fire sale prices. If an FMI were to
take such steps, its participants could suddenly be faced with significant and unexpectedcredit and liquidity exposures that might be extremely difficult to manage at the time. This, inturn, might lead to further disruptions in the financial system and undermine publicconfidence in the safety, soundness, and reliability of the financial infrastructure.
2.3.
More broadly, FMIs may be linked to or dependent upon one another, may havecommon participants, and may serve interconnected institutions and markets. Complex
interdependencies may be a normal part of an FMI’s structure or operations. In many cases,
interdependencies have facilitated significant improvements in the safety and efficiency of
FMIs’ activities and processes. Interdependencies, however, can also present an importantsource of systemic risk. 23 For example, these interdependencies raise the potential for
disruptions to spread quickly and widely across markets. If an FMI depends on the smoothfunctioning of one or more FMIs for its payment, clearing, settlement, and recording
processes, a disruption in one FMI can disrupt other FMIs simultaneously. These
interdependencies, consequently, can transmit disruptions beyond a specific FMI and its
participants and affect the broader economy.
Legal risk
2.4.
For the purposes of this report, legal risk is the risk of the unexpected application ofa law or regulation, usually resulting in a loss. Legal risk can also arise if the application of
relevant laws and regulations is uncertain. For example, legal risk encompasses the risk thata counterparty faces from an unexpected application of a law that renders contracts illegal or
unenforceable. Legal risk also includes the risk of loss resulting from a delay in the recovery
of financial assets or a freezing of positions resulting from a legal procedure. In cross-borderas well as some national contexts, different bodies of law can apply to a single transaction,

23

18

See also CPSS, The interdependencies of payment and settlement systems, June 2008.

CPSS-IOSCO – Principles for financial market infrastructures – April 2012

activity, or participant. In such instances, an FMI and its participants may face losses
resulting from the unexpected application of a law, or the application of a law different fromthat specified in a contract, by a court in a relevant jurisdiction.
Credit risk
2.5.
FMIs and their participants may face various types of credit risk, which is the riskthat a counterparty, whether a participant or other entity, will be unable to meet fully its
financial obligations when due, or at any time in the future. FMIs and their participants may
face replacement-cost risk (often associated with pre-settlement risk) and principal risk (often
associated with settlement risk). Replacement-cost risk is the risk of loss of unrealised gains
on unsettled transactions with a counterparty (for example, the unsettled transactions of a
CCP). The resulting exposure is the cost of replacing the original transaction at current
market prices. Principal risk is the risk that a counterparty will lose the full value involved in atransaction, for example, the risk that a seller of a financial asset will irrevocably deliver theasset but not receive payment. Credit risk can also arise from other sources, such as thefailure of settlement banks, custodians, or linked FMIs to meet their financial obligations.
Liquidity risk
2.6.
FMIs and their participants may face liquidity risk, which is the risk that acounterparty, whether a participant or other entity, will have insufficient funds to meet its
financial obligations as and when expected, although it may be able to do so in the future.
Liquidity risk includes the risk that a seller of an asset will not receive payment when due,and the seller may have to borrow or liquidate assets to complete other payments. It also
includes the risk that a buyer of an asset will not receive delivery when due, and the buyer
may have to borrow the asset in order to complete its own delivery obligation. Thus, bothparties to a financial transaction are potentially exposed to liquidity risk on the settlement
date. Liquidity problems have the potential to create systemic problems, particularly if theyoccur when markets are closed or illiquid or when asset prices are changing rapidly, or if theycreate concerns about solvency. Liquidity risk can also arise from other sources, such as thefailure or the inability of settlement banks, nostro agents, custodian banks, liquidity providers,
and linked FMIs to perform as expected.
General business risk
2.7.
In addition, FMIs face general business risks, which are the risks related to theadministration and operation of an FMI as a business enterprise, excluding those related tothe default of a participant or another entity, such as a settlement bank, global custodian, or
another FMI. General business risk refers to any potential impairment of the financial
condition (as a business concern) of an FMI due to declines in its revenues or growth in its
expenses, resulting in expenses exceeding revenues and a loss that must be charged
against capital. Such impairment may be a result of adverse reputational effects, poor
execution of business strategy, ineffective response to competition, losses in other businesslines of the FMI or its parent, or other business factors. Business-related losses also mayarise from risks covered by other principles, for example, legal or operational risk. A failure to
manage general business risk could result in a disruption of an FMI’s business operations.
Custody and investment risks
2.8.
FMIs may also face custody and investment risks on the assets that they own andthose they hold on behalf of their participants. Custody risk is the risk of loss on assets heldin custody in the event of a custodian’s (or sub-custodian’s) insolvency, negligence, fraud,

CPSS-IOSCO – Principles for financial market infrastructures – April 201219

poor administration, or inadequate recordkeeping. Investment risk is the risk of loss faced by
an FMI when it invests its own or its participants’ resources, such as collateral. These risks
can be relevant not only to the costs of holding and investing resources but also to the safety
and reliability of an FMI’s risk-management systems. The failure of an FMI to properly
safeguard its assets could result in credit, liquidity, and reputational problems for the FMI
itself.
Operational risk
2.9.
All FMIs face operational risk, which is the risk that deficiencies in information
systems or internal processes, human errors, management failures, or disruptions fromexternal events will result in the reduction, deterioration, or breakdown of services provided
by an FMI. These operational failures may lead to consequent delays, losses, liquidity
problems, and in some cases systemic risks. Operational deficiencies also can reduce theeffectiveness of measures that FMIs may take to manage risk, for example, by impairing theirability to complete settlement, or by hampering their ability to monitor and manage their
credit exposures. In the case of TRs, operational deficiencies could limit the usefulness ofthe transaction data maintained by a TR. Possible operational failures include errors ordelays in processing, system outages, insufficient capacity, fraud, and data loss and leakage.
Operational risk can stem from both internal and external sources. For example, participants
can generate operational risk for FMIs and other participants, which could result in liquidity or
operational problems within the broader financial system.
Box 2
Risk considerations for trade repositories
TRs face risks that, if not controlled effectively, could have a material negative impact on themarkets they serve. The primary risk to a TR is operational risk, although other risks may hamper its
safe and efficient functioning. As part of its core recordkeeping function, a TR must ensure that thedata it maintains is accurate and current in order to serve as a reliable central data source. The
continuous availability of data stored in a TR is also essential. Specific operational risks that a TR
must manage include risks to data integrity, data security, and business continuity. Because thedata recorded by a TR may be used as inputs to the activities of the TR’s participants, relevant
authorities, and other parties, including other FMIs and service providers, all trade data collected,
stored, and disseminated by a TR should be protected from corruption, loss, leakage, unauthorised
access, and other processing risks. In addition, a TR may be part of a network linking various
entities (such as CCPs, dealers, custodians, and service providers) and could transmit risk or cause
processing delays to such linked entities in the event of an operational disruption.

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CPSS-IOSCO – Principles for financial market infrastructures – April 2012

3.0.

Principles for financial market infrastructures

General organisation
The foundation of an FMI’s risk-management framework includes its authority, structure,rights, and responsibilities. The following set of principles provides guidance on (a) the legal
basis for the FMI’s activities, (b) the governance structure of the FMI, and (c) the framework
for the comprehensive management of risks, to help establish a strong foundation for the risk
management of an FMI.
Principle 1: Legal basis
An FMI should have a well-founded, clear, transparent, and enforceable legal basis foreach material aspect of its activities in all relevant jurisdictions.
Key considerations
1.

The legal basis should provide a high degree of certainty for each material aspect ofan FMI’s activities in all relevant jurisdictions.

2.

An FMI should have rules, procedures, and contracts that are clear, understandable,
and consistent with relevant laws and regulations.

3.

An FMI should be able to articulate the legal basis for its activities to relevant
authorities, participants, and, where relevant, participants’ customers, in a clear andunderstandable way.

4.

An FMI should have rules, procedures, and contracts that are enforceable in all
relevant jurisdictions. There should be a high degree of certainty that actions takenby the FMI under such rules and procedures will not be voided, reversed, or subject
to stays.

5.

An FMI conducting business in multiple jurisdictions should identify and mitigate therisks arising from any potential conflict of laws across jurisdictions.

Explanatory note
3.1.1. A robust legal basis for an FMI’s activities in all relevant jurisdictions is critical to an
FMI’s overall soundness. The legal basis defines, or provides the foundation for relevant
parties to define, the rights and obligations of the FMI, its participants, and other relevant
parties, such as its participants’ customers, custodians, settlement banks, and service
providers. Most risk-management mechanisms are based on assumptions about the mannerand time at which these rights and obligations arise through the FMI. Therefore, if risk
management is to be sound and effective, the enforceability of rights and obligations relating
to an FMI and its risk management should be established with a high degree of certainty. If
the legal basis for an FMI’s activities and operations is inadequate, uncertain, or opaque,then the FMI, its participants, and their customers may face unintended, uncertain, or
unmanageable credit or liquidity risks, which may also create or amplify systemic risks.

CPSS-IOSCO – Principles for financial market infrastructures – April 201221

Legal basis
3.1.2. The legal basis should provide a high degree of certainty for each material aspect ofan FMI’s activities in all relevant jurisdictions. 24 The legal basis consists of the legal
framework and the FMI’s rules, procedures, and contracts. The legal framework includes
general laws and regulations that govern, among other things, property, contracts,
insolvency, corporations, securities, banking, secured interests, and liability. In some cases,
the legal framework that governs competition and consumer and investor protection may also
be relevant. Laws and regulations specific to an FMI’s activities include those governing its
authorization and its regulation, supervision, and oversight; rights and interests in financial
instruments; settlement finality; netting; immobilisation and dematerialisation of securities;
arrangements for DvP, PvP, or DvD; collateral arrangements (including margin
arrangements); default procedures; and the resolution of an FMI. An FMI should establish
rules, procedures, and contracts that are clear, understandable, and consistent with the legal
framework and provide a high degree of legal certainty. An FMI also should consider whether
the rights and obligations of the FMI, its participants, and as appropriate, other parties, as set
forth in its rules, procedures, and contracts are consistent with relevant industry standards
and market protocols.
3.1.3. An FMI should be able to articulate the legal basis for its activities to relevant
authorities, participants, and, where relevant, participants’ customers in a clear andunderstandable way. One recommended approach to articulating the legal basis for eachmaterial aspect of an FMI’s activities is to obtain well-reasoned and independent legal
opinions or analyses. A legal opinion or analysis should, to the extent practicable, confirm theenforceability of the FMI’s rules and procedures and must provide reasoned support for its
conclusions. An FMI should consider sharing these legal opinions and analyses with its
participants in an effort to promote confidence among participants and transparency in thesystem. In addition, an FMI should seek to ensure that its activities are consistent with thelegal basis in all relevant jurisdictions. These jurisdictions could include (a) those where an
FMI is conducting business (including through linked FMIs); (b) those where its participants
are incorporated, located, or otherwise conducting business for the purposes of participation;(c) those where collateral is located or held; and (d) those indicated in relevant contracts.
3.1.4. A TR’s rules, procedures, and contracts should be clear about the legal status of thetransaction records that it stores. Most TRs store transaction data that do not represent
legally enforceable trade records. For some TRs, however, participants may agree that the
TR’s electronic transaction record provides the official economic details of a legally binding
contract, which enables trade details to be used for the calculation of payment obligations
and other events that may occur during the life of the transaction. A TR should identify andmitigate any legal risks associated with any such ancillary services that it may provide.
Further, the legal basis should also determine the rules and procedures for providing accessand disclosing data to participants, relevant authorities, and the public to meet theirrespective information needs, as well as data protection and confidentiality issues (see also
Principle 24 on disclosure of market data by TRs).

24

The materiality of an aspect of an FMI´s activity has to be determined in light of this report’s objectives– enhancing safety and efficiency – and underlying principles. Therefore, an aspect of an FMI’s activities is or
becomes material if it can be a source of a material risk, especially, but not limited to, credit, liquidity, generalbusiness, custody, investment, or operational risks. In addition, parts of the activity that have a significant
effect on the FMI’s efficiency may also qualify as material aspects of the activity covered by the principle on
legal basis.

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CPSS-IOSCO – Principles for financial market infrastructures – April 2012

Rights and interests
3.1.5. The legal basis should clearly define the rights and interests of an FMI, itsparticipants, and, where relevant, its participants’ customers in the financial instruments,
such as cash and securities, or other relevant assets held in custody, directly or indirectly, by
the FMI. The legal basis should fully protect both a participant’s assets held in custody by the
FMI and, where appropriate, a participant’s customer’s assets held by or through the FMI
from the insolvency of relevant parties and other relevant risks. It should also protect theseassets when held at a custodian or linked FMI. In particular, consistent with Principle 11 on
CSDs and Principle 14 on segregation and portability, the legal basis should protect theassets and positions of a participant’s customers in a CSD and CCP. In addition, the legal
basis should provide certainty, where applicable, with respect to an FMI’s interests in, andrights to use and dispose of, collateral; an FMI’s authority to transfer ownership rights orproperty interests; and an FMI’s rights to make and receive payments, in all cases,
notwithstanding the bankruptcy or insolvency of its participants, participants’ customers, or
custodian bank. 25 Also, the FMI should structure its operations so that its claims against
collateral provided to it by a participant should have priority over all other claims, and theclaims of the participant to that same collateral should have priority over the claims of thirdparty creditors. For TRs, the legal basis also should specifically define the rights andinterests of participants and other relevant stakeholders with respect to the data stored in the
TR’s systems.
Settlement finality
3.1.6. There should be a clear legal basis regarding when settlement finality occurs in an
FMI in order to define when key financial risks are transferred in the system, including thepoint at which transactions are irrevocable. Settlement finality is an important building blockfor risk-management systems (see also Principle 8). An FMI should consider, in particular,
the actions that would need to be taken in the event of a participant’s insolvency. A key
question is whether transactions of an insolvent participant would be honoured as final, or
could be considered void or voidable by liquidators and relevant authorities. In somecountries, for example, so-called “zero-hour rules” in insolvency law can have the effect ofreversing a payment that appears to have been settled in a payment system. 26 Because thispossibility can lead to credit and liquidity risks, zero-hour rules that undermine settlement
finality should be eliminated. An FMI also should consider the legal basis for the external
settlement mechanisms it uses, such as funds transfer or securities transfer systems. The
laws of the relevant jurisdictions should support the provisions of the FMI’s legal agreementswith its participants and settlement banks relating to finality.

25

Collateral arrangements may involve either a pledge or a title transfer, including transfer of full ownership. If an
FMI accepts a pledge, it should have a high degree of certainty that the pledge has been validly created in therelevant jurisdiction and validly perfected, if necessary. If an FMI relies on a title transfer, including transfer offull ownership, it should have a high degree of certainty that the transfer is validly created in the relevant
jurisdiction and will be enforced as agreed and not recharacterised, for example, as an invalid or unperfected
pledge or some other unintended category of transaction. An FMI should also have a high degree of certainty
that the transfer itself is not voidable as an unlawful preference under insolvency law. See also Principle 5 oncollateral, Principle 6 on margin, and Principle 13 on participant-default rules and procedures.

26

In the context of payment systems, “zero-hour rules” make all transactions by a bankrupt participant void fromthe start (“zero hour”) of the day of the bankruptcy (or similar event). In an RTGS system, for example, theeffect could be to reverse payments that have apparently already been settled and were thought to be final. In
a DNS system, such a rule could cause the netting of all transactions to be unwound. This could entail arecalculation of all net positions and could cause significant changes to participants’ balances.

CPSS-IOSCO – Principles for financial market infrastructures – April 201223

Netting arrangements
3.1.7. If an FMI has a netting arrangement, the enforceability of the netting arrangement
should have a sound and transparent legal basis. 27 In general, netting offsets obligations
between or among participants in the netting arrangement, thereby reducing the number andvalue of payments or deliveries needed to settle a set of transactions. Netting can reduce
potential losses in the event of a participant default and may reduce the probability of a
default. 28 Netting arrangements should be designed to be explicitly recognised and supported
under the law and enforceable against an FMI and an FMI’s failed participants in bankruptcy.
Without such legal underpinnings, net obligations may be challenged in judicial oradministrative insolvency proceedings. If these challenges are successful, the FMI and its
participants could be liable for gross settlement amounts that could drastically increase
obligations because gross obligations could be many multiples of net obligations.
3.1.8. Novation, open offer, and other similar legal devices that enable an FMI to act as a
CCP should be founded on a sound legal basis. 29 In novation (and substitution), the originalcontract between the buyer and seller is discharged and two new contracts are created, one
between the CCP and the buyer and the other between the CCP and the seller. The CCP
thereby assumes the original parties’ contractual obligations to each other. In an open-offer
system, the CCP extends an open offer to act as a counterparty to market participants andthereby is interposed between participants at the time a trade is executed. If all pre-agreed
conditions are met, there is never a contractual relationship between the buyer and seller.
Where supported by the legal framework, novation, open offer, and other similar legal
devices give market participants legal certainty that a CCP is supporting the transaction.
Enforceability
3.1.9. The rules, procedures, and contracts related to an FMI’s operation should be
enforceable in all relevant jurisdictions. In particular, the legal basis should support theenforceability of the participant-default rules and procedures that an FMI uses to handle adefaulting or insolvent participant, especially any transfers and close-outs of a direct orindirect participant’s assets or positions (see also Principle 13 on participant-default rules
and procedures). An FMI should have a high degree of certainty that such actions taken
under such rules and procedures will not be voided, reversed, or subject to stays, including
with respect to the resolution regimes applicable to its participants. 30 Ambiguity about theenforceability of procedures could delay and possibly prevent an FMI from taking actions tofulfil its obligations to non-defaulting participants or to minimise its potential losses.
Insolvency law should support isolating risk and retaining and using collateral and cash
payments previously paid into an FMI, notwithstanding a participant default or thecommencement of an insolvency proceeding against a participant.
3.1.10. An FMI should establish rules, procedures, and contracts related to its operations
that are enforceable when the FMI is implementing its plans for recovery or orderly wind-

27

There are several types of netting arrangements used in the market that may be relevant to an FMI. Some
types of arrangements net payments or other contractual obligations resulting from market trades (or both) on
an ongoing basis, while others close-out payments or obligations when an event such as insolvency occurs.
There are a number of legal structures for these types of netting arrangements.

28

An FMI may bilaterally net its obligations with each participant, facilitate the bilateral netting of obligations
between participants, or provide for the multilateral netting of obligations.

29

In some countries, for example, assumption of obligation may be used instead of arrangements to replace theoriginal contract between the buyer and seller with the two new contracts.

30

However, rights triggered only because of entry into resolution or the exercise of resolution powers may besubject to stays. See for example FSB, Key attributes of effective resolution regimes for financial institutions,
KA 4.2, 4.3, and Annex IV, paragraph 1.3.

24

CPSS-IOSCO – Principles for financial market infrastructures – April 2012

down. Where relevant, they should adequately address issues and associated risks resulting
from (a) cross-border participation and interoperability of FMIs and (b) foreign participants inthe case of an FMI which is being wound down. There should be a high degree of certainty
that actions taken by the FMI under such rules and procedures will not be voided, reversed,
or subject to stays. Ambiguity about the enforceability of procedures that facilitate theimplementation of the FMI’s plans for recovery or orderly wind-down, or the resolution of the
FMI, could delay and possibly prevent the FMI or the relevant authorities from taking
appropriate actions and hence increase the risk of a disruption to its critical services or adisorderly wind-down of the FMI. In the case that an FMI is being wound down or resolved,
the legal basis should support decisions or actions concerning termination, close-out netting,the transfer of cash and securities positions of an FMI, or the transfer of all or parts of therights and obligations provided in a link arrangement to a new entity.
Conflict-of-laws issues
3.1.11 Legal risk due to conflict of laws may arise if an FMI is, or reasonably may become,subject to the laws of various other jurisdictions (for example, when it accepts participants
established in those jurisdictions, when assets are held in multiple jurisdictions, or whenbusiness is conducted in multiple jurisdictions). In such cases, an FMI should identify andanalyse potential conflict-of-laws issues and develop rules and procedures to mitigate thisrisk. For example, the rules governing its activities should clearly indicate the law that is
intended to apply to each aspect of an FMI’s operations. The FMI and its participants should
be aware of applicable constraints on their abilities to choose the law that will govern the
FMI’s activities when there is a difference in the substantive laws of the relevant jurisdictions.
For example, such constraints may exist because of jurisdictions’ differing laws on insolvency
and irrevocability. A jurisdiction ordinarily does not permit contractual choices of law thatwould circumvent that jurisdiction’s fundamental public policy. Thus, when uncertainty exists
regarding the enforceability of an FMI’s choice of law in relevant jurisdictions, the FMI should
obtain reasoned and independent legal opinions and analysis in order to address properly
such uncertainty.
Mitigating legal risk
3.1.12. In general, there is no substitute for a sound legal basis and full legal certainty. In
some practical situations, however, full legal certainty may not be achievable. In this case,the authorities may need to take steps to address the legal framework. Pending thisresolution, an FMI should investigate steps to mitigate its legal risk through the selective useof alternative risk-management tools that do not suffer from the legal uncertainty identified.
These could include, in appropriate circumstances and if legally enforceable, participant
requirements, exposure limits, collateral requirements, and prefunded default arrangements.
The use of such tools may limit an FMI’s exposure if its activities are found to be notsupported by relevant laws and regulations. If such controls are insufficient or not feasible,
an FMI could apply activity limits and, in extreme circumstances, restrict access or not
perform the problematic activity until the legal situation is addressed.

CPSS-IOSCO – Principles for financial market infrastructures – April 201225

Principle 2: Governance
An FMI should have governance arrangements that are clear and transparent, promote
the safety and efficiency of the FMI, and support the stability of the broader financial
system, other relevant public interest considerations, and the objectives of relevant
stakeholders.
Key considerations
1.

An FMI should have objectives that place a high priority on the safety and efficiencyof the FMI and explicitly support financial stability and other relevant public interest
considerations.

2.

An FMI should have documented governance arrangements that provide clear anddirect lines of responsibility and accountability. These arrangements should be
disclosed to owners, relevant authorities, participants, and, at a more general level,
the public.

3.

The roles and responsibilities of an FMI’s board of directors (or equivalent) should
be clearly specified, and there should be documented procedures for its functioning,
including procedures to identify, address, and manage member conflicts of interest.
The board should review both its overall performance and the performance of its
individual board members regularly.

4.

The board should contain suitable members with the appropriate skills andincentives to fulfil its multiple roles. This typically requires the inclusion of nonexecutive board member(s).

5.

The roles and responsibilities of management should be clearly specified. An FMI’s
management should have the appropriate experience, a mix of skills, and theintegrity necessary to discharge their responsibilities for the operation and risk
management of the FMI.

6.

The board should establish a clear, documented risk-management framework that
includes the FMI’s risk-tolerance policy, assigns responsibilities and accountability
for risk decisions, and addresses decision making in crises and emergencies.
Governance arrangements should ensure that the risk-management and internal
control functions have sufficient authority, independence, resources, and access tothe board.

7.

The board should ensure that the FMI’s design, rules, overall strategy, and majordecisions reflect appropriately the legitimate interests of its direct and indirect
participants and other relevant stakeholders. Major decisions should be clearly
disclosed to relevant stakeholders and, where there is a broad market impact, thepublic.

Explanatory note
3.2.1. Governance is the set of relationships between an FMI’s owners, board of directors(or equivalent), management, and other relevant parties, including participants, authorities,
and other stakeholders (such as participants’ customers, other interdependent FMIs, and thebroader market). Governance provides the processes through which an organisation sets its
objectives, determines the means for achieving those objectives, and monitors performanceagainst those objectives. Good governance provides the proper incentives for an FMI’s board
and management to pursue objectives that are in the interest of its stakeholders and that
support relevant public interest considerations.

26

CPSS-IOSCO – Principles for financial market infrastructures – April 2012

FMI objectives
3.2.2. Given the importance of FMIs and the fact that their decisions can have widespread
impact, affecting multiple financial institutions, markets, and jurisdictions, it is essential foreach FMI to place a high priority on the safety and efficiency of its operations and explicitly
support financial stability and other relevant public interests. Supporting the public interest isa broad concept that includes, for example, fostering fair and efficient markets. For example,
in certain OTC derivatives markets, industry standards and market protocols have beendeveloped to increase certainty, transparency, and stability in the market. If a CCP in suchmarkets were to diverge from these practices, it could, in some cases, undermine themarket’s efforts to develop common processes to help reduce uncertainty. An FMI’s
governance arrangements should also include appropriate consideration of the interests ofparticipants, participants’ customers, relevant authorities, and other stakeholders. A TR, forexample, should have objectives, policies, and procedures that support the effective andappropriate disclosure of market data to relevant authorities and the public (see Principle 24).
For all types of FMIs, governance arrangements should provide for fair and open access(see Principle 18 on access and participation requirements) and for effective implementationof recovery or wind-down plans, or resolution.
Governance arrangements
3.2.3. Governance arrangements, which define the structure under which the board andmanagement operate, should be clearly and thoroughly documented. These arrangements
should include certain key components such as the (a) role and composition of the board andany board committees, (b) senior management structure, (c) reporting lines between
management and the board, (d) ownership structure, (e) internal governance policy,(f) design of risk management and internal controls, (g) procedures for the appointment ofboard members and senior management, and (h) processes for ensuring performanceaccountability. Governance arrangements should provide clear and direct lines of
responsibility and accountability, particularly between management and the board, andensure sufficient independence for key functions such as risk management, internal control,
and audit. These arrangements should be disclosed to owners, the authorities, participants,
and, at a more general level, the public.
3.2.4. No single set of governance arrangements is appropriate for all FMIs and all market
jurisdictions. Arrangements may differ significantly because of national law, ownership
structure, or organisational form. For example, national law may require an FMI to maintain a
two-tier board system in which the supervisory board (all non-executive directors) is
separated from the management board (all executive directors). Further, an FMI may be
owned by its participants or by another organisation, may be operated as a for-profit or notfor-profit enterprise, or may be organised as a bank or non-bank entity. While specificarrangements vary, this principle is intended to be generally applicable to all ownership andorganisational structures.
3.2.5. Depending on its ownership structure and organisational form, an FMI may need tofocus particular attention on certain aspects of its governance arrangements. An FMI that ispart of a larger organisation, for example, should place particular emphasis on the clarity ofits governance arrangements, including in relation to any conflicts of interests andoutsourcing issues that may arise because of the parent or other affiliated organisation’s
structure. The FMI’s governance arrangements should also be adequate to ensure thatdecisions of affiliated organisations are not detrimental to the FMI. 31 An FMI that is, or is part31

If an FMI is wholly owned or controlled by another entity, authorities should also review the governancearrangements of that entity to see that they do not have adverse effects on the FMI’s observance of thisprinciple.

CPSS-IOSCO – Principles for financial market infrastructures – April 201227

of, a for-profit entity may need to place particular emphasis on managing any conflicts
between income generation and safety. For example, a TR should ensure that it effectively
identifies and manages conflicts of interests that may arise between its public role as acentralised data repository and its own commercial interests, particularly if it offers services
other than recordkeeping. Where relevant, cross-border issues should be appropriately
identified, assessed, and dealt with in the governance arrangements, both at the FMI level
and at the level(s) of its parent entity(ies).
3.2.6. An FMI may also need to focus particular attention on certain aspects of its riskmanagement arrangements as a result of its ownership structure or organisational form. If an
FMI provides services that present a distinct risk profile from, and potentially pose significant
additional risks to, its payment, clearing, settlement, or recording function, the FMI needs tomanage those additional risks adequately. This may include separating the additional
services that the FMI provides from its payment, clearing, settlement, and recording function
legally, or taking equivalent action. The ownership structure and organisational form may
also need to be considered in the preparation and implementation of the FMI’s recovery or
wind-down plans or in assessments of the FMI’s resolvability.
3.2.7. Central bank-operated systems may need to tailor the application of this principle inlight of the central bank’s own governance requirements and specific policy mandates. If acentral bank is an operator of an FMI, as well as the overseer of private-sector FMIs, it needs
to consider how to best address any possible or perceived conflicts of interest that may arise
between those functions. Except when explicitly required by law, regulation, or policy
mandates, a central bank should avoid using its oversight authority to disadvantage privatesector FMIs relative to an FMI the central bank owns or operates. This can be facilitated byseparating the operator and oversight functions into different organisational units within thecentral bank that are managed by different personnel. Where there is competition withprivate-sector systems, a central bank should also be careful to protect confidential
information about external systems collected in its role as overseer and avoid its misuse.
Roles, responsibilities, and composition of the board of directors
3.2.8. An FMI’s board has multiple roles and responsibilities that should be clearlyspecified. These roles and responsibilities should include (a) establishing clear strategic aims
for the entity; (b) ensuring effective monitoring of senior management (including selecting its
senior managers, setting their objectives, evaluating their performance, and, whereappropriate, removing them); (c) establishing appropriate compensation policies (whichshould be consistent with best practices and based on long-term achievements, in particular,
the safety and efficiency of the FMI); (d) establishing and overseeing the risk-management
function and material risk decisions; (e) overseeing internal control functions (including
ensuring independence and adequate resources); (f) ensuring compliance with allsupervisory and oversight requirements; (g) ensuring consideration of financial stability andother relevant public interests; and (h) providing accountability to the owners, participants,
and other relevant stakeholders. 32
3.2.9. Policies and procedures related to the functioning of the board should be clear anddocumented. These policies include the responsibilities and functioning of board committees.
A board would normally be expected to have, among others, a risk committee, an audit
committee, and a compensation committee, or equivalents. All such committees should haveclearly assigned responsibilities and procedures. 33 Board policies and procedures should

32

See Financial Stability Forum, FSF principles for sound compensation practices, April 2009, for additional
guidance in establishing appropriate compensation policies.

33

Such committees would normally be composed mainly of, and, if possible, led by, non-executive or
independent directors (see also paragraph 3.2.10).

28

CPSS-IOSCO – Principles for financial market infrastructures – April 2012include processes to identify, address, and manage potential conflicts of interest of board
members. Conflicts of interest include, for example, circumstances in which a board member
has material competing business interests with the FMI. Further, policies and proceduresshould also include regular reviews of the board’s performance and the performance of eachindividual member, as well as, potentially, periodic independent assessments ofperformance.
3.2.10. Governance policies related to board composition, appointment, and term should
also be clear and documented. The board should be composed of suitable members with anappropriate mix of skills (including strategic and relevant technical skills), experience, andknowledge of the entity (including an understanding of the FMI’s interconnectedness withother parts of the financial system). Members should also have a clear understanding of theirroles in corporate governance, be able to devote sufficient time to their roles, ensure that
their skills remain up-to-date, and have appropriate incentives to fulfil their roles. Members
should be able to exercise objective and independent judgment. Independence from theviews of management typically requires the inclusion of non-executive board members,
including independent board members, as appropriate. 34 Definitions of an independent board
member vary and often are determined by local laws and regulations, but the key
characteristic of independence is the ability to exercise objective, independent judgment after
fair consideration of all relevant information and views and without undue influence fromexecutives or from inappropriate external parties or interests. 35 The precise definition of
independence used by an FMI should be specified and publicly disclosed, and should
exclude parties with significant business relationships with the FMI, cross-directorships, orcontrolling shareholdings, as well as employees of the organisation. Further, an FMI should
publicly disclose which board members it regards as independent. An FMI may also need toconsider setting a limit on the duration of board members’ terms.
Roles and responsibilities of management
3.2.11. An FMI should have clear and direct reporting lines between its management andboard in order to promote accountability, and the roles and responsibilities of management
should be clearly specified. An FMI’s management should have the appropriate experience,a mix of skills, and the integrity necessary to discharge their responsibilities for the operation
and risk management of the FMI. Under board direction, management should ensure that the
FMI’s activities are consistent with the objectives, strategy, and risk tolerance of the FMI, as
determined by the board. Management should ensure that internal controls and related
procedures are appropriately designed and executed in order to promote the FMI’s
objectives, and that these procedures include a sufficient level of management oversight.
Internal controls and related procedures should be subject to regular review and testing by
well-trained and staffed risk-management and internal-audit functions. Additionally, senior
management should be actively involved in the risk-control process and should ensure thatsignificant resources are devoted to its risk-management framework.
Risk-management governance3.2.12. Because the board is ultimately responsible for managing an FMI’s risks, it should
establish a clear, documented risk-management framework that includes the FMI’s risk-

34

Having non-executive members included on a board, for example, may (depending on local corporate law)help in balancing considerations of safety and efficiency with competitiveness and, where applicable,
profitability.

35

An FMI organised in a jurisdiction with national laws on board structure or composition that do not facilitate theuse of independent members should use alternative means to enhance its board’s ability to exercise
independent judgment, such as advisory or supervisory boards with appropriate members.

CPSS-IOSCO – Principles for financial market infrastructures – April 201229

tolerance policy, assigns responsibilities and accountability for risk decisions, and addresses
decision making in crises and emergencies. The board should regularly monitor the FMI’s
risk profile to ensure that it is consistent with the FMI’s business strategy and risk-tolerance
policy. In addition, the board should ensure that the FMI has an effective system of controls
and oversight, including adequate governance and project management processes, over themodels used to quantify, aggregate, and manage the FMI’s risks. Board approval should be
required for material decisions that would have a significant impact on the risk profile of theentity, such as the limits for total credit exposure and large individual credit exposures. Other
material decisions that may require board approval include the introduction of new products,
implementation of new links, use of new crisis-management frameworks, adoption ofprocesses and templates for reporting significant risk exposures, and adoption of processes
for considering adherence to relevant market protocols. In the OTC derivatives markets,
CCPs are expected to adhere to practices or arrangements that have become establishedmarket conventions or to act in a manner that does not conflict with such terms, unless the
CCP has reasonable grounds not to do so and that does not conflict with the market’s wider
interest. In this regard, where a CCP supports a market and is expected to fully adhere tomarketwide protocols and related decisions, the CCP should be involved in the development
and establishment of such standards. It is critical that market governance processes fullyreflect the role of the CCP in the market. The arrangements adopted by a CCP should betransparent to its participants and regulators.
3.2.13. The board and governance arrangements, generally, should support the use of clear
and comprehensive rules and key procedures, including detailed and effective participantdefault rules and procedures (see Principle 13). The board should have procedures in place
to support its capacity to act appropriately and immediately if any risks arise that threaten the
FMI’s viability as a going concern. The governance arrangements should also provide for
effective decision making in a crisis and support any procedures and rules designed tofacilitate the recovery or orderly wind-down of the FMI.
3.2.14. In addition, the governance of the risk-management function is particularly
important. It is essential that an FMI’s risk-management personnel have sufficient
independence, authority, resources, and access to the board to ensure that the operations of
the FMI are consistent with the risk-management framework set by the board. The reportinglines for risk management should be clear and separate from those for other operations of
the FMI, and there should be an additional direct reporting line to a non-executive director on
the board via a chief risk officer (or equivalent). To help the board discharge its risk-related
responsibilities, an FMI should consider the case for a risk committee, responsible foradvising the board on the FMI’s overall current and future risk tolerance and strategy. A
CCP, however, should have such a risk committee or its equivalent. An FMI’s risk committee
should be chaired by a sufficiently knowledgeable individual who is independent of the FMI’s
executive management and be composed of a majority of members who are non-executive
members. The committee should have a clear and public mandate and operating procedures
and, where appropriate, have access to external expert advice.
3.2.15. Where an FMI, in accordance with applicable law, maintains a two-tier board
system, the roles and responsibilities of the board and senior management will be allocatedto the supervisory board and the management board, as appropriate. The reporting lines of
the risk and other committees need to reflect this allocation, as well as the legal
responsibilities of the management and supervisory boards. Therefore a direct reporting line
for the risk-management function may involve members of the management board. In
addition, the establishment of a risk committee has to take into account the legally founded
responsibility of the management board for managing the risks of the FMI.
Model validation
3.2.16. The board should ensure that there is adequate governance surrounding the
adoption and use of models, such as for credit, collateral, margining, and liquidity

30

CPSS-IOSCO – Principles for financial market infrastructures – April 2012

risk-management systems. An FMI should validate, on an ongoing basis, the models andtheir methodologies used to quantify, aggregate, and manage the FMI’s risks. The validation
process should be independent of the development, implementation, and operation of themodels and their methodologies, and the validation process should be subjected to anindependent review of its adequacy and effectiveness. Validation should include (a) an
evaluation of the conceptual soundness of (including developmental evidence supporting)the models, (b) an ongoing monitoring process that includes verification of processes andbenchmarking, and (c) an analysis of outcomes that includes backtesting.
Internal controls and audit
3.2.17. The board is responsible for establishing and overseeing internal controls and audit.
An FMI should have sound internal control policies and procedures to help manage its risks.
For example, as part of a variety of risk controls, the board should ensure that there are
adequate internal controls to protect against the misuse of confidential information. An FMI
should also have an effective internal audit function, with sufficient resources andindependence from management to provide, among other activities, a rigorous andindependent assessment of the effectiveness of an FMI’s risk-management and control
processes (see also Principle 3 on the framework for the comprehensive management ofrisks). The board will typically establish an audit committee to oversee the internal audit
function. In addition to reporting to senior management, the audit function should haveregular access to the board through an additional reporting line.
Stakeholder input
3.2.18. An FMI’s board should consider all relevant stakeholders’ interests, including thoseof its direct and indirect participants, in making major decisions, including those relating to
the system’s design, rules, and overall business strategy. An FMI with cross-border
operations, in particular, should ensure that the full range of views across the jurisdictions inwhich it operates is appropriately considered in the decision-making process. Mechanisms
for involving stakeholders in the board’s decision-making process may include stakeholder
representation on the board (including direct and indirect participants), user committees, andpublic consultation processes. As opinions among interested parties are likely to differ, theFMI should have clear processes for identifying and appropriately managing the diversity of
stakeholder views and any conflicts of interest between stakeholders and the FMI. Without
prejudice to local requirements on confidentiality and disclosure, the FMI should clearly andpromptly inform its owners, participants, other users, and, where appropriate, the broader
public, of the outcome of major decisions, and consider providing summary explanations for
decisions to enhance transparency where it would not endanger candid board debate orcommercial confidentiality.

CPSS-IOSCO – Principles for financial market infrastructures – April 201231

Principle 3: Framework for the comprehensive management of risks
An FMI should have a sound risk-management framework for comprehensively
managing legal, credit, liquidity, operational, and other risks.
Key considerations
1.

An FMI should have risk-management policies, procedures, and systems thatenable it to identify, measure, monitor, and manage the range of risks that arise in orare borne by the FMI. Risk-management frameworks should be subject to periodic
review.

2.

An FMI should provide incentives to participants and, where relevant, theircustomers to manage and contain the risks they pose to the FMI.

3.

An FMI should regularly review the material risks it bears from and poses to otherentities (such as other FMIs, settlement banks, liquidity providers, and service
providers) as a result of interdependencies and develop appropriate riskmanagement tools to address these risks.

4.

An FMI should identify scenarios that may potentially prevent it from being able toprovide its critical operations and services as a going concern and assess theeffectiveness of a full range of options for recovery or orderly wind-down. An FMI
should prepare appropriate plans for its recovery or orderly wind-down based on the
results of that assessment. Where applicable, an FMI should also provide relevant
authorities with the information needed for purposes of resolution planning.

Explanatory note
3.3.1. An FMI should take an integrated and comprehensive view of its risks, including therisks it bears from and poses to its participants and their customers, as well as the risks itbears from and poses to other entities, such as other FMIs, settlement banks, liquidity
providers, and service providers (for example, matching and portfolio compression service
providers). An FMI should consider how various risks relate to, and interact with, each other.
The FMI should have a sound risk-management framework (including policies, procedures,and systems) that enable it to identify, measure, monitor, and manage effectively the rangeof risks that arise in or are borne by the FMI. An FMI’s framework should include theidentification and management of interdependencies. An FMI should also provide appropriate
incentives and the relevant information for its participants and other entities to manage andcontain their risks vis-à-vis the FMI. As discussed in Principle 2 on governance, the board of
directors plays a critical role in establishing and maintaining a sound risk-management
framework.
Identification of risks
3.3.2. To establish a sound risk-management framework, an FMI should first identify therange of risks that arise within the FMI and the risks it directly bears from or poses to its
participants, its participants’ customers, and other entities. It should identify those risks that
could materially affect its ability to perform or to provide services as expected. Typicallythese include legal, credit, liquidity, and operational risks. An FMI should also consider otherrelevant and material risks, such as market (or price), concentration, and general businessrisks, as well as risks that do not appear to be significant in isolation, but when combinedwith other risks become material. The consequences of these risks may have significant
reputational effects on the FMI and may undermine an FMI’s financial soundness as well as
the stability of the broader financial markets. In identifying risks, an FMI should take a broad
perspective and identify the risks that it bears from other entities, such as other FMIs,
settlement banks, liquidity providers, service providers, and any entities that could bematerially affected by the FMI’s inability to provide services. For example, the relationship

32

CPSS-IOSCO – Principles for financial market infrastructures – April 2012

between an SSS and an LVPS to achieve DvP settlement can create system-based
interdependencies.
Comprehensive risk policies, procedures, and controls
3.3.3. An FMI’s board and senior management are ultimately responsible for managing the
FMI’s risks (see Principle 2 on governance). The board should determine an appropriate
level of aggregate risk tolerance and capacity for the FMI. The board and senior
management should establish policies, procedures, and controls that are consistent with the
FMI’s risk tolerance and capacity. The FMI’s policies, procedures, and controls serve as thebasis for identifying, measuring, monitoring, and managing the FMI’s risks and should coverroutine and non-routine events, including the potential inability of a participant, or the FMI
itself, to meet its obligations. An FMI’s policies, procedures, and controls should address all
relevant risks, including legal, credit, liquidity, general business, and operational risks. These
policies, procedures, and controls should be part of a coherent and consistent frameworkthat is reviewed and updated periodically and shared with the relevant authorities.
Information and control systems
3.3.4. In addition, an FMI should employ robust information and risk-control systems toprovide the FMI with the capacity to obtain timely information necessary to apply riskmanagement policies and procedures. In particular, these systems should allow for theaccurate and timely measurement and aggregation of risk exposures across the FMI, themanagement of individual risk exposures and the interdependencies between them, and theassessment of the impact of various economic and financial shocks that could affect the FMI.
Information systems should also enable the FMI to monitor its credit and liquidity exposures,
overall credit and liquidity limits, and the relationship between these exposures and limits. 36
3.3.5. Where appropriate, an FMI should also provide its participants and its participants’customers with the relevant information to manage and contain their credit and liquidity risks.
An FMI may consider it beneficial to provide its participants and its participants’ customers
with information necessary to monitor their credit and liquidity exposures, overall credit andliquidity limits, and the relationship between these exposures and limits. For example, where
the FMI permits participants’ customers to create exposures in the FMI that are borne by theparticipants, the FMI should provide participants with the capacity to limit such risks.
Incentives to manage risks
3.3.6. In establishing risk-management policies, procedures, and systems, an FMI should
provide incentives to participants and, where relevant, their customers to manage andcontain the risks they pose to the FMI. There are several ways in which an FMI may provide
incentives. For example, an FMI could apply financial penalties to participants that fail tosettle securities in a timely manner or to repay intraday credit by the end of the operatingday. Another example is the use of loss-sharing arrangements proportionate to the
exposures brought to the FMI. Such approaches can help reduce the moral hazard that may
arise from formulas in which losses are shared equally among participants or other formulas
where losses are not shared proportionally to risk.

36

These information systems should permit, where practicable, the provision of real time information to enable
participants to manage risks. If an FMI does not provide real time information, it should provide clear, full,
updated information to participants throughout the day (as frequently as possible) and consider appropriateenhancements to its systems.

CPSS-IOSCO – Principles for financial market infrastructures – April 201233

Interdependencies
3.3.7. An FMI should regularly review the material risks it bears from and poses to otherentities (such as other FMIs, settlement banks, liquidity providers, or service providers) as aresult of interdependencies and develop appropriate risk-management tools to address theserisks (see also Principle 20 on FMI links). In particular, an FMI should have effective riskmanagement tools to manage all relevant risks, including the legal, credit, liquidity, generalbusiness, and operational risks that it bears from and poses to other entities, in order to limit
the effects of disruptions from and to such entities as well as disruptions from and to thebroader financial markets. These tools should include business continuity arrangements thatallow for rapid recovery and resumption of critical operations and services in the event ofoperational disruptions (see Principle 17 on operational risk), liquidity risk-management
techniques (see Principle 7 on liquidity risk), and recovery or orderly wind-down plans should
the FMI become non-viable. 37 Because of the interdependencies between and amongsystems, an FMI should ensure that its crisis-management arrangements allow for effective
coordination among the affected entities, including cases in which its own viability or theviability of an interdependent entity is in question.
Recovery and orderly wind-down plans
3.3.8. An FMI should identify scenarios that may potentially prevent it from being able toprovide its critical operations and services as a going concern and assess the effectivenessof a full range of options for recovery or orderly wind-down. These scenarios should take into
account the various independent and related risks to which the FMI is exposed. Using thisanalysis (and taking into account any constraints potentially imposed by domestic
legislation), the FMI should prepare appropriate plans for its recovery or orderly wind-down.
The plan should contain, among other elements, a substantive summary of the key recovery
or orderly wind-down strategies, the identification of the FMI’s critical operations andservices, and a description of the measures needed to implement the key strategies. An FMI
should have the capacity to identify and provide to related entities the information needed to
implement the plan on a timely basis during stress scenarios. In addition, these plans should
be reviewed and updated regularly. Where applicable, an FMI should provide relevant
authorities with the information, including strategy and scenario analysis, needed for
purposes of resolution planning.
Internal controls
3.3.9. An FMI also should have comprehensive internal processes to help the board andsenior management monitor and assess the adequacy and effectiveness of an FMI’s riskmanagement policies, procedures, systems, and controls. While business-line management
serves as the first “line of defence,” the adequacy of and adherence to control mechanisms
should be assessed regularly through independent compliance programmes andindependent audits. 38 A robust internal audit function can provide an independent
assessment of the effectiveness of an FMI’s risk-management and control processes. An
emphasis on the adequacy of controls by senior management and the board as well asinternal audit can also help counterbalance a business-management culture that may favour
business interests over establishing and adhering to appropriate controls. In addition,

37

Although TRs are typically not exposed to financial risks from their recordkeeping activities, they may be a partof a network linking various entities that could include CCPs, dealers, custodians, and service providers, andtherefore should ensure that they effectively manage and minimise their own risks to reduce the potential forsystemic risk to spread to such linked entities.

38

Audits should be performed by qualified and independent individuals who did not participate in the creation of
the control mechanisms. At times the FMI may find it necessary to engage a team of external auditors.

34

CPSS-IOSCO – Principles for financial market infrastructures – April 2012

proactive engagement of audit and internal control functions when changes are underconsideration can also be beneficial. Specifically, FMIs that involve their internal audit
function in pre-implementation reviews will often reduce their need to expend additional
resources to retrofit processes and systems with critical controls that had been overlooked
during initial design phases and construction efforts.

CPSS-IOSCO – Principles for financial market infrastructures – April 201235

Credit and liquidity risk management
An FMI or its participants may face credit and liquidity risks arising from the FMI’s payment,
clearing, and settlement processes. Credit risk is the risk that a counterparty will be unable tomeet fully its financial obligations when due or at any time in the future. These counterparties
may include the FMI’s participants (see Principle 4 on credit risk), settlement banks (seePrinciple 9 on money settlements), and custodians (see Principle 16 on custody andinvestment risks). Liquidity risk is the risk that a counterparty will have insufficient funds tomeet its financial obligations when due, but may be able to do so at some time in the future.
Although credit and liquidity risks are distinct concepts, there is often significant interaction
between these risks. For example, a participant default in an FMI would likely result in the
FMI facing both credit and liquidity risk, potentially requiring the FMI to draw on its liquidity
resources to meet its immediate obligations. An FMI has a range of risk-management tools to
mitigate and manage these risks.
The following set of principles on (a) credit risk management, (b) collateral, (c) margin, and(d) liquidity risk management form the core of the standards for financial risk management
and financial resources. These principles contain extensive cross references because of theinteraction among the four standards. For example, the margin principle builds on the credit
risk principle as applied to CCPs. The margin principle is also related to the collateralprinciple, which establishes the form and attributes of collateral that a CCP should hold.
Taken together, these four principles are designed to provide a high degree of confidence
that an FMI will continue operating and serve as a source of financial stability even in
extreme market conditions. These principles are not applicable to CSDs or TRs to the extent
that they do not face credit and liquidity risks.
Principle 4: Credit risk
An FMI should effectively measure, monitor, and manage its credit exposures toparticipants and those arising from its payment, clearing, and settlement processes.
An FMI should maintain sufficient financial resources to cover its credit exposure toeach participant fully with a high degree of confidence. In addition, a CCP that is
involved in activities with a more-complex risk profile or that is systemically importantin multiple jurisdictions should maintain additional financial resources sufficient tocover a wide range of potential stress scenarios that should include, but not be limited
to, the default of the two participants and their affiliates that would potentially cause
the largest aggregate credit exposure to the CCP in extreme but plausible market
conditions. All other CCPs should maintain additional financial resources sufficient tocover a wide range of potential stress scenarios that should include, but not be limited
to, the default of the participant and its affiliates that would potentially cause thelargest aggregate credit exposure to the CCP in extreme but plausible market
conditions.
Key considerations
1.

An FMI should establish a robust framework to manage its credit exposures to its
participants and the credit risks arising from its payment, clearing, and settlement
processes. Credit exposure may arise from current exposures, potential future
exposures, or both.

2.

An FMI should identify sources of credit risk, routinely measure and monitor credit
exposures, and use appropriate risk-management tools to control these risks.

3.

A payment system or SSS should cover its current and, where they exist, potential
future exposures to each participant fully with a high degree of confidence using

36

CPSS-IOSCO – Principles for financial market infrastructures – April 2012

collateral and other equivalent financial resources (see Principle 5 on collateral). In
the case of a DNS payment system or DNS SSS in which there is no settlement
guarantee but where its participants face credit exposures arising from its payment,
clearing, and settlement processes, such an FMI should maintain, at a minimum,
sufficient resources to cover the exposures of the two participants and their affiliatesthat would create the largest aggregate credit exposure in the system.
4.

A CCP should cover its current and potential future exposures to each participant
fully with a high degree of confidence using margin and other prefunded financial
resources (see Principle 5 on collateral and Principle 6 on margin). In addition, a
CCP that is involved in activities with a more-complex risk profile or that issystemically important in multiple jurisdictions should maintain additional financial
resources to cover a wide range of potential stress scenarios that should include,
but not be limited to, the default of the two participants and their affiliates that would
potentially cause the largest aggregate credit exposure for the CCP in extreme but
plausible market conditions. All other CCPs should maintain additional financial
resources sufficient to cover a wide range of potential stress scenarios that should
include, but not be limited to, the default of the participant and its affiliates that would
potentially cause the largest aggregate credit exposure for the CCP in extreme but
plausible market conditions. In all cases, a CCP should document its supporting
rationale for, and should have appropriate governance arrangements relating to, theamount of total financial resources it maintains.

5.

A CCP should determine the amount and regularly test the sufficiency of its total
financial resources available in the event of a default or multiple defaults in extreme
but plausible market conditions through rigorous stress testing. A CCP should haveclear procedures to report the results of its stress tests to appropriate decision
makers at the CCP and to use these results to evaluate the adequacy of and adjust
its total financial resources. Stress tests should be performed daily using standard
and predetermined parameters and assumptions. On at least a monthly basis, a
CCP should perform a comprehensive and thorough analysis of stress testing
scenarios, models, and underlying parameters and assumptions used to ensure
they are appropriate for determining the CCP’s required level of default protection inlight of current and evolving market conditions. A CCP should perform this analysisof stress testing more frequently when the products cleared or markets served
display high volatility, become less liquid, or when the size or concentration of
positions held by a CCP’s participants increases significantly. A full validation of a
CCP’s risk-management model should be performed at least annually.

6.

In conducting stress testing, a CCP should consider the effect of a wide range of
relevant stress scenarios in terms of both defaulters’ positions and possible pricechanges in liquidation periods. Scenarios should include relevant peak historic pricevolatilities, shifts in other market factors such as price determinants and yield
curves, multiple defaults over various time horizons, simultaneous pressures infunding and asset markets, and a spectrum of forward-looking stress scenarios in avariety of extreme but plausible market conditions.

7.

An FMI should establish explicit rules and procedures that address fully any credit
losses it may face as a result of any individual or combined default among its
participants with respect to any of their obligations to the FMI. These rules andprocedures should address how potentially uncovered credit losses would beallocated, including the repayment of any funds an FMI may borrow from liquidity
providers. These rules and procedures should also indicate the FMI’s process toreplenish any financial resources that the FMI may employ during a stress event, sothat the FMI can continue to operate in a safe and sound manner.

CPSS-IOSCO – Principles for financial market infrastructures – April 201237

Explanatory note
3.4.1. Credit risk is broadly defined as the risk that a counterparty will be unable to meetfully its financial obligations when due or at any time in the future. The default of a participant(and its affiliates) has the potential to cause severe disruptions to an FMI, its otherparticipants, and the financial markets more broadly. 39 Therefore, an FMI should establish arobust framework to manage its credit exposures to its participants and the credit risks
arising from its payment, clearing, and settlement processes (see also Principle 3 on theframework for the comprehensive management of risks, Principle 9 on money settlements,
and Principle 16 on custody and investment risks). Credit exposure may arise in the form of
current exposures, potential future exposures, or both. 40 Current exposure, in this context, isdefined as the loss that an FMI (or in some cases, its participants) would face immediately if
a participant were to default. 41 Potential future exposure is broadly defined as any potential
credit exposure that an FMI could face at a future point in time. 42 The type and level of credit
exposure faced by an FMI will vary based on its design and the credit risk of thecounterparties concerned. 43
Credit risk in payment systems
3.4.2. Sources of credit risk. A payment system may face credit risk from its participants,
its payment and settlement processes, or both. This credit risk is driven mainly by current
exposures from extending intraday credit to participants. 44 For example, a central bank that
operates a payment system and provides intraday credit will face current exposures. A
payment system can avoid carrying over current exposures to the next day by requiring its
participants to refund any credit extensions before the end of the day. Intraday credit canlead to potential future exposures even when the FMI accepts collateral to secure the credit.
A payment system would face potential future exposure if the value of collateral posted by aparticipant to cover intraday credit were to fall below the amount of credit extended to theparticipant by the FMI, leaving a residual exposure.
3.4.3. Sources of credit risk in deferred net settlement systems. A payment system that
employs a DNS mechanism may face financial exposures arising from its relationship with its
participants or its payment and settlement processes. A DNS payment system may explicitly
guarantee settlement, whether the guarantee is provided by the FMI itself or its participants.
In such systems, the guarantor of the arrangement would face current exposure if a

39

An affiliate is defined as a company that controls, is controlled by, or is under common control with theparticipant. Control of a company is defined as (a) ownership, control, or holding with power to vote 20 percent
or more of a class of voting securities of the company; or (b) consolidation of the company for financial
reporting purposes.

40

See also BCBS, The application of Basel II to trading activities and the treatment of double default effects,
April 2005, p 4 (joint paper with IOSCO). See also BCBS, International convergence of capital measurement
and capital standards, June 2006, annex 4, pp 254-257 (various definitions of transactions and risks; seeespecially, definitions of “current exposure” and “peak exposure”).

41

Current exposure is technically defined as the larger of zero or the market value (or replacement cost) of atransaction or portfolio of transactions within a netting set with a counterparty that would be lost upon thedefault of the counterparty.

42

Potential future exposure is technically defined as the maximum exposure estimated to occur at a future point
in time at a high level of statistical confidence. Potential future exposure arises from potential fluctuations in
the market value of a participant’s open positions between the time they are incurred or reset to the current
market price and the time they are liquidated or effectively hedged.

43

In considering its credit exposure to a central bank, on a case-by-case basis an FMI may take into account the
special characteristics of the central bank.

44

Many payment systems do not face credit risk from their participants or payment and settlement processes,
although they may face significant liquidity risk.

38

CPSS-IOSCO – Principles for financial market infrastructures – April 2012

participant were not to meet its payment or settlement obligations. Even in a DNS systemthat does not have an explicit guarantee, participants in the payment system may still facesettlement risk vis-à-vis each other. Whether this risk involves credit exposures or liquidity
exposures, or a combination of both, will depend on the type and scope of obligations,
including any contingent obligations, the participants bear. The type of obligations will, in
turn, depend on factors such as the payment system’s design, rules, and legal framework.
3.4.4. Measuring and monitoring credit risk. A payment system should frequently andregularly measure and monitor its credit risks, throughout the day using timely information. A
payment system should ensure it has access to adequate information, such as appropriate
collateral valuations, to allow it to measure and monitor its current exposures and degree ofcollateral coverage. In a DNS payment system without a settlement guarantee, the FMI
should provide the capacity to its participants to measure and monitor their current
exposures to each other in the system or adopt rules that require participants to provide
relevant exposure information. Current exposure is relatively straightforward to measure andmonitor; however, potential future exposure may require modelling or estimation. In order tomonitor its risks associated with current exposure, a payment system should monitor market
conditions for developments that could affect these risks, such as collateral values. In orderto estimate its potential future exposure and associated risk, a payment system should model
possible changes in collateral values and market conditions over an appropriate liquidation
period. A payment system, where appropriate, needs to monitor the existence of large
exposures to its participants and their customers. Additionally, it should monitor any changes
in the creditworthiness of its participants.
3.4.5. Mitigating and managing credit risk. A payment system should mitigate its credit
risks to the extent possible. A payment system can, for example, eliminate some of its or its
participants’ credit risks associated with the settlement process by employing an RTGS
mechanism. In addition, a payment system should limit its current exposures by limiting
intraday credit extensions and, where relevant, avoid carrying over these exposures to thenext day by requiring participants to refund any credit extensions before the end of the day. 45
Such limits should balance the usefulness of credit to facilitate settlement within the systemagainst the payment system’s credit exposures.
3.4.6. In order to manage the risk from a participant default, a payment system should
consider the impact of participant defaults and robust techniques for managing collateral. A
payment system should cover its current and, where they exist, potential future exposures toeach participant fully with a high degree of confidence using collateral and other equivalentfinancial resources (equity can be used after deduction of the amount dedicated to cover
general business risk) (see Principle 5 on collateral and Principle 15 on general businessrisk). 46 By requiring collateral to cover the credit exposures, a payment system mitigates, andin some cases eliminates, its current exposure and may provide participants with an
incentive to manage credit risks they pose to the payment system or other participants.
Further, this collateralisation reduces the need in a DNS payment system to unwind
payments should a participant default on its obligations. Collateral or other equivalentfinancial resources can fluctuate in value, however, so the payment system should establish
prudent haircuts to mitigate the resulting potential future exposure.
3.4.7. A DNS payment system that explicitly guarantees settlement, whether the guarantee
is from the FMI itself or from its participants, should maintain sufficient financial resources to45

A central bank often avoids using limits on a participant’s credit because of its role as a monetary authority
and liquidity provider.

46

Equity may only be used up to the amount held in sufficiently liquid net assets. Such use of equity should bestrictly limited to avoiding disruptions in settlement when collateral is not available in a timely manner.

CPSS-IOSCO – Principles for financial market infrastructures – April 201239

cover fully all current and potential future exposures using collateral and other equivalentfinancial resources. A DNS payment system in which there is no settlement guarantee, butwhere its participants face credit exposures arising from its payment and settlement
processes, should maintain, at a minimum, sufficient resources to cover the exposures of thetwo participants and their affiliates that would create the largest aggregate credit exposure in
the system. 47 A higher level of coverage should be considered for a payment system thatcreates large exposures or that could have a significant systemic impact if more than two
participants and their affiliates were to default.
Credit risk in SSSs
3.4.8. Sources of credit risk. An SSS may face a number of credit risks from its participantsor its settlement processes. An SSS faces counterparty credit risk when it extends intraday
or overnight credit to participants. This extension of credit creates current exposures and canlead to potential future exposures, even when the SSS accepts collateral to secure the credit.
An SSS would face potential future exposure if the value of collateral posted by a participant
to cover this credit might fall below the amount of credit extended to the participant by the
SSS, leaving a residual exposure. In addition, an SSS that explicitly guarantees settlement
would face current exposures if a participant were not to fund its net debit position or meet its
obligations to deliver financial instruments. Further, if an SSS does not use a DvP settlement
mechanism, the SSS or its participants face principal risk, which is the risk of loss of
securities or payments made to the defaulting participant prior to the detection of the default(see Principle 12 on exchange-of-value settlement systems).
3.4.9.
Sources of credit risk in deferred net settlement systems. An SSS may settle
securities on a gross basis and funds on a net basis (DvP model 2) or settle both securities
and funds on a net basis (DvP model 3). Further, an SSS that uses a DvP model 2 or 3
settlement mechanism may explicitly guarantee settlement, whether the guarantee is by the
FMI itself or by its participants. In such systems, this guarantee represents an extension of
intraday credit from the guarantor. In an SSS that does not provide an explicit settlement
guarantee, participants may face settlement risk vis-à-vis each other if a participant defaults
on its obligations. Whether this settlement risk involves credit exposures, liquidity exposures,or a combination of both will depend on the type and scope of the obligations, including any
contingent obligations, the participants bear. The type of obligations will, in turn, depend on
factors such as the SSS’s design, rules, and legal framework.
3.4.10. Measuring and monitoring credit risk. An SSS should frequently and regularly
measure and monitor its credit risks throughout the day using timely information. An SSS
should ensure it has access to adequate information, such as appropriate collateralvaluations, to allow it to measure and monitor its current exposures and degree of collateralcoverage. If credit risk exists between participants, the SSS should provide the capacity toparticipants to measure and monitor their current exposures to each other in the system or
adopt rules that require participants to provide relevant exposure information. Current
exposure should be relatively straightforward to measure and monitor; however, potential
future exposure may require modelling or estimation. In order to monitor its risks associatedwith current exposure, an SSS should monitor market conditions for developments that could
affect these risks, such as collateral values. In order to estimate its potential future exposureand associated risk, an SSS should model possible changes in collateral values and market
conditions over an appropriate liquidation period. An SSS, where appropriate, needs tomonitor the existence of large exposures to its participants and their customers. Additionally,it should monitor any changes in the creditworthiness of its participants.

47

If the financial exposure faced by the DNS payment system is a liquidity exposure, then Principle 7 would
apply.

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CPSS-IOSCO – Principles for financial market infrastructures – April 2012

3.4.11. Mitigating and managing credit risk. An SSS should mitigate its credit risks to theextent possible. An SSS should, for example, eliminate its or its participants’ principal risk
associated with the settlement process by employing an exchange-of-value settlement
system (see Principle 12 on exchange-of-value settlement systems). The use of a systemthat settles securities and funds on a gross, obligation-by-obligation basis (DvP model 1)
would further reduce credit and liquidity exposures among participants and between
participants and the SSS. In addition, an SSS should limit its current exposures by limiting
intraday credit extensions and, where relevant, overnight credit extensions. 48 Such limits
should balance the usefulness of credit to facilitate settlement within the system against the
SSS’s credit exposures.
3.4.12. In order to manage the risk from a participant default, an SSS should consider the
impact of participant defaults and use robust techniques for managing collateral. An SSS
should cover its current and, where they exist, potential future exposures to each participant
fully with a high degree of confidence using collateral and other equivalent financial
resources (equity can be used after deduction of the amount dedicated to cover generalbusiness risk) (see Principle 5 on collateral and Principle 15 on general business risk). 49 By
requiring collateral to cover the credit exposures, an SSS mitigates, and in some cases
eliminates, its current exposures and may provide participants with an incentive to manage
the credit risks they pose to the SSS or other participants. Further, this collateralisation
allows an SSS that employs a DvP model 2 or 3 mechanism to avoid unwinding transactions
or to mitigate the effect of an unwind should a participant default on its obligations. Collateraland other equivalent financial resources can fluctuate in value, however, so the SSS needs
to establish prudent haircuts to mitigate the resulting potential future exposures.
3.4.13. An SSS that uses a DvP model 2 or 3 mechanism and explicitly guarantees
settlement, whether the guarantee is from the FMI itself or from its participants, should
maintain sufficient financial resources to cover fully, with a high degree of confidence, allcurrent and potential future exposures using collateral and other equivalent financial
resources. An SSS that uses a DvP model 2 or 3 mechanism and does not explicitly
guarantee settlement, but where its participants face credit exposures arising from its
payment, clearing, and settlement processes, should maintain, at a minimum, sufficient
resources to cover the exposures of the two participants and their affiliates that would create
the largest aggregate credit exposure in the system. 50 A higher level of coverage should beconsidered for an SSS that has large exposures or that could have a significant systemic
impact if more than two participants and their affiliates were to default.
Credit risk in CCPs
3.4.14. Sources of credit risk. A CCP typically faces both current and potential future
exposures because it typically holds open positions with its participants. Current exposure
arises from fluctuations in the market value of open positions between the CCP and its
participants. 51 Potential future exposure arises from potential fluctuations in the market valueof a defaulting participant’s open positions until the positions are closed out, fully hedged, or

48

A central bank often avoids using limits on a participant’s credit because of its role as a monetary authority
and liquidity provider.

49

Equity may only be used up to the amount held in sufficiently liquid net assets. Such use of equity should bestrictly limited to avoiding disruptions in settlement when collateral is not available in a timely manner.

50

If the financial exposure faced by the DNS SSS is a liquidity exposure, then principle 7 would apply.

51

For example, for a CCP that pays and collects variation margin (after marking positions to market and then,upon completion of the variation cycle, resetting the value of positions to zero daily), the current exposure is
the difference between the current (that is, at the moment) value of open positions and the value of thepositions when the CCP last marked them to market for the purpose of collecting variation margin.

CPSS-IOSCO – Principles for financial market infrastructures – April 201241

transferred by the CCP following an event of default. 52 For example, during the period inwhich a CCP neutralises or closes out a position following the default of a participant, themarket value of the position or asset being cleared may change, which could increase the
CCP’s credit exposure, potentially significantly. 53 A CCP can also face potential future
exposure due to the potential for collateral (initial margin) to decline significantly in value overthe close-out period.
3.4.15. Measuring and monitoring credit risk. A CCP should frequently and regularly
measure and monitor its credit risks throughout the day using timely information. A CCP
should ensure that it has access to adequate information to allow it to measure and monitor
its current and potential future exposures. Current exposure is relatively straightforward tomeasure and monitor when relevant market prices are readily available. Potential future
exposure is typically more challenging to measure and monitor and usually requires
modelling and estimation of possible future market price developments and other variables
and conditions, as well as specifying an appropriate time horizon for the close out of
defaulted positions. In order to estimate the potential future exposures that could result fromparticipant defaults, a CCP should identify risk factors and monitor potential market
developments and conditions that could affect the size and likelihood of its losses in theclose out of a defaulting participant’s positions. A CCP should monitor the existence of large
exposures to its participants and, where appropriate, their customers. Additionally, it should
monitor any changes in the creditworthiness of its participants.
3.4.16. Mitigating and managing credit risk. A CCP should mitigate its credit risk to theextent possible. For example, to control the build-up of current exposures, a CCP should
require that open positions be marked to market and that each participant pay funds, typicallyin the form of variation margin, to cover any loss in its positions’ net value at least daily; sucha requirement limits the accumulation of current exposures and therefore mitigates potential
future exposures. In addition, a CCP should have the authority and operational capacity tomake intraday margin calls, both scheduled and unscheduled, from participants. Further, a
CCP may choose to place limits on credit exposures in some cases, even if collateralised.
Limits on concentrations of positions or additional collateral requirements may also be
warranted.
3.4.17. A CCP typically uses a sequence of prefunded financial resources, often referred toas a “waterfall,” to manage its losses caused by participant defaults. The waterfall may
include a defaulter’s initial margin, the defaulter’s contribution to a prefunded default
arrangement, a specified portion of the CCP’s own funds, and other participants’contributions to a prefunded default arrangement. 54 Initial margin is used to cover a CCP’s

52

For positions that are marked to market and settled daily, potential future exposure is typically related to theinterval between the last daily mark-to-market and the point the position is closed out. That is, potential future
exposure includes uncovered current exposure stemming from the price development from the last mark-tomarket to the time of close out, full hedging, or transfer.

53

A CCP may close out a defaulting participant’s positions by entering the market to buy or sell contracts
identical but opposite to the net positions held by the defaulting participant at current market prices (seePrinciple 13 on participant-default rules and procedures). (The CCP may alternatively auction the defaulting
participant’s positions to other participants, whether in whole or in parts). During the liquidation period, market
prices on the open positions can change, exposing the CCP to additional liquidation costs until the point ofclose out. To mitigate this risk, a CCP may also temporarily hedge the defaulter’s positions by entering into
positions with values that are negatively correlated with the values of the positions held by the defaulting
participant. The CCP’s liquidation cost therefore not only includes the uncovered current exposure that would
exist at the time of default but also the potential future exposure associated with relevant changes in market
prices during the liquidation period.

54

Prefunded default arrangements for loss mutualisation and other pooling-of-resources arrangements involve
trade-offs that a CCP should carefully assess and balance. For example, a CCP may be able to protect itself
against defaults in extreme conditions more efficiently using pooled resources, as the costs are shared among

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CPSS-IOSCO – Principles for financial market infrastructures – April 2012

potential future exposures, as well as current exposures not covered by variation margin, toeach participant with a high degree of confidence. 55 However, a CCP generally remains
exposed to residual risk (or tail risk) if a participant defaults and market conditions
concurrently change more drastically than is anticipated in the margin calculations. In such
scenarios, a CCP’s losses may exceed the defaulting participant’s posted margin. Although it
is not feasible to cover all such tail risks given the unknown scope of potential losses due toprice changes, a CCP should maintain additional financial resources, such as additional
collateral or a prefunded default arrangement, to cover a portion of the tail risk.
3.4.18. A CCP should cover its current and potential future exposures to each participant
fully with a high degree of confidence using margin and other prefunded financial resources.
As discussed more fully in Principle 6 on margin, a CCP should establish initial margin
requirements that are commensurate with the risks of each product and portfolio. Initial
margin should meet an established single-tailed confidence level of at least 99 percent of theestimated distribution of future exposure. 56 For a CCP that calculates margin at the portfolio
level, this standard applies to the distribution of future exposure of each portfolio. For a CCP
that calculates margin at more-granular levels, such as at the subportfolio level or productlevel, the standard must be met for the corresponding distributions of future exposure.
3.4.19. In addition to fully covering its current and potential future exposures, a CCP should
maintain additional financial resources sufficient to cover a wide range of potential stressscenarios involving extreme but plausible market conditions. Specifically, a CCP that is
involved in activities with a more-complex risk profile (such as clearing financial instrumentsthat are characterised by discrete jump-to-default price changes or that are highly correlatedwith potential participant defaults) or that is systemically important in multiple jurisdictions,should maintain additional financial resources sufficient to cover a wide range of potential
stress scenarios that should include, but not be limited to, the default of the two participants
and their affiliates that would potentially cause the largest aggregate credit exposure for the
CCP in extreme but plausible market conditions. Determinations of whether a CCP issystemically important in multiple jurisdictions should include consideration of, among otherfactors, (a) the location of the CCP’s participants, (b) the aggregate volume and value oftransactions that originate in each jurisdiction in which it operates, (c) the proportion of its
total volume and value of transactions that originate in each jurisdiction in which it operates,(d) the range of currencies in which the instruments it clears are cleared or settled, (e) any
links it has with FMIs located in other jurisdictions, and (f) the extent to which it clears
instruments that are subject to mandatory clearing obligations in multiple jurisdictions. Allother CCPs should maintain additional financial resources sufficient to cover a wide range ofpotential stress scenarios that should include, but not be limited to, the default of theparticipant and its affiliates that would potentially cause the largest aggregate credit exposurefor the CCP in extreme but plausible market conditions. In all cases, a CCP should document
its supporting rationale for, and should have appropriate governance arrangements relating
to (see Principle 2 on governance), the amount of total financial resources it maintains.

participants. The lower cost provides an incentive to increase the available financial resources so that the
CCP is more financially secure. The pooling of resources, however, also increases the interdependencies
among participants. The proportion of assets used to absorb a default that is pooled across participants
versus the proportion that is segregated, such as margins, should balance the safety and soundness of the
CCP against the increased interdependencies among participants in order to minimise systemic risk.
55

Other resources may be used in place of initial margin; however, these resources should be prefunded and ofequivalent or stronger quality in comparison to prudently designed margin arrangements.

56

This concept parallels the technical definition of potential future exposure as a risk measure. See footnote 42.

CPSS-IOSCO – Principles for financial market infrastructures – April 201243

Testing the sufficiency of a CCP’s total financial resources
3.4.20. A CCP should determine the amount and regularly test the sufficiency of its total
financial resources through stress testing. A CCP should also conduct reverse stress tests,
as appropriate, to test how severe stress conditions would be covered by its total financial
resources. Because initial margin is a key component of a CCP’s total financial resources, a
CCP should also test the adequacy of its initial margin requirements and model throughbacktesting and sensitivity analysis, respectively (see Principle 6 for further discussion on
testing of the initial margin requirements and model).
3.4.21. Stress testing. A CCP should determine the amount and regularly test thesufficiency of its total financial resources available in the event of a default or multiple
defaults in extreme but plausible market conditions through rigorous stress testing. A CCP
should have clear procedures to report the results of its stress tests to appropriate decision
makers at the CCP and to use these results to evaluate the adequacy of and adjust its total
financial resources. Stress tests should be performed daily using standard andpredetermined parameters and assumptions. On at least a monthly basis, a CCP should
perform a comprehensive and thorough analysis of stress-testing scenarios, models, andunderlying parameters and assumptions used to ensure they are appropriate for determining
the CCP’s required level of default protection in light of current and evolving market
conditions. A CCP should perform this analysis of stress testing more frequently when the
products cleared or markets served display high volatility, become less liquid, or when thesize or concentration of positions held by a CCP’s participants increases significantly. A full
validation of a CCP’s risk-management model should be performed at least annually. 57
3.4.22. In conducting stress testing, a CCP should consider a wide range of relevant stressscenarios in terms of both defaulters’ positions and possible price changes in liquidation
periods. 58 Scenarios should include relevant peak historic price volatilities, shifts in othermarket factors such as price determinants and yield curves, multiple defaults over various
time horizons, simultaneous pressures in funding and asset markets, and a spectrum of
forward-looking stress scenarios in a variety of extreme but plausible market conditions. 59
Extreme but plausible conditions should not be considered a fixed set of conditions, butrather, conditions that evolve. Stress tests should quickly incorporate emerging risks andchanges in market assumptions (for example, departures from usual patterns of comovements in prices among the products a CCP clears). 60 A CCP proposing to clear new
products should consider movements in prices of any relevant related products.
3.4.23. Reverse stress tests. A CCP should conduct, as appropriate, reverse stress tests
aimed at identifying the extreme scenarios and market conditions in which its total financial
resources would not provide sufficient coverage of tail risk. Reverse stress tests require a

57

Although a CCP may use the results of stress testing to assess the validity of the stress scenarios, models,and underlying parameters and assumptions, these aspects should not be arbitrarily adjusted to control theadequacy of total financial resources. Stress scenarios, models, and underlying parameters and assumptions
should be examined based on historical data of prices of cleared products and participants’ positions andpotential developments of these factors under extreme but plausible market conditions in the markets that the
CCP serves. See paragraph 3.4.22.

58

The risk-management methods of some CCPs may integrate the management of risk from participant
positions with risks from price developments. If this integrated risk-management approach is well
implemented, stress scenarios can take into account appropriate combinations in defaulting positions andprice changes.

59

See BCBS, Principles for sound stress testing practices and supervision, May 2009.

60

Dependence among exposures as well as between participants and exposures should be considered. If an
FMI calculates exposures on a portfolio basis, then the dependence of the instruments within participants’
portfolios needs to be stressed.

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CPSS-IOSCO – Principles for financial market infrastructures – April 2012

CCP to model hypothetical positions and extreme market conditions that may go beyond
what are considered extreme but plausible market conditions in order to help understandmargin calculations and the sufficiency of financial resources given the underlying
assumptions modelled. Modelling extreme market conditions can help a CCP determine thelimits of its current model and resources; however, it requires the CCP to exercise judgment
when modelling different markets and products. A CCP should develop hypothetical extreme
scenarios and market conditions tailored to the specific risks of the markets and of the
products it serves. Reverse stress testing should be considered a helpful management tool
but need not, necessarily, drive the CCP’s determination of the appropriate level of financial
resources.
Use of financial resources
3.4.24. The rules of an FMI should expressly set out the waterfall, including thecircumstances in which specific resources of the FMI can be used in a participant default(see Principle 13 on participant-default rules and procedures and Principle 23 on disclosureof rules, key procedures, and market data). For the purposes of this principle, an FMI should
not include as “available” to cover credit losses from participant defaults those resources thatare needed to cover current operating expenses, potential general business losses, or otherlosses from other activities in which the FMI is engaged (see Principle 15 on generalbusiness risk). In addition, if an FMI serves multiple markets (either in the same jurisdiction
or multiple jurisdictions), its ability to use resources supplied by participants in one market tocover losses from a participant default in another market should have a sound legal basis, beclear to all participants, and avoid significant levels of contagion risk between markets andparticipants. The design of an FMI’s stress tests should take into account the extent to which
resources are pooled across markets in scenarios involving one or more participant defaults
across several markets.
Contingency planning for uncovered credit losses
3.4.25. In certain extreme circumstances, the post-liquidation value of the collateral andother financial resources that secure an FMI’s credit exposures may not be sufficient to covercredit losses resulting from those exposures fully. An FMI should analyse and plan for how it
would address any uncovered credit losses. An FMI should establish explicit rules andprocedures that address fully any credit losses it may face as a result of any individual or
combined default among its participants with respect to any of their obligations to the FMI.
These rules and procedures should address how potentially uncovered credit losses would
be allocated, including the repayment of any funds an FMI may borrow from liquidity
providers. 61 An FMI’s rules and procedures should also indicate its process to replenish any
financial resources it may employ during a stress event, so that it can continue to operate ina safe and sound manner.

61

For instance, an FMI’s rules and procedures might provide the possibility to allocate uncovered credit losses
by writing down potentially unrealised gains by non-defaulting participants and the possibility of calling foradditional contributions from participants based on the relative size and risk of their portfolios.

CPSS-IOSCO – Principles for financial market infrastructures – April 201245

Principle 5: Collateral
An FMI that requires collateral to manage its or its participants’ credit exposure
should accept collateral with low credit, liquidity, and market risks. An FMI should also
set and enforce appropriately conservative haircuts and concentration limits.
Key considerations
1.

An FMI should generally limit the assets it (routinely) accepts as collateral to thosewith low credit, liquidity, and market risks.

2.

An FMI should establish prudent valuation practices and develop haircuts that are
regularly tested and take into account stressed market conditions.

3.

In order to reduce the need for procyclical adjustments, an FMI should establish
stable and conservative haircuts that are calibrated to include periods of stressedmarket conditions, to the extent practicable and prudent.

4.

An FMI should avoid concentrated holdings of certain assets where this would
significantly impair the ability to liquidate such assets quickly without significant
adverse price effects.

5.

An FMI that accepts cross-border collateral should mitigate the risks associated with
its use and ensure that the collateral can be used in a timely manner.

6.

An FMI should use a collateral management system that is well-designed andoperationally flexible.

Explanatory note
3.5.1. Collateralising credit exposures protects an FMI and, where relevant, its participants
against potential losses in the event of a participant default (see Principle 4 on credit risk).
Besides mitigating an FMI’s own credit risk, the use of collateral can provide participants withincentives to manage the risks they pose to the FMI or other participants. An FMI should
apply prudent haircuts to the value of the collateral to achieve a high degree of confidence
that the liquidation value of the collateral will be greater than or equal to the obligation thatthe collateral secures in extreme but plausible market conditions. 62 Additionally, an FMI
should have the capacity to use the collateral promptly when needed.
Acceptable collateral
3.5.2. An FMI should generally limit the assets it (routinely) accepts as collateral to thosewith low credit, liquidity, and market risks. In the normal course of business, an FMI may be
exposed to risk from certain types of collateral that are not considered to have low credit,
liquidity, and market risks. However, in some instances, these assets may be acceptable
collateral for credit purposes if an appropriate haircut is applied. An FMI must be confident of
the collateral’s value in the event of liquidation and of its capacity to use that collateralquickly, especially in stressed market conditions. An FMI that accepts collateral with credit,
liquidity, and market risks above minimum levels should demonstrate that it sets andenforces appropriately conservative haircuts and concentration limits. 63

62

The risk-management methods of some FMIs may integrate the management of risk from participant positions
with the risk from fluctuations in the value of collateral provided by participants.

63

In general, guarantees are not acceptable collateral. However, in rare circumstances and subject to regulatory
approval, a guarantee fully backed by collateral that is realisable on a same-day basis may serve as
acceptable collateral. An explicit guarantee from the relevant central bank of issue would constitute acceptable
collateral providing it is supported by the legal framework applicable to and the policies of the central bank.

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CPSS-IOSCO – Principles for financial market infrastructures – April 2012

3.5.3. Further, an FMI should regularly adjust its requirements for acceptable collateral inaccordance with changes in underlying risks. When evaluating types of collateral, an FMI
should consider potential delays in accessing the collateral due to the settlement conventions
for transfers of the asset. In addition, participants should not be allowed to post their own
debt or equity securities, or debt or equity of companies closely linked to them, as
collateral. 64 More generally, an FMI should mitigate specific wrong-way risk by limiting theacceptance of collateral that would likely lose value in the event that the participant providing
the collateral defaults. 65 The FMI should measure and monitor the correlation between acounterparty’s creditworthiness and the collateral posted and take measures to mitigate therisks, for instance by setting more-conservative haircuts.
3.5.4. If an FMI plans to use assets held as collateral to secure liquidity facilities in theevent of a participant default, the FMI will also need to consider, in determining acceptable
collateral, what will be acceptable as security to lenders offering liquidity facilities (seePrinciple 7).
Valuing collateral
3.5.5. To have adequate assurance of the collateral’s value in the event of liquidation, an
FMI should establish prudent valuation practices and develop haircuts that are regularly
tested and take into account stressed market conditions. An FMI should, at a minimum, markits collateral to market daily. Haircuts should reflect the potential for asset values and liquidity
to decline over the interval between their last revaluation and the time by which an FMI canreasonably assume that the assets can be liquidated. Haircuts also should incorporate
assumptions about collateral value during stressed market conditions and reflect regularstress testing that takes into account extreme price moves, as well as changes in market
liquidity for the asset. If market prices do not fairly represent the true value of the assets, an
FMI should have the authority to exercise discretion in valuing assets according topredefined and transparent methods. An FMI’s haircut procedures should be independently
validated at least annually. 66
Limiting procyclicality
3.5.6. An FMI should appropriately address procyclicality in its collateral arrangements. To
the extent practicable and prudent, an FMI should establish stable and conservative haircutsthat are calibrated to include periods of stressed market conditions in order to reduce theneed for procyclical adjustments. In this context, procyclicality typically refers to changes inrisk-management practices that are positively correlated with market, business, or credit
cycle fluctuations and that may cause or exacerbate financial instability. 67 While changes incollateral values tend to be procyclical, collateral arrangements can increase procyclicality if
haircut levels fall during periods of low market stress and increase during periods of highmarket stress. For example, in a stressed market, an FMI may require the posting ofadditional collateral both because of the decline of asset prices and because of an increase

64

Covered bonds issued by a participant or a closely linked company may be accepted as collateral, provided
the underlying collateral of these covered bonds would be appropriately segregated by the issuer from its own
assets and considered as acceptable under this principle.

65

Specific wrong-way risk is defined as the risk that an exposure to a counterparty is highly likely to increase
when the creditworthiness of that counterparty is deteriorating.

66

Validation of the FMI’s haircut procedures should be performed by personnel of sufficient expertise who are
independent of the personnel that created and applied the haircut procedures. These expert personnel could
be drawn from within the FMI. However, a review by personnel external to the FMI may also be necessary attimes.

67

See also CGFS, The role of margin requirements and haircuts in procyclicality, March 2010.

CPSS-IOSCO – Principles for financial market infrastructures – April 201247

in haircut levels. Such actions could exacerbate market stress and contribute to driving down
asset prices further, resulting in additional collateral requirements. This cycle could exert
further downward pressure on asset prices. Addressing issues of procyclicality may create
additional costs for FMIs and their participants in periods of low market stress because ofhigher collateral requirements, but result in additional protection and potentially less-costly
and less-disruptive adjustments in periods of high market stress.
Avoiding concentrations of collateral
3.5.7. An FMI should avoid concentrated holdings of certain assets where this would
significantly impair the ability to liquidate such assets quickly without significant adverse priceeffects. High concentrations within holdings can be avoided by establishing concentration
limits or imposing concentration charges. Concentration limits restrict participants’ ability toprovide certain collateral assets above a specified threshold as established by the FMI.
Concentration charges penalise participants for maintaining holdings of certain assets
beyond a specified threshold as established by the FMI. Further, concentration limits andcharges should be constructed to prevent participants from covering a large share of theircollateral requirements with the most risky assets acceptable. Concentration limits andcharges should be periodically reviewed by the FMI to determine their adequacy.
Cross-border collateral
3.5.8. If an FMI accepts cross-border (or foreign) collateral, it should identify and mitigate
any additional risks associated with its use and ensure that it can be used in a timely
manner. 68 A cross-border collateral arrangement can provide an efficient liquidity bridge
across markets, help relax collateral constraints for some participants, and contribute to theefficiency of some asset markets. These linkages, however, can also create significant
interdependencies and risks to FMIs that need to be evaluated and managed by the affected
FMIs (see also Principle 17 on operational risk and Principle 20 on FMI links). For example,
an FMI should have appropriate legal and operational safeguards to ensure that it can use
the cross-border collateral in a timely manner and should identify and address any significant
liquidity effects. An FMI also should consider foreign-exchange risk where collateral isdenominated in a currency different from that in which the exposure arises, and set haircuts
to address the additional risk to a high level of confidence. The FMI should have the capacity
to address potential operational challenges of operating across borders, such as differencesin time zones or operating hours of foreign CSDs or custodians.
Collateral management systems
3.5.9. An FMI should use a well-designed and operationally flexible collateral management
system. Such a system should accommodate changes in the ongoing monitoring andmanagement of collateral. Where appropriate, the system should allow for the timely
calculation and execution of margin calls, the management of margin call disputes, and theaccurate daily reporting of levels of initial and variation margin. Further, a collateralmanagement system should track the extent of reuse of collateral (both cash and non-cash)
and the rights of an FMI to the collateral provided to it by its counterparties. An FMI’s
collateral management system should also have functionality to accommodate the timely
deposit, withdrawal, substitution, and liquidation of collateral. An FMI should allocate
sufficient resources to its collateral management system to ensure an appropriate level ofoperational performance, efficiency, and effectiveness. Senior management should ensurethat the FMI’s collateral management function is adequately staffed to ensure smooth

68

Cross-border collateral has at least one of the following foreign attributes: (a) the currency of denomination,(b) the jurisdiction in which the assets are located, or (c) the jurisdiction in which the issuer is established.

48

CPSS-IOSCO – Principles for financial market infrastructures – April 2012

operations, especially during times of market stress, and that all activities are tracked andreported, as appropriate, to senior management. 69
Reuse of collateral
3.5.10. Reuse of collateral refers to the FMI’s subsequent use of collateral that has been
provided by participants in the normal course of business. This differs from the FMI’s use ofcollateral in a default scenario during which the defaulter’s collateral, which has become theproperty of the FMI, can be used to access liquidity facilities or can be liquidated to coverlosses (see Principle 13 on participant-default rules and procedures). An FMI should haveclear and transparent rules regarding the reuse of collateral (see Principle 23 on disclosureof rules, key procedures, and market data). In particular, the rules should clearly specify
when an FMI may reuse its participant collateral and the process for returning that collateralto participants. In general, an FMI should not rely on the reuse of collateral as an instrument
for increasing or maintaining its profitability. However, an FMI may invest any cash collateral
received from participants on their behalf (see Principle 16 on custody and investment risks).

69

Information included in summary reports should incorporate information on the reuse of collateral and theterms of such reuse, including instrument, credit quality, and maturity. These reports should also track
concentration of individual collateral asset classes.

CPSS-IOSCO – Principles for financial market infrastructures – April 201249

Principle 6: Margin
A CCP should cover its credit exposures to its participants for all products through aneffective margin system that is risk-based and regularly reviewed.
Key considerations
1.

A CCP should have a margin system that establishes margin levels commensuratewith the risks and particular attributes of each product, portfolio, and market it
serves.

2.

A CCP should have a reliable source of timely price data for its margin system. A
CCP should also have procedures and sound valuation models for addressing
circumstances in which pricing data are not readily available or reliable.

3.

A CCP should adopt initial margin models and parameters that are risk-based andgenerate margin requirements sufficient to cover its potential future exposure toparticipants in the interval between the last margin collection and the close out of
positions following a participant default. Initial margin should meet an establishedsingle-tailed confidence level of at least 99 percent with respect to the estimateddistribution of future exposure. For a CCP that calculates margin at the portfolio
level, this requirement applies to each portfolio’s distribution of future exposure. For
a CCP that calculates margin at more-granular levels, such as at the subportfolio
level or by product, the requirement must be met for the corresponding distributionsof future exposure. The model should (a) use a conservative estimate of the time
horizons for the effective hedging or close out of the particular types of products
cleared by the CCP (including in stressed market conditions), (b) have anappropriate method for measuring credit exposure that accounts for relevant productrisk factors and portfolio effects across products, and (c) to the extent practicableand prudent, limit the need for destabilising, procyclical changes.

4.

A CCP should mark participant positions to market and collect variation margin atleast daily to limit the build-up of current exposures. A CCP should have theauthority and operational capacity to make intraday margin calls and payments, bothscheduled and unscheduled, to participants.

5.

In calculating margin requirements, a CCP may allow offsets or reductions inrequired margin across products that it clears or between products that it andanother CCP clear, if the risk of one product is significantly and reliably correlatedwith the risk of the other product. Where two or more CCPs are authorised to offer
cross-margining, they must have appropriate safeguards and harmonised overallrisk-management systems.

6.

A CCP should analyse and monitor its model performance and overall margin
coverage by conducting rigorous daily backtesting and at least monthly, and morefrequent where appropriate, sensitivity analysis. A CCP should regularly conduct anassessment of the theoretical and empirical properties of its margin model for all
products it clears. In conducting sensitivity analysis of the model’s coverage, a CCP
should take into account a wide range of parameters and assumptions that reflectpossible market conditions, including the most-volatile periods that have been
experienced by the markets it serves and extreme changes in the correlations
between prices.

7.

A CCP should regularly review and validate its margin system.

Explanatory note
3.6.1. An effective margining system is a key risk-management tool for a CCP to manage
the credit exposures posed by its participants’ open positions (see also Principle 4 on credit

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CPSS-IOSCO – Principles for financial market infrastructures – April 2012

risk). A CCP should collect margin, which is a deposit of collateral in the form of money,
securities, or other financial instruments to assure performance and to mitigate its credit
exposures for all products that it clears if a participant defaults (see also Principle 5 oncollateral). Margin systems typically differentiate between initial margin and variation
margin. 70 Initial margin is typically collected to cover potential changes in the value of eachparticipant’s position (that is, potential future exposure) over the appropriate close-out period
in the event the participant defaults. Calculating potential future exposure requires modelling
potential price movements and other relevant factors, as well as specifying the target degreeof confidence and length of the close-out period. Variation margin is collected and paid out toreflect current exposures resulting from actual changes in market prices. To calculate
variation margin, open positions are marked to current market prices and funds are typicallycollected from (or paid to) a counterparty to settle any losses (or gains) on those positions.
Margin requirements
3.6.2. One of the most common risk-management tools used by CCPs to limit their credit
exposure is a requirement that each participant provide collateral to protect the CCP against
a high percentile of the distribution of future exposure. In this report, such requirements aredescribed as margin requirements. Margining, however, is not the only risk-management tool
available to a CCP (see also Principle 4 on credit risk). In the case of some CCPs for cash
markets, the CCP may require each participant to provide collateral to cover credit
exposures; they may call these requirements margin, or they may hold this collateral in apool known as a clearing fund. 71
3.6.3. When setting margin requirements, a CCP should have a margin system that
establishes margin levels commensurate with the risks and particular attributes of eachproduct, portfolio, and market it serves. Product risk characteristics can include, but are notlimited to, price volatility and correlation, non-linear price characteristics, jump-to-default risk,
market liquidity, possible liquidation procedures (for example, tender by or commission tomarket-makers), and correlation between price and position such as wrong-way risk. 72
Margin requirements need to account for the complexity of the underlying instruments andthe availability of timely, high-quality pricing data. For example, OTC derivatives require
more-conservative margin models because of their complexity and the greater uncertainty of
the reliability of price quotes. Furthermore, the appropriate close-out period may vary amongproducts and markets depending upon the product’s liquidity, price, and other characteristics.
Additionally, a CCP for cash markets (or physically deliverable derivatives products) shouldtake into account the risk of “fails to deliver” of securities (or other relevant instruments) in its
margin methodology. In a fails-to-deliver scenario, the CCP should continue to margin
positions for which a participant fails to deliver the required security (or other relevant
instrument) on the settlement date.
Price information
3.6.4. A CCP should have a reliable source of timely price data because such data is
critical for a CCP’s margin system to operate accurately and effectively. In most cases, a
CCP should rely on market prices from continuous, transparent, and liquid markets. If a CCP
acquires pricing data from third-party pricing services, the CCP should continually evaluate
the data’s reliability and accuracy. A CCP should also have procedures and sound valuation

70

Variation margin may also be called mark-to-market margin or variation settlement in some jurisdictions.

71

For the purposes of this report, a clearing fund is a prefunded default arrangement.

72

Correlation should not be understood to be limited to linear correlation, but rather to encompass a broad rangeof co-dependence or co-movement in relevant economic variables.

CPSS-IOSCO – Principles for financial market infrastructures – April 201251

models for addressing circumstances in which pricing data from markets or third-party
sources are not readily available or reliable. A CCP should have its valuation models
validated under a variety of market scenarios at least annually by a qualified andindependent party to ensure that its model accurately produces appropriate prices, andwhere appropriate, the CCP should adjust its calculation of initial margin to reflect any
identified model risk. 73 A CCP should address all pricing and market liquidity concerns on an
ongoing basis in order to conduct daily measurement of its risks.
3.6.5. For some markets, such as OTC markets, prices may not be reliable because of thelack of a continuous liquid market. In contrast to an exchange-traded market, there may not
be a steady stream of live transactions from which to determine current market prices. 74
Although independent third-party sources would be preferable, in some cases, participants
may be an appropriate source of price data, as long as the CCP has a system that ensuresthat prices submitted by participants are reliable and accurately reflect the value of cleared
products. Moreover, even when quotes are available, bid-ask spreads may be volatile andwiden, particularly during times of market stress, thereby constraining the CCP’s ability tomeasure accurately and promptly its exposure. In cases where price data is not available orreliable, a CCP should analyse historical information about actual trades submitted forclearing and indicative prices, such as bid-ask spreads, as well as the reliability of price data,
especially in volatile and stressed markets, to determine appropriate prices. When prices are
estimated, the systems and models used for this purpose must be subject to annual
validation and testing.
Initial margin methodology
3.6.6. A CCP should adopt initial margin models and parameters that are risk-based andgenerate margin requirements that are sufficient to cover its potential future exposures toparticipants in the interval between the last margin collection and the close out of positions
following a participant default. Initial margin should meet an established single-tailed
confidence level of at least 99 percent with respect to the estimated distribution of future
exposure. 75 For a CCP that calculates margin at the portfolio level, this requirement applies
to each portfolio’s distribution of future exposure. For a CCP that calculates margin at moregranular levels, such as at the subportfolio level or by product, the requirement must be met
for the corresponding distributions of future exposure at a stage prior to margining among
subportfolios or products. The method selected by the CCP to estimate its potential future
exposure should be capable of measuring and incorporating the effects of price volatility andother relevant product factors and portfolio effects over a close-out period that reflects themarket size and dynamics for each product cleared by the CCP. 76 The estimation may
account for the CCP’s ability to implement effectively the hedging of future exposure. The
method selected by the CCP should take into account correlations across product prices,market liquidity for close out or hedging, and the potential for non-linear risk exposures
posed by certain products, including jump-to-default risks. A CCP should have the authority

73

Validation of the FMI’s valuation procedures should be performed by personnel with sufficient expertise whoare independent of the personnel that created and use the valuation procedures. These expert personnel
could be drawn from within the FMI. However, a review by personnel external to the FMI may also benecessary at times.

74

As of the date of this report’s publication, regulatory requirements regarding trading in OTC markets arecontinuing to evolve.

75This concept parallels the technical definition of potential future exposure as a risk measure. See footnote 42.

76

CCPs often calculate exposures for a shorter period, commonly one day, and, when necessary, scale up tocover the liquidation period. A CCP should be cautious when scaling because the standard square-root of timeheuristic is not appropriate for prices that are serially correlated or exhibit non-linear dynamics.

52

CPSS-IOSCO – Principles for financial market infrastructures – April 2012

and operational capacity to make intraday initial margin calls, both scheduled andunscheduled, to its participants.
3.6.7. Close-out period. A CCP should select an appropriate close-out period for eachproduct that it clears and document the close-out periods and related analysis for eachproduct type. A CCP should base its determination of the close-out periods for its initial
margin model upon historical price and liquidity data, as well as reasonably foreseeable
events in a default scenario. The close-out period should account for the impact of aparticipant’s default on prevailing market conditions. Inferences about the potential impact ofa default on the close-out period should be based on historical adverse events in the productcleared, such as significant reductions in trading or other market dislocations. The close-out
period should be based on anticipated close-out times in stressed market conditions but may
also take into account a CCP’s ability to hedge effectively the defaulter’s portfolio. Further,close-out periods should be set on a product-specific basis because less-liquid products
might require significantly longer close-out periods. A CCP should also consider and address
position concentrations, which can lengthen close-out timeframes and add to price volatility
during close outs.
3.6.8. Sample period for historical data used in the margin model. A CCP should select anappropriate sample period for its margin model to calculate required initial margin for eachproduct that it clears and should document the period and related analysis for each producttype. The amount of margin may be very sensitive to the sample period and the marginmodel. Selection of the period should be carefully examined based on the theoreticalproperties of the margin model and empirical tests on these properties using historical data.
In certain instances, a CCP may need to determine margin levels using a shorter historicalperiod to reflect new or current volatility in the market more effectively. Conversely, a CCP
may need to determine margin levels based on a longer historical period in order to reflect
past volatility. A CCP should also consider simulated data projections that would captureplausible events outside of the historical data especially for new products without enoughhistory to cover stressed market conditions.
3.6.9. Specific wrong-way risk. A CCP should identify and mitigate any credit exposurethat may give rise to specific wrong-way risk. Specific wrong-way risk arises where an
exposure to a counterparty is highly likely to increase when the creditworthiness of thatcounterparty is deteriorating. For example, participants in a CCP clearing credit-default
swaps should not be allowed to clear single-name credit-default swaps on their own names
or on the names of their legal affiliates. A CCP is expected to review its portfolio regularly inorder to identify, monitor, and mitigate promptly any exposures that give rise to specificwrong-way risk.
3.6.10. Limiting procyclicality. A CCP should appropriately address procyclicality in its
margin arrangements. In this context, procyclicality typically refers to changes in riskmanagement practices that are positively correlated with market, business, or credit cycle
fluctuations and that may cause or exacerbate financial instability. For example, in a periodof rising price volatility or credit risk of participants, a CCP may require additional initial
margin for a given portfolio beyond the amount required by the current margin model. This
could exacerbate market stress and volatility further, resulting in additional margin
requirements. These adverse effects may occur without any arbitrary change in riskmanagement practices. To the extent practicable and prudent, a CCP should adopt forwardlooking and relatively stable and conservative margin requirements that are specificallydesigned to limit the need for destabilising, procyclical changes. To support this objective, a
CCP could consider increasing the size of its prefunded default arrangements to limit theneed and likelihood of large or unexpected margin calls in times of market stress. 77 These77

See also CGFS, The role of margin requirements and haircuts in procyclicality, March 2010.

CPSS-IOSCO – Principles for financial market infrastructures – April 201253

procedures may create additional costs for CCPs and their participants in periods of low
market volatility due to higher margin or prefunded default arrangement contributions, butthey may also result in additional protection and potentially less costly and less disruptive
adjustments in periods of high market volatility. In addition, transparency regarding margin
practices when market volatility increases may help mitigate the effects of procyclicality.
Nevertheless, it may be impractical and even imprudent for a CCP to establish margin
requirements that are independent of significant or cyclical changes in price volatility.
Variation margin3.6.11. A CCP faces the risk that its exposure to its participants can change rapidly as aresult of changes in prices, positions, or both. Adverse price movements, as well as
participants building larger positions through new trading, can rapidly increase a CCP’s
exposures to its participants (although some markets may impose trading limits or position
limits that reduce this risk). A CCP can ascertain its current exposure to each participant bymarking each participant’s outstanding positions to current market prices. To the extent
permitted by a CCP’s rules and supported by law, the CCP should net any gains against any
losses and require frequent (at least daily) settlement of gains and losses. This settlement
should involve the daily (and, when appropriate, intraday) collection of variation margin fromparticipants whose positions have lost value and can include payments to participants whose
positions have gained value. The regular collection of variation margin prevents current
exposures from accumulating and mitigates the potential future exposures a CCP might face.
A CCP should also have the authority and operational capacity to make intraday variation
margin calls and payments, both scheduled and unscheduled, to its participants. A CCP
should consider the potential impact of its intraday variation margin collections and paymentson the liquidity position of its participants and should have the operational capacity to makeintraday variation margin payments.
Portfolio margining
3.6.12. In calculating margin requirements, a CCP may allow offsets or reductions inrequired margin amounts between products for which it is the counterparty if the risk of one
product is significantly and reliably correlated with the risk of another product. 78 A CCP
should base such offsets on an economically meaningful methodology that reflects thedegree of price dependence between the products. Often, price dependence is modelled
through correlations, but more complete or robust measures of dependence should beconsidered, particularly for non-linear products. In any case, the CCP should consider how
price dependence can vary with overall market conditions, including in stressed market
conditions. Following the application of offsets, the CCP needs to ensure that the margin
meets or exceeds the single-tailed confidence level of at least 99 percent with respect to theestimated distribution of the future exposure of the portfolio. If a CCP uses portfolio
margining, it should continuously review and test offsets among products. It should test therobustness of its portfolio method on both actual and appropriate hypothetical portfolios. It isespecially important to test how correlations perform during periods of actual and simulated
market stress to assess whether the correlations break down or otherwise behave erratically.
Prudent assumptions informed by these tests should be made about product offsets.
Cross-margining
3.6.13. Two or more CCPs may enter into a cross-margining arrangement, which is anagreement among the CCPs to consider positions and supporting collateral at their78

Effects on the value of positions in the two products will also depend on whether these positions are long or
short positions.

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CPSS-IOSCO – Principles for financial market infrastructures – April 2012

respective organisations as a common portfolio for participants that are members of two or
more of the organisations (see also Principle 20 on FMI links). The aggregate collateralrequirements for positions held in cross-margined accounts may be reduced if the value ofthe positions held at the separate CCPs move inversely in a significant and reliable fashion.
In the event of a participant default under a cross-margining arrangement, participating CCPs
may be allowed to use any excess collateral in the cross-margined accounts to cover losses.
3.6.14. CCPs that participate in cross-margining arrangements must share information
frequently and ensure that they have appropriate safeguards, such as joint monitoring of
positions, margin collections, and price information. Each CCP must thoroughly understandthe others’ respective risk-management practices and financial resources. The CCPs should
also have harmonised overall risk-management systems and should regularly monitor
possible discrepancies in the calculation of their exposures, especially with regard tomonitoring how price correlations perform over time. This harmonisation is especiallyrelevant in terms of selecting an initial margin methodology, setting margin parameters,
segregating accounts and collateral, and establishing default-management arrangements. Allof the precautions with regard to portfolio margining discussed above would apply to crossmargining regimes between or among CCPs. CCPs operating a cross-margining
arrangement should also analyse fully the impact of cross-margining on prefunded default
arrangements and on the adequacy of overall financial resources. The CCPs must have inplace arrangements that are legally robust and operationally viable to govern the crossmargining arrangement.
Testing margin coverage
3.6.15. A CCP should analyse and monitor its model performance and overall margin
coverage by conducting rigorous daily backtesting and at least monthly, and more-frequent
as appropriate, sensitivity analysis. A CCP also should regularly conduct an assessment of
the theoretical and empirical properties of its margin model for all products it clears. In orderto validate its margin models and parameters, a CCP should have a backtesting programmethat tests its initial margin models against identified targets. Backtesting is an ex-postcomparison of observed outcomes with the outputs of the margin models. A CCP should also
conduct sensitivity analysis to assess the coverage of the margin methodology under various
market conditions using historical data from realised stressed market conditions andhypothetical data for unrealised stressed market conditions. Sensitivity analysis should also
be used to determine the impact of varying important model parameters. Sensitivity analysis
is an effective tool to explore hidden shortcomings that cannot be discovered throughbacktesting. The results of both the backtesting and sensitivity analyses should be disclosed
to participants.
3.6.16. Backtesting. A CCP should backtest its margin coverage using participant positions
from each day in order to evaluate whether there are any exceptions to its initial margin
coverage. This assessment of margin coverage should be considered an integral part of theevaluation of the model’s performance. Coverage should be evaluated across products andparticipants and take into account portfolio effects across asset classes within the CCP. The
initial margin model’s actual coverage, along with projected measures of its performance,
should meet at least the established single-tailed confidence level of 99 percent with respect
to the estimated distribution of future exposure over an appropriate close-out period. 79 In
case backtesting indicates that the model did not perform as expected (that is, the model did
not identify the appropriate amount of initial margin necessary to achieve the intended

79

This period should be appropriate to capture the risk characteristics of the specific instrument in order to allow
the CCP to estimate the magnitude of the price changes expected to occur in the interval between the last
margin collection and the time the CCP estimates it will be able to close out the relevant positions.

CPSS-IOSCO – Principles for financial market infrastructures – April 201255

coverage), a CCP should have clear procedures for recalibrating its margining system, suchas by making adjustments to parameters and sampling periods. In addition, a CCP should
evaluate the source of backtesting exceedances to determine if a fundamental change to themargin methodology is warranted or if only the recalibration of current parameters isnecessary. Backtesting procedures alone are not sufficient to evaluate the effectiveness ofmodels and adequacy of financial resources against forward-looking risks.
3.6.17. Sensitivity analysis. A CCP should test the sensitivity of its margin model coverageusing a wide range of parameters and assumptions that reflect possible market conditions inorder to understand how the level of margin coverage might be affected by highly stressedmarket conditions. The FMI should ensure that the range of parameters and assumptions
captures a variety of historical and hypothetical conditions, including the most-volatile periods
that have been experienced by the markets it serves and extreme changes in thecorrelations between prices. The CCP should conduct sensitivity analysis on its marginmodel coverage at least monthly using the results of these sensitivity tests and conduct athorough analysis of the potential losses it could suffer. A CCP should evaluate the potential
losses in individual participants’ positions and, where appropriate, their customers’ positions.
Furthermore, for a CCP clearing credit instruments, parameters reflective of thesimultaneous default of both participants and the underlying credit instruments should beconsidered. Sensitivity analysis should be performed on both actual and simulated positions.
Rigorous sensitivity analysis of margin requirements may take on increased importancewhen markets are illiquid or volatile. This analysis should be conducted more frequently
when markets are unusually volatile or less liquid or when the size or concentration of
positions held by its participants increases significantly.
Validation of the margin methodology
3.6.18. A CCP should regularly review and validate its margin system. A CCP’s margin
methodology should be reviewed and validated by a qualified and independent party at least
annually, or more frequently if there are material market developments. Any material
revisions or adjustments to the methodology or parameters should be subject to appropriate
governance processes (see also Principle 2 on governance) and validated prior to
implementation. CCPs operating a cross-margining arrangement should also analyse theimpact of cross-margining on prefunded default arrangements and evaluate the adequacy ofoverall financial resources. Also, the margin methodology, including the initial margin models
and parameters used by a CCP, should be made as transparent as possible. At a minimum,
the basic assumptions of the analytical method selected and the key data inputs should be
disclosed to participants. Ideally, a CCP would make details of its margin methodology
available to its participants for use in their individual risk-management efforts.
Timeliness and possession of margin payments
3.6.19. A CCP should establish and rigorously enforce timelines for margin collections andpayments and set appropriate consequences for failure to pay on time. A CCP withparticipants in a range of time zones may need to adjust its procedures for margining(including the times at which it makes margin calls) to take into account the liquidity of aparticipant’s local funding market and the operating hours of relevant payment andsettlement systems. Margin should be held by the CCP until the exposure has been
extinguished; that is, margin should not be returned before settlement is successfully
concluded.

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Principle 7: Liquidity risk
An FMI should effectively measure, monitor, and manage its liquidity risk. An FMI
should maintain sufficient liquid resources in all relevant currencies to effect sameday and, where appropriate, intraday and multiday settlement of payment obligations
with a high degree of confidence under a wide range of potential stress scenarios thatshould include, but not be limited to, the default of the participant and its affiliates thatwould generate the largest aggregate liquidity obligation for the FMI in extreme but
plausible market conditions.
Key considerations
1.

An FMI should have a robust framework to manage its liquidity risks from its
participants, settlement banks, nostro agents, custodian banks, liquidity providers,and other entities.

2.

An FMI should have effective operational and analytical tools to identify, measure,and monitor its settlement and funding flows on an ongoing and timely basis,including its use of intraday liquidity.

3.

A payment system or SSS, including one employing a DNS mechanism, should
maintain sufficient liquid resources in all relevant currencies to effect same-day
settlement, and where appropriate intraday or multiday settlement, of payment
obligations with a high degree of confidence under a wide range of potential stressscenarios that should include, but not be limited to, the default of the participant andits affiliates that would generate the largest aggregate payment obligation in extreme
but plausible market conditions.

4.

A CCP should maintain sufficient liquid resources in all relevant currencies to settle
securities-related payments, make required variation margin payments, and meetother payment obligations on time with a high degree of confidence under a wide
range of potential stress scenarios that should include, but not be limited to, thedefault of the participant and its affiliates that would generate the largest aggregate
payment obligation to the CCP in extreme but plausible market conditions. In
addition, a CCP that is involved in activities with a more-complex risk profile or thatis systemically important in multiple jurisdictions should consider maintaining
additional liquidity resources sufficient to cover a wider range of potential stressscenarios that should include, but not be limited to, the default of the twoparticipants and their affiliates that would generate the largest aggregate payment
obligation to the CCP in extreme but plausible market conditions.

5.

For the purpose of meeting its minimum liquid resource requirement, an FMI’s
qualifying liquid resources in each currency include cash at the central bank of issue
and at creditworthy commercial banks, committed lines of credit, committed foreignexchange swaps, and committed repos, as well as highly marketable collateral heldin custody and investments that are readily available and convertible into cash withprearranged and highly reliable funding arrangements, even in extreme but plausible
market conditions. If an FMI has access to routine credit at the central bank of issue,
the FMI may count such access as part of the minimum requirement to the extent it
has collateral that is eligible for pledging to (or for conducting other appropriate
forms of transactions with) the relevant central bank. All such resources should beavailable when needed.

6.

An FMI may supplement its qualifying liquid resources with other forms of liquid
resources. If the FMI does so, then these liquid resources should be in the form ofassets that are likely to be saleable or acceptable as collateral for lines of credit,
swaps, or repos on an ad hoc basis following a default, even if this cannot be
reliably prearranged or guaranteed in extreme market conditions. Even if an FMI

CPSS-IOSCO – Principles for financial market infrastructures – April 201257

does not have access to routine central bank credit, it should still take account ofwhat collateral is typically accepted by the relevant central bank, as such assets
may be more likely to be liquid in stressed circumstances. An FMI should notassume the availability of emergency central bank credit as a part of its liquidity
plan.
7.

An FMI should obtain a high degree of confidence, through rigorous due diligence,that each provider of its minimum required qualifying liquid resources, whether aparticipant of the FMI or an external party, has sufficient information to understandand to manage its associated liquidity risks, and that it has the capacity to perform
as required under its commitment. Where relevant to assessing a liquidity provider’sperformance reliability with respect to a particular currency, a liquidity provider’spotential access to credit from the central bank of issue may be taken into account.
An FMI should regularly test its procedures for accessing its liquid resources at aliquidity provider.

8.

An FMI with access to central bank accounts, payment services, or securities
services should use these services, where practical, to enhance its management ofliquidity risk.

9.

An FMI should determine the amount and regularly test the sufficiency of its liquid
resources through rigorous stress testing. An FMI should have clear procedures toreport the results of its stress tests to appropriate decision makers at the FMI and touse these results to evaluate the adequacy of and adjust its liquidity riskmanagement framework. In conducting stress testing, an FMI should consider awide range of relevant scenarios. Scenarios should include relevant peak historic
price volatilities, shifts in other market factors such as price determinants and yield
curves, multiple defaults over various time horizons, simultaneous pressures infunding and asset markets, and a spectrum of forward-looking stress scenarios in avariety of extreme but plausible market conditions. Scenarios should also take into
account the design and operation of the FMI, include all entities that might posematerial liquidity risks to the FMI (such as settlement banks, nostro agents,
custodian banks, liquidity providers, and linked FMIs), and where appropriate, covera multiday period. In all cases, an FMI should document its supporting rationale for,and should have appropriate governance arrangements relating to, the amount andform of total liquid resources it maintains.

10.

An FMI should establish explicit rules and procedures that enable the FMI to effectsame-day and, where appropriate, intraday and multiday settlement of payment
obligations on time following any individual or combined default among its
participants. These rules and procedures should address unforeseen and potentially
uncovered liquidity shortfalls and should aim to avoid unwinding, revoking, ordelaying the same-day settlement of payment obligations. These rules andprocedures should also indicate the FMI’s process to replenish any liquidity
resources it may employ during a stress event, so that it can continue to operate in asafe and sound manner.

Explanatory note
3.7.1. Liquidity risk arises in an FMI when it, its participants, or other entities cannot settle
their payment obligations when due as part of the clearing or settlement process. Dependingon the design of an FMI, liquidity risk can arise between the FMI and its participants,
between the FMI and other entities (such as its settlement banks, nostro agents, custodianbanks, and liquidity providers), or between participants in an FMI (such as in a DNS payment
system or SSS). It is particularly important for an FMI to manage carefully its liquidity risk if,
as is typical in many systems, the FMI relies on incoming payments from participants or otherentities during the settlement process in order to make payments to other participants. If a58

CPSS-IOSCO – Principles for financial market infrastructures – April 2012

participant or another entity fails to pay the FMI, the FMI may not have sufficient funds tomeet its payment obligations to other participants. In such an event, the FMI would need torely on its own liquidity resources (that is, liquid assets and prearranged funding
arrangements) to cover the funds shortfall and complete settlement. An FMI should have arobust framework to manage its liquidity risks from the full range of participants and otherentities. In some cases, a participant may play other roles within the FMI, such as asettlement or custodian bank or liquidity provider. These other roles should be considered indetermining an FMI’s liquidity needs.
Sources of liquidity risk
3.7.2. An FMI should clearly identify its sources of liquidity risk and assess its current andpotential future liquidity needs on a daily basis. An FMI can face liquidity risk from the default
of a participant. For example, if an FMI extends intraday credit, implicitly or explicitly, toparticipants, such credit, even when fully collateralised, may create liquidity pressure in theevent of a participant default. The FMI might not be able to convert quickly the defaulting
participant’s collateral into cash at short notice. If an FMI does not have sufficient cash tomeet all of its payment obligations to participants, there will be a settlement failure. An FMI
can also face liquidity risk from its settlement banks, nostro agents, custodian banks, andliquidity providers, as well as linked FMIs and service providers, if they fail to perform as
expected. Moreover, as noted above, an FMI may face additional risk from entities that havemultiple roles within the FMI (for example, a participant that also serves as the FMI’s
settlement bank or liquidity provider). These interdependencies and the multiple roles that anentity may serve within an FMI should be taken into account by the FMI.
3.7.3. An FMI that employs a DNS mechanism may create direct liquidity exposures
between participants. For example, in a payment system that uses a multilateral net
settlement mechanism, participants may face liquidity exposures to each other if one of theparticipants fails to meet its obligations. Similarly, in an SSS that uses a DvP model 2 or 3
settlement mechanism and does not guarantee settlement, participants may face liquidity
exposures to each other if one of the participants fails to meet its obligations. 80 A longstanding concern is that these types of systems may address a potential settlement failure by
unwinding transfers involving the defaulting participant. 81 An unwind imposes liquidity
pressures (and, potentially, replacement costs) on the non-defaulting participants. If all suchtransfers must be deleted, and if the unwind occurs at a time when money markets andsecurities lending markets are illiquid (for example, at or near the end of the day), theremaining participants could be confronted with shortfalls of funds or securities that would be
extremely difficult to cover. The potential total liquidity pressure of unwinding could be equal
to the gross value of the netted transactions.
Measuring and monitoring liquidity risk
3.7.4. An FMI should have effective operational and analytical tools to identify, measure,and monitor its settlement and funding flows on an ongoing and timely basis, including its
use of intraday liquidity. In particular, an FMI should understand and assess the value andconcentration of its daily settlement and funding flows through its settlement banks, nostro
agents, and other intermediaries. An FMI also should be able to monitor on a daily basis thelevel of liquid assets (such as cash, securities, other assets held in custody, andinvestments) that it holds. An FMI should be able to determine the value of its available liquid80

See also Annex D on summary of designs of payment systems, SSSs, and CCPs, and CPSS, Delivery versus
payment in securities settlement systems, September 1992.

81

Unwinding involves deleting some or all of the defaulting participant’s provisional funds transfers and, in an
SSS, securities transfers and then recalculating the settlement obligations of the other participants.

CPSS-IOSCO – Principles for financial market infrastructures – April 201259

assets, taking into account the appropriate haircuts on those assets (see Principle 5 oncollateral and Principle 6 on margin). In a DNS system, the FMI should provide sufficient
information and analytical tools to help its participants measure and monitor their liquidity
risks in the FMI.
3.7.5. If an FMI maintains prearranged funding arrangements, the FMI should also identify,
measure, and monitor its liquidity risk from the liquidity providers of those arrangements. An
FMI should obtain a high degree of confidence through rigorous due diligence that eachliquidity provider, whether or not it is a participant in the FMI, would have the capacity toperform as required under the liquidity arrangement and is subject to commensurate
regulation, supervision, or oversight of its liquidity risk-management requirements. Where
relevant to assessing a liquidity provider's performance reliability with respect to a particularcurrency, the liquidity provider’s potential access to credit from the relevant central bank may
be taken into account.
Managing liquidity risk
3.7.6. An FMI should also regularly assess its design and operations to manage liquidity
risk in the system. An FMI that employs a DNS mechanism may be able to reduce its or its
participants’ liquidity risk by using alternative settlement designs, such as new RTGS designs
with liquidity-saving features or a continuous or extremely frequent batch settlement system.
In addition, it could reduce the liquidity demands of its participants by providing participants
with sufficient information or control systems to help them manage their liquidity needs andrisks. Furthermore, an FMI should ensure that it is operationally ready to manage the liquidity
risk caused by participants’ or other entities’ financial or operational problems. Among otherthings, the FMI should have the operational capacity to reroute payments, where feasible, on
a timely basis in case of problems with a correspondent bank.
3.7.7. An FMI has other risk-management tools that it can use to manage its or, where
relevant, its participants’ liquidity risk. To mitigate and manage liquidity risk stemming from aparticipant default, an FMI could use, either individually or in combination, exposure limits,collateral requirements, and prefunded default arrangements. To mitigate and manage
liquidity risks from the late-day submission of payments or other transactions, an FMI could
adopt rules or financial incentives for timely submission. To mitigate and manage liquidity risk
stemming from a service provider or a linked FMI, an FMI could use, individually or in
combination, selection criteria, concentration or exposure limits, and collateral requirements.
For example, an FMI should seek to manage or diversify its settlement flows and liquid
resources to avoid excessive intraday or overnight exposure to one entity. This, however,may involve trade-offs between the efficiency of relying on an entity and the risks of being
overly dependent on that entity. These tools are often also used by an FMI to manage its
credit risk.
Maintaining sufficient liquid resources for payment systems and SSSs
3.7.8. An FMI should ensure that it has sufficient liquid resources, as determined byregular and rigorous stress testing, to effect settlement of payment obligations with a highdegree of confidence under a wide range of potential stress scenarios. A payment system or
SSS, including one employing a DNS mechanism, should maintain sufficient liquid resourcesin all relevant currencies to effect same-day and, where appropriate, intraday or multiday
settlement of payment obligations with a high degree of confidence under a wide range ofpotential stress scenarios that should include, but not be limited to, the default of theparticipant and its affiliates that would generate the largest aggregate payment obligation in
extreme but plausible market conditions. In some instances, a payment system or SSS mayneed to have sufficient liquid resources to effect settlement of payment obligations overmultiple days to account for any potential liquidation of collateral that is outlined in the FMI’s
participant-default procedures.

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Maintaining sufficient liquid resources for CCPs
3.7.9. Similarly, a CCP should maintain sufficient liquid resources in all relevant currencies
to settle securities-related payment obligations, make required variation margin payments,and meet other payment obligations on time with a high degree of confidence under a wide
range of potential stress scenarios that should include, but not be limited to, the default of theparticipant and its affiliates that would generate the largest aggregate payment obligation to
the CCP in extreme but plausible market conditions. In addition, a CCP that is involved in
activities with a more-complex risk profile or that is systemically important in multiple
jurisdictions should consider maintaining additional liquidity resources sufficient to cover a
wider range of potential stress scenarios that should include, but not be limited to, the defaultof the two participants and their affiliates that would generate the largest aggregate payment
obligation to the CCP in extreme but plausible market conditions. The CCP should carefully
analyse its liquidity needs, and the analysis is expected to be reviewed by the relevant
authorities. In many cases, a CCP may need to maintain sufficient liquid resources to meetpayments to settle required margin and other payment obligations over multiple days toaccount for multiday hedging and close-out activities as directed by the CCP’s participantdefault procedures.
Liquid resources for meeting the minimum requirement
3.7.10. For the purpose of meeting its minimum liquid resource requirement, an FMI’s
qualifying liquid resources in each currency include cash at the central bank of issue and at
creditworthy commercial banks, committed lines of credit, committed foreign exchange
swaps, and committed repos, as well as highly marketable collateral held in custody andinvestments that are readily available and convertible into cash with prearranged and highly
reliable funding arrangements, even in extreme but plausible market conditions. If an FMI
has access to routine credit at the central bank of issue, the FMI may count such access as
part of the minimum requirement to the extent it has collateral that is eligible for pledging to(or for conducting other appropriate forms of transactions with) the relevant central bank. Allsuch resources should be available when needed. However, such access does not eliminate
the need for sound risk-management practices and adequate access to private-sector
liquidity resources. 82
Other liquid resources
3.7.11. An FMI may supplement its qualifying liquid resources with other forms of liquid
resources. If the FMI does so, then these liquid resources should be in the form of assetsthat are likely to be saleable or acceptable as collateral for lines of credit, swaps, or repos onan ad hoc basis following a default, even if this cannot be reliably prearranged or guaranteed
in extreme market conditions. An FMI may consider using such resources within its liquidity
risk management framework in advance of, or in addition to, using its qualifying liquid
resources. This may be particularly beneficial where liquidity needs exceed qualifying liquid
resources, where qualifying liquid resources can be preserved to cover a future default, or
where using other liquid resources would cause less liquidity dislocation to the FMI's
participants and the financial system as a whole. Even if an FMI does not have access toroutine central bank credit, it should take account of what collateral is typically accepted by
the relevant central bank of issue, as such assets may be more likely to be liquid in stressed
circumstances. In any case, an FMI should not assume the availability of emergency central
bank credit as a part of its liquidity plan.

82

The authority or authorities with primary responsibility for an FMI will assess the adequacy of an FMI’s liquidity
risk-management procedures, considering the views of the central banks of issue in accordance with
Responsibility E.

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Assessing liquidity providers
3.7.12. If an FMI has prearranged funding arrangements, the FMI should obtain a highdegree of confidence, through rigorous due diligence, that each provider of its minimum
required qualifying liquid resources, whether a participant of the FMI or an external party, has
sufficient information to understand and to manage its associated liquidity risks, and that it
has the capacity to perform as required under its commitment. Where relevant to assessing aliquidity provider's performance reliability with respect to a particular currency, a liquidity
provider’s potential access to credit from the central bank of issue may be taken into
account. Additionally, an FMI should adequately plan for the renewal of prearranged funding
arrangements with liquidity providers in advance of their expiration.
Procedures regarding the use of liquid resources
3.7.13. An FMI should have detailed procedures for using its liquid resources to complete
settlement during a liquidity shortfall. An FMI’s procedures should clearly document thesequence for using each type of liquid resource (for example, the use of certain assets
before prearranged funding arrangements). These procedures may include instructions foraccessing cash deposits or overnight investments of cash deposits, executing same-day
market transactions, or drawing on prearranged liquidity lines. In addition, an FMI should
regularly test its procedures for accessing its liquid resources at a liquidity provider, including
by activating and drawing down test amounts from committed credit facilities and by testing
operational procedures for conducting same-day repos.
Central bank services 83
3.7.14. If an FMI has access to central bank accounts, payment services, securities
services, or collateral management services, it should use these services, where practical, toenhance its management of liquidity risk. Cash balances at the central bank of issue, forexample, offer the highest liquidity (see Principle 9 on money settlements).
Stress testing of liquidity needs and resources
3.7.15. An FMI should determine the amount and regularly test the sufficiency of its liquid
resources through rigorous stress testing. An FMI should have clear procedures to report theresults of its stress tests to appropriate decision makers at the FMI and to use these resultsto evaluate the adequacy of and adjust its liquidity risk-management framework. In
conducting stress testing, an FMI should consider a wide range of relevant scenarios.
Scenarios should include relevant peak historic price volatilities, shifts in other market factors
such as price determinants and yield curves, multiple defaults over various time horizons,
simultaneous pressures in funding and asset markets, and a spectrum of forward-looking
stress scenarios in a variety of extreme but plausible market conditions. 84 Scenarios should
also consider the design and operation of the FMI, include all entities that might posematerial liquidity risks to the FMI (such as settlement banks, nostro agents, custodian banks,
liquidity providers, and linked FMIs), and where appropriate, cover a multiday period. An FMI
should also consider any strong inter-linkages or similar exposures between its participants,
as well as the multiple roles that participants may play with respect to the risk managementof the FMI, and assess the probability of multiple failures and the contagion effect among its
participants that such failures may cause.

83

The use of central bank services or credit is subject to the relevant legal framework and the policies anddiscretion of the relevant central bank.

84

See BCBS, Principles for sound stress testing practices and supervision, May 2009.

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3.7.16. Reverse stress tests. An FMI should conduct, as appropriate, reverse stress tests
aimed at identifying the extreme default scenarios and extreme market conditions for which the
FMI’s liquid resources would be insufficient. In other words, these tests identify how severe
stress conditions would be covered by the FMI’s liquid resources. An FMI should judge whether
it would be prudent to prepare for these severe conditions and various combinations of factors
influencing these conditions. Reverse stress tests require an FMI to model extreme market
conditions that may go beyond what are considered extreme but plausible market conditions inorder to help understand the sufficiency of liquid resources given the underlying assumptions
modelled. Modelling extreme market conditions can help an FMI determine the limits of its
current model and resources; however, it requires the FMI to exercise judgment when modelling
different markets and products. An FMI should develop hypothetical extreme scenarios andmarket conditions tailored to the specific risks of the markets and of the products it serves.
Reverse stress tests should be considered a helpful risk-management tool but they need not,necessarily, drive an FMI’s determination of the appropriate level of liquid resources.
3.7.17. Frequency of stress testing. Liquidity stress testing should be performed on a daily
basis using standard and predetermined parameters and assumptions. In addition, on atleast a monthly basis, an FMI should perform a comprehensive and thorough analysis ofstress testing scenarios, models, and underlying parameters and assumptions used toensure they are appropriate for achieving the FMI’s identified liquidity needs and resources inlight of current and evolving market conditions. An FMI should perform stress testing more
frequently when markets are unusually volatile, when they are less liquid, or when the size orconcentration of positions held by its participants increases significantly. A full validation of
an FMI’s liquidity risk-management model should be performed at least annually.
Contingency planning for uncovered liquidity shortfalls
3.7.18. In certain extreme circumstances, the liquid resources of an FMI or its participants may
not be sufficient to meet the payment obligations of the FMI to its participants or the payment
obligations of participants to each other within the FMI. 85 In a stressed environment, forexample, normally liquid assets held by an FMI may not be sufficiently liquid to obtain same-day
funding, or the liquidation period may be longer than expected. An FMI should establish explicit
rules and procedures that enable the FMI to effect same-day, and where appropriate, intraday
and multiday settlement of payment obligations on time following any individual or combined
default among its participants. These rules and procedures should address unforeseen andpotentially uncovered liquidity shortfalls and should aim to avoid unwinding, revoking, ordelaying the same-day settlement of payment obligations. These rules and procedures should
also indicate the FMI’s process to replenish any liquidity resources it may employ during a
stress event, so that it can continue to operate in a safe and sound manner.
3.7.19. If an FMI allocates potentially uncovered liquidity shortfalls to its participants, theFMI should have clear and transparent rules and procedures for the allocation of shortfalls.
These procedures could involve a funding arrangement between the FMI and its participants,
the mutualisation of shortfalls among participants according to a clear and transparent
formula, or the use of liquidity rationing (for example, reductions in payouts to participants).
Any allocation rule or procedure must be discussed thoroughly with and communicatedclearly to participants, as well as be consistent with participants’ respective regulatory
liquidity risk-management requirements. Furthermore, an FMI should consider and validate,through simulations and other techniques and through discussions with each participant, thepotential impact on each participant of any such same-day allocation of liquidity risk andeach participant’s ability to bear proposed liquidity allocations.

85

These exceptional circumstances could arise from unforeseen operational problems or unanticipated rapidchanges in market conditions.

CPSS-IOSCO – Principles for financial market infrastructures – April 201263

Settlement
A key risk that an FMI faces is settlement risk, which is the risk that settlement will not takeplace as expected. An FMI faces this risk whether settlement of a transaction occurs on the
FMI’s books, on the books of another FMI, or on the books of an external party (for example,
a central bank or a commercial bank). The following set of principles provides guidance on(a) settlement finality, (b) money settlements, and (c) physical deliveries.
Principle 8: Settlement finality
An FMI should provide clear and certain final settlement, at a minimum by the end of
the value date. Where necessary or preferable, an FMI should provide final settlement
intraday or in real time.
Key considerations
1.

An FMI’s rules and procedures should clearly define the point at which settlement isfinal.

2.

An FMI should complete final settlement no later than the end of the value date, andpreferably intraday or in real time, to reduce settlement risk. An LVPS or SSS should
consider adopting RTGS or multiple-batch processing during the settlement day.

3.

An FMI should clearly define the point after which unsettled payments, transfer
instructions, or other obligations may not be revoked by a participant.

Explanatory note
3.8.1. An FMI should be designed to provide clear and certain final settlement of
payments, transfer instructions, or other obligations. Final settlement is defined as theirrevocable and unconditional transfer of an asset or financial instrument, or the discharge ofan obligation by the FMI or its participants in accordance with the terms of the underlying
contract. 86 A payment, transfer instruction, or other obligation that an FMI accepts forsettlement in accordance with its rules and procedures should be settled with finality on theintended value date. 87 The value date is the day on which the payment, transfer instruction,or other obligation is due and the associated funds and securities are typically available to
the receiving participant. 88 Completing final settlement by the end of the value date isimportant because deferring final settlement to the next-business day can create both credit
and liquidity pressures for an FMI’s participants and other stakeholders, and potentially be asource of systemic risk. Where necessary or preferable, an FMI should provide intraday orreal-time settlement finality to reduce settlement risk.
3.8.2. Although some FMIs guarantee settlement, this principle does not necessarily
require an FMI to provide such a guarantee. Instead, this principle requires FMIs to clearly
define the point at which the settlement of a payment, transfer instruction, or other obligation
is final, and to complete the settlement process no later than the end of the value date, and86

Final settlement (or settlement finality) is a legally defined moment. See also Principle 1 on legal basis.

87

The value date of an FMI’s settlement activity might not necessarily coincide with the exact calendar date if
the FMI introduces night-time settlement.

88

This principle is not intended to discourage an FMI from offering a facility for entering transaction details in
advance of the value date.

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preferably earlier in the value date. Similarly, this principle is not intended to eliminate fails todeliver in securities trades. 89 The occurrence of non-systemic amounts of such failures,
although potentially undesirable, should not by itself be interpreted as a failure to satisfy thisprinciple. 90 However, an FMI should take steps to mitigate both the risks and the implicationsof such failures to deliver securities (see Principle 4 on credit risk, Principle 7 on liquidity risk,
and other relevant principles).
Final settlement
3.8.3. An FMI’s rules and procedures should clearly define the point at which settlement isfinal. A clear definition of when settlements are final also greatly assists in a resolution
scenario such that the positions of the participant in resolution and other affected parties canbe quickly ascertained.
3.8.4. An FMI’s legal framework and rules generally determine finality. The legal basis
governing the FMI, including the insolvency law, must acknowledge the discharge of apayment, transfer instruction, or other obligation between the FMI and system participants, or
between or among participants, for the transaction to be considered final. An FMI should takereasonable steps to confirm the effectiveness of cross-border recognition and protection ofcross-system settlement finality, especially when it is developing plans for recovery or orderly
wind-down or providing relevant authorities information relating to its resolvability. Becauseof the complexity of legal frameworks and system rules, particularly in the context of crossborder settlement where legal frameworks are not harmonised, a well-reasoned legal opinion
is generally necessary to establish the point at which finality takes place (see also Principle 1
on legal basis).
Same-day settlement
3.8.5. An FMI’s processes should be designed to complete final settlement, at a minimum
no later than the end of the value date. This means that any payment, transfer instruction, orother obligation that has been submitted to and accepted by an FMI in accordance with its
risk management and other relevant acceptance criteria should be settled on the intended
value date. An FMI that is not designed to provide final settlement on the value date (orsame-day settlement) would not satisfy this principle, even if the transaction’s settlement
date is adjusted back to the value date after settlement. This is because, in most of sucharrangements, there is no certainty that final settlement will occur on the value date as
expected. Further, deferral of final settlement to the next-business day can entail overnightrisk exposures. For example, if an SSS or CCP conducts its money settlements using
instruments or arrangements that involve next-day settlement, a participant’s default on its
settlement obligations between the initiation and finality of settlement could pose significant
credit and liquidity risks to the FMI and its other participants. 91
Intraday settlement
3.8.6. Depending on the type of obligations that an FMI settles, the use of intraday
settlement, either in multiple batches or in real time, may be necessary or desirable to reduce

89

These fails typically occur because of miscommunication between the counterparties, operational problems inthe delivery of securities, or failure to acquire a specific security associated with the trade by a specific point in
time.

90

In certain markets, participants may have adopted the convention of rescheduling delivery until the trade
finally settles.

91

In most cases, next-day settlements over weekend periods involve multi-day settlement risk.

CPSS-IOSCO – Principles for financial market infrastructures – April 201265

settlement risk. 92 As such, some types of FMIs, such as LVPSs and SSSs, should consider
adopting RTGS or multiple-batch settlement to complete final settlement intraday. RTGS is
the real-time settlement of payments, transfer instructions, or other obligations individually on
a transaction-by-transaction basis. Batch settlement is the settlement of groups of payments,
transfer instructions, or other obligations together at one or more discrete, often pre-specified
times during the processing day. With batch settlement, the time between the acceptanceand final settlement of transactions should be kept short. 93 To speed up settlements, an FMI
should encourage its participants to submit transactions promptly. To validate the finality ofsettlement, an FMI also should inform its participants of their final account balances and,
where practical, settlement date and time as quickly as possible, preferably in real time. 94
3.8.7. The use of multiple-batch settlement and RTGS involves different trade-offs.
Multiple-batch settlement based on a DNS mechanism, for example, may expose
participants to settlement risks for the period during which settlement is deferred. Theserisks, if not sufficiently controlled, could result in the inability of one or more participants tomeet their financial obligations. Conversely, while an RTGS system can mitigate or eliminate
these settlement risks, it requires participants to have sufficient liquidity to cover all theiroutgoing payments and can therefore require relatively large amounts of intraday liquidity.
This liquidity can come from various sources, including balances at a central bank orcommercial bank, incoming payments, and intraday credit. An RTGS system may be able toreduce its liquidity needs by implementing a queuing facility or other liquidity-saving
mechanisms. 95
Revocation of unsettled payments, transfer instructions, or other obligations
3.8.8. An FMI should clearly define the point after which unsettled payments, transfer
instructions, or other obligations may not be revoked by a participant. In general, an FMI
should prohibit the unilateral revocation of accepted and unsettled payments, transfer
instructions, or other obligations after a certain point or time in the settlement day, so as to
avoid creating liquidity risks. In all cases, cutoff times and materiality rules for exceptions
should be clearly defined. The rules should make clear that changes to operating hours are
exceptional and require individual justifications. For example, an FMI may want to permit
extensions for reasons connected with the implementation of monetary policy or widespread
financial market disruption. If extensions are allowed for participants with operating problems
to complete processing, the rules governing the approval and duration of such extensions
should be clear to participants.

92

For example, intraday or real-time finality is sometimes necessary for monetary policy or payments operations,settlement of back-to-back transactions, intraday margin calls by CCPs, or safe and efficient cross-border links
between CSDs that perform settlement functions.

93

Transactions, in certain circumstances, may be settled on a gross basis although through multiple batches
during the operating day.

94

Nominal value date might not necessarily coincide with local settlement date.

95

See also CPSS, New developments in large value payment systems, May 2005.

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Principle 9: Money settlements
An FMI should conduct its money settlements in central bank money where practicaland available. If central bank money is not used, an FMI should minimise and strictly
control the credit and liquidity risk arising from the use of commercial bank money.
Key considerations
1.

An FMI should conduct its money settlements in central bank money, wherepractical and available, to avoid credit and liquidity risks.

2.

If central bank money is not used, an FMI should conduct its money settlements
using a settlement asset with little or no credit or liquidity risk.

3.

If an FMI settles in commercial bank money, it should monitor, manage, and limit its
credit and liquidity risks arising from the commercial settlement banks. In particular,
an FMI should establish and monitor adherence to strict criteria for its settlementbanks that take account of, among other things, their regulation and supervision,creditworthiness, capitalisation, access to liquidity, and operational reliability. An FMI
should also monitor and manage the concentration of credit and liquidity exposures
to its commercial settlement banks.

4.

If an FMI conducts money settlements on its own books, it should minimise andstrictly control its credit and liquidity risks.

5.

An FMI’s legal agreements with any settlement banks should state clearly whentransfers on the books of individual settlement banks are expected to occur, thattransfers are to be final when effected, and that funds received should betransferable as soon as possible, at a minimum by the end of the day and ideallyintraday, in order to enable the FMI and its participants to manage credit andliquidity risks.

Explanatory note
3.9.1. An FMI typically needs to conduct money settlements with or between its
participants for a variety of purposes, such as the settlement of individual payment
obligations, funding and defunding activities, and the collection and distribution of margin
payments. 96 To conduct such money settlements, an FMI can use central bank money orcommercial bank money. Central bank money is a liability of a central bank, in this case in
the form of deposits held at the central bank, which can be used for settlement purposes.
Settlement in central bank money typically involves the discharge of settlement obligations
on the books of the central bank of issue. Commercial bank money is a liability of acommercial bank, in the form of deposits held at the commercial bank, which can be used forsettlement purposes. Settlement in commercial bank money typically occurs on the books ofa commercial bank. In this model, an FMI typically establishes an account with one or morecommercial settlement banks and requires each of its participants to establish an accountwith one of them. In some cases, the FMI itself can serve as the settlement bank. Money
settlements are then effected through accounts on the books of the FMI, which may need to
be funded and defunded. An FMI may also use a combination of central bank andcommercial bank monies to conduct settlements, for example, by using central bank moneyfor funding and defunding activities and using commercial bank money for the settlement of
individual payment obligations.

96

It should be noted, however, that the settlement of payment obligations does not always require a transfer ofmonies; in some cases, an offsetting process can discharge obligations.

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Credit and liquidity risk in money settlements
3.9.2. An FMI and its participants may face credit and liquidity risks from money
settlements. Credit risk may arise when a settlement bank has the potential to default on its
obligations (for example, if the settlement bank becomes insolvent). When an FMI settles on
its own books, participants face credit risk from the FMI itself. Liquidity risk may arise inmoney settlements if, after a payment obligation has been settled, participants or the FMI
itself are unable to transfer readily their assets at the settlement bank into other liquid assets,such as claims on a central bank.
Central bank money
3.9.3. An FMI should conduct its money settlements using central bank money, wherepractical and available, to avoid credit and liquidity risks. With the use of central bank money,a payment obligation is typically discharged by providing the FMI or its participants with adirect claim on the central bank, that is, the settlement asset is central bank money. Central
banks have the lowest credit risk and are the source of liquidity with regard to their currencyof issue. Indeed, one of the fundamental purposes of central banks is to provide a safe andliquid settlement asset. The use of central bank money, however, may not always bepractical or available. For example, an FMI or its participants may not have direct access to
all relevant central bank accounts and payment services. A multicurrency FMI that hasaccess to all relevant central bank accounts and payment services may find that some
central bank payment services do not operate, or provide finality, at the times when it needs
to make money settlements.
Commercial bank money
3.9.4. If central bank money is not used, an FMI should conduct its money settlements
using a settlement asset with little or no credit or liquidity risk. An alternative to the use ofcentral bank money is commercial bank money. When settling in commercial bank money, apayment obligation is typically discharged by providing the FMI or its participants with a direct
claim on the relevant commercial bank. To conduct settlements in commercial bank money,
an FMI and its participants need to establish accounts with at least one commercial bank,and likely hold intraday or overnight balances, or both. The use of commercial bank money tosettle payment obligations, however, can create additional credit and liquidity risks for the
FMI and its participants. For example, if the commercial bank conducting settlement
becomes insolvent, the FMI and its participants may not have immediate access to theirsettlement funds or ultimately receive the full value of their funds.
3.9.5. If an FMI uses a commercial bank for its money settlements, it should monitor,
manage, and limit its credit and liquidity risks arising from the commercial settlement bank.
For example, an FMI should limit both the probability of being exposed to a commercial
settlement bank’s failure and limit the potential losses and liquidity pressures to which it
would be exposed in the event of such a failure. An FMI should establish and monitor
adherence to strict criteria for its commercial settlement banks that take into account, among
other things, their regulation and supervision, creditworthiness, capitalisation, access toliquidity, and operational reliability. A commercial settlement bank should be subject toeffective banking regulation and supervision. It should also be creditworthy, be wellcapitalised, and have ample liquidity from the marketplace or the central bank of issue.
3.9.6. In addition, an FMI should take further steps to limit its credit exposures and liquidity
pressures by diversifying the risk of a commercial settlement bank failure, where reasonable,
through use of multiple commercial settlement banks. In some jurisdictions, however, there
may be only one commercial settlement bank that meets appropriate criteria for

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creditworthiness and operational reliability. Additionally, even with multiple commercial
settlement banks, the extent to which risk is actually diversified depends upon the distribution
or concentration of participants using different commercial settlement banks and the amounts
owed by those participants. 97 An FMI should monitor and manage the full range andconcentration of exposures to its commercial settlement banks and assess its potential
losses and liquidity pressures as well as those of its participants in the event that thecommercial settlement bank with the largest share of activity were to fail.
Settlement on the books of an FMI
3.9.7. If money settlement does not occur in central bank money and the FMI conducts
money settlements on its own books, it should minimise and strictly control its credit andliquidity risks. In such an arrangement, an FMI offers cash accounts to its participants, and apayment or settlement obligation is discharged by providing an FMI’s participants with adirect claim on the FMI itself. The credit and liquidity risks associated with a claim on an FMI
are therefore directly related to the FMI’s overall credit and liquidity risks. One way an FMI
could minimise these risks is to limit its activities and operations to clearing and settlement
and closely related processes. Further, to settle payment obligations, the FMI could beestablished as a supervised special-purpose financial institution and limit the provision of
cash accounts to only participants. 98 In some cases, an FMI can further mitigate risk by
having participants fund and defund their cash accounts at the FMI using central bankmoney. In such an arrangement, an FMI is able to back the settlements conducted on its own
books with balances that it holds in its account at the central bank.
Finality of funds transfers between settlement accounts
3.9.8. In settlements involving either central bank or commercial bank money, a criticalissue is the timing of the finality of funds transfers. These transfers should be final wheneffected (see also Principle 1 on legal basis and Principle 8 on settlement finality). To thisend, an FMI’s legal agreements with any settlement banks should state clearly whentransfers on the books of individual settlement banks are expected to occur, that transfers
are to be final when effected, and that funds received should be transferable as soon as
possible, at a minimum by the end of the day and ideally intraday, in order to enable the FMI
and its participants to manage credit and liquidity risks. If an FMI conducts intraday money
settlements (for example, to collect intraday margin), the arrangement should provide realtime finality or intraday finality at the times when an FMI wishes to effect money settlement.

97

The concentration of an FMI’s exposure to a commercial settlement bank can be further exacerbated if thecommercial settlement bank has multiple roles with respect to the FMI. For example, an FMI may use aparticular commercial settlement bank that is also a participant in the FMI for depositing and investing funds,
for depositing and transferring securities, and for back-up liquidity resources. See Principle 7 on liquidity risk.

98

Depending on local laws, these special-purpose institutions would generally be required to have banking
licenses and be subject to prudential supervision.

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Principle 10: Physical deliveries
An FMI should clearly state its obligations with respect to the delivery of physicalinstruments or commodities and should identify, monitor, and manage the risks
associated with such physical deliveries.
Key considerations
1.

An FMI’s rules should clearly state its obligations with respect to the delivery ofphysical instruments or commodities.

2.

An FMI should identify, monitor, and manage the risks and costs associated with thestorage and delivery of physical instruments or commodities.

Explanatory note
3.10.1. An FMI may settle transactions using physical delivery, which is the delivery of anasset, such as an instrument or a commodity, in physical form. 99 For example, the settlementof futures contracts cleared by a CCP may allow or require the physical delivery of anunderlying financial instrument or commodity. An FMI that provides physical settlement
should have rules that clearly state its obligations with respect to the delivery of physicalinstruments or commodities. 100 In addition, an FMI should identify, monitor, and manage therisks and costs associated with the storage and delivery of such physical instruments andcommodities.
Rules that state the FMI’s obligations
3.10.2. An FMI’s rules should clearly state its obligations with respect to the delivery ofphysical instruments or commodities. The obligations that an FMI may assume with respect
to physical deliveries vary based on the types of assets that the FMI settles. An FMI should
clearly state which asset classes it accepts for physical delivery and the proceduressurrounding the delivery of each. An FMI also should clearly state whether its obligation is tomake or receive physical deliveries or to indemnify participants for losses incurred in thedelivery process. Clear rules on physical deliveries enable the FMI and its participants totake the appropriate steps to mitigate the risks posed by such physical deliveries. An FMI
should engage with its participants to ensure that they have an understanding of their
obligations and the procedures for effecting physical delivery.
Risk of storage and delivery
3.10.3. An FMI should identify, monitor, and manage the risks and costs associated with thestorage and delivery of physical instruments or commodities. Issues relating to delivery may
arise, for example, when a derivatives contract requires physical delivery of an underlying
instrument or commodity. An FMI should plan for and manage physical deliveries by
establishing definitions for acceptable physical instruments or commodities, theappropriateness of alternative delivery locations or assets, rules for warehouse operations,and the timing of delivery, when relevant. If an FMI is responsible for the warehousing and99

Examples of physical instruments that may be covered under this principle include securities, commercial
paper, and other debt instruments that are issued in paper form.

100

The term “physical delivery” in the credit-default swap market typically refers to the process by which theprotection buyer of a credit-default swap contract “delivers” an instrument to the protection seller after a credit
event but does not necessarily involve the delivery of an instrument in paper form. This type of “physicaldelivery” is outside the scope of this principle. Immobilised and dematerialised securities, which represent thenormal market practice, are covered in Principle 11 on CSDs.

70

CPSS-IOSCO – Principles for financial market infrastructures – April 2012transportation of a commodity, it should make arrangements that take into account thecommodity’s particular characteristics (for example, storage under specific conditions, suchas an appropriate temperature and humidity for perishables).
3.10.4. An FMI should have appropriate processes, procedures, and controls to manage therisks of storing and delivering physical assets, such as the risk of theft, loss, counterfeiting, or
deterioration of assets. An FMI’s policies and procedures should ensure that the FMI’s recordof physical assets accurately reflects its holdings of assets, for example, by separating duties
between handling physical assets and maintaining records. An FMI also should haveappropriate employment policies and procedures for personnel that handle physical assets
and should include appropriate pre-employment checks and training. In addition, an FMI
should consider other measures, such as insurance coverage and random storage facility
audits, to mitigate its storage and delivery risks (other than principal risk).
Matching participants for delivery and receipt
3.10.5. In some instances, an FMI serving a commodity market can reduce its risks
associated with the physical storage and delivery of commodities by matching participantsthat have delivery obligations with those due to receive the commodities, thereby removing
itself from direct involvement in the storage and delivery process. In such instances, the legal
obligations for delivery should be clearly expressed in the rules, including default rules, andany related agreements. In particular, an FMI should be clear whether the receiving
participant should seek compensation from the FMI or the delivering participant in the eventof a loss. Additionally, an FMI holding margin should not release the margin of the matched
participants until it confirms that both have fulfilled their respective obligations. An FMI should
also monitor its participants’ performance and, to the extent practicable, ensure that its
participants have the necessary systems and resources to be able to fulfil their physicaldelivery obligations.

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Central securities depositories and exchange-of-value settlement
systems
CSDs and exchange-of-value settlement systems have unique risks associated with theirfunction and design. While the nature and scope of activities performed by CSDs vary basedon jurisdiction and market practices, CSDs play a critical role in the protection of securities
and help ensure the integrity of securities transactions. Similarly, exchange-of-value
settlement systems play a critical role in mitigating principle risk by linking the final settlementof one obligation to the final settlement of another. The following two principles provide
specific guidance to CSDs and exchange-of-value settlement systems.
Principle 11: Central securities depositories
A CSD should have appropriate rules and procedures to help ensure the integrity of
securities issues and minimise and manage the risks associated with the safekeeping
and transfer of securities. A CSD should maintain securities in an immobilised or
dematerialised form for their transfer by book entry.
Key considerations
1.

A CSD should have appropriate rules, procedures, and controls, including robust
accounting practices, to safeguard the rights of securities issuers and holders,prevent the unauthorised creation or deletion of securities, and conduct periodic andat least daily reconciliation of securities issues it maintains.

2.

A CSD should prohibit overdrafts and debit balances in securities accounts.

3.

A CSD should maintain securities in an immobilised or dematerialised form for theirtransfer by book entry. Where appropriate, a CSD should provide incentives toimmobilise or dematerialise securities.

4.

A CSD should protect assets against custody risk through appropriate rules andprocedures consistent with its legal framework.

5.

A CSD should employ a robust system that ensures segregation between the CSD’s
own assets and the securities of its participants and segregation among thesecurities of participants. Where supported by the legal framework, the CSD should
also support operationally the segregation of securities belonging to a participant’s
customers on the participant’s books and facilitate the transfer of customer holdings.

6.

A CSD should identify, measure, monitor, and manage its risks from other activities
that it may perform; additional tools may be necessary in order to address theserisks.

Explanatory note
3.11.1. A CSD is an entity that provides securities accounts and, in many countries,
operates an SSS. A CSD also provides central safekeeping and asset services, which may
include the administration of corporate actions and redemptions, and plays an important rolein helping to ensure the integrity of securities issues. 101 Securities can be held at the CSD

101

Where an entity legally defined as a CSD or an SSS does not hold or facilitate the holding of assets orcollateral owned by their participants, the CSD or SSS in general would not be required to have arrangements
to manage the safekeeping of such assets or collateral.

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either in physical (but immobilised) form or in dematerialised form (that is, as electronic
records). The precise activities of a CSD vary based on its jurisdiction and market practices.
A CSD, for example, may be the official securities registrar and maintain the definitive recordof legal ownership for a security; however, in some cases, another entity may serve as theofficial securities registrar. Further, the activities of a CSD may vary depending on whether it
operates in a jurisdiction with a direct or indirect holding arrangement or a combination of
both. 102 A CSD should have clear and comprehensive rules and procedures to ensure thatthe securities it holds on behalf of its participants are appropriately accounted for on its
books and protected from risks associated with the other services that the CSD may provide.
Rules, procedures, and controls to safeguard the integrity of securities issues
3.11.2. The preservation of the rights of issuers and holders of securities is essential for theorderly functioning of a securities market. Therefore, a CSD should employ appropriate rules,
procedures, and controls to safeguard the rights of securities issuers and holders, preventthe unauthorised creation or deletion of securities, and conduct periodic and at least daily
reconciliation of the securities issues that it maintains. A CSD should, in particular, maintainrobust accounting practices and perform end-to-end auditing to verify that its records areaccurate and provide a complete accounting of its securities issues. If a CSD records theissuance of securities (alone or in conjunction with other entities), it should verify andaccount for the initial issuance of securities and ensure that newly issued securities aredelivered in a timely manner. To further safeguard the integrity of the securities issues, a
CSD should conduct periodic and at least daily reconciliation of the totals of securities issues
in the CSD for each issuer (or its issuing agent), and ensure that the total number of
securities recorded in the CSD for a particular issue is equal to the amount of securities ofthat issue held on the CSD's books. Reconciliation may require coordination with otherentities if the CSD does not (or does not exclusively) record the issuance of the security or is
not the official registrar of the security. For instance, if the issuer (or its issuing agent) is the
only entity that can verify the total amount of an individual issue, it is important that the CSD
and the issuer cooperate closely to ensure that the securities in circulation in a systemcorrespond to the volume issued into that system. If the CSD is not the official securities
registrar for the securities issuer, reconciliation with the official securities registrar should be
required.
Overdrafts and debit balances in securities accounts
3.11.3. A CSD should prohibit overdrafts and debit balances in securities accounts to avoid
credit risk and reduce the potential for the creation of securities. If a CSD were to allow
overdrafts or a debit balance in a participant’s securities account in order to credit anotherparticipant’s securities account, a CSD would effectively be creating securities and would
affect the integrity of the securities issue.
Immobilisation and dematerialisation
3.11.4. A CSD can maintain securities in physical form or dematerialised form. 103 Securities
held in physical form may be transferred via physical delivery or immobilised and transferred102

In a direct holding system, each beneficial or direct owner of the security is known to the CSD or the issuer. In
some countries, the use of direct holding systems is required by law. Alternatively, an indirect holding system
employs a multi-tiered arrangement for the custody and transfer of ownership of securities (or the transfer ofsimilar interests therein) in which investors are identified only at the level of their custodian or intermediary. In
either system, the shareholder list may be maintained by the issuer, CSD, securities registrar, or transfer
agent.

103

Dematerialisation involves the elimination of physical certificates or documents of title that represent
ownership of securities so that securities exist only as accounting records.

CPSS-IOSCO – Principles for financial market infrastructures – April 201273

via book entry. 104 The safekeeping and transferring of securities in physical form, however,creates additional risks and costs, such as the risk of destruction or theft of certificates,
increased processing costs, and increased time to clear and settle securities transactions. By
immobilising securities and transferring them via book entry, a CSD can improve efficiency
through increased automation and reduce the risk of errors and delays in processing. 105
Dematerialising securities also eliminates the risk of destruction or theft of certificates. A
CSD should therefore maintain securities in an immobilised or dematerialised form andtransfer securities via book entry. 106 To facilitate the immobilisation of all physical securities
of a particular issue, a global note representing the whole issue can be issued. In certain
cases, however, immobilisation or dematerialisation within a CSD may not be legally possibleor practicable. Legal requirements, for example, may limit the possible implementation or
extent of immobilisation and dematerialisation. In such cases, a CSD should provide
incentives to immobilise or dematerialise securities. 107
Protection of assets
3.11.5. A CSD should protect assets against custody risk, including the risk of loss becauseof the CSD’s negligence, misuse of assets, fraud, poor administration, inadequate
recordkeeping, or failure to protect a participant’s interests in securities or because of the
CSD’s insolvency or claims by the CSD’s creditors. A CSD should have rules andprocedures consistent with its legal framework and robust internal controls to achieve theseobjectives. 108 Where appropriate, a CSD should consider insurance or other compensation
schemes to protect participants against misappropriation, destruction, and theft of securities.
3.11.6. A CSD should employ a robust system that ensures the segregation of assets
belonging to the CSD from the securities belonging to its participants. In addition, the CSD
should segregate participants’ securities from those of other participants through theprovision of separate accounts. While the title to securities is typically held in a CSD, often
the beneficial owner, or the owner depending on the legal framework, of the securities does
not participate directly in the system. Rather, the owner establishes relationships with CSD
participants (or other intermediaries) that provide safekeeping and administrative services
related to the holding and transfer of securities on behalf of customers. Where supported by
the legal framework, a CSD also should support operationally the segregation of securities
belonging to a participant’s customers on the participant’s books and facilitate the transfer ofcustomer holdings to another participant. 109 Where relevant, the segregation of accounts
typically helps provide appropriate protection against the claims of a CSD’s creditors or theclaims of the creditors of a participant in the event of its insolvency.

104

Immobilisation involves concentrating the location of securities in a depository and transferring ownership bybook entry.

105

Improved efficiency through book-entry settlement also may support the development of more-liquid securities
markets.

106

Book-entry transfers also facilitate the settlement of securities through a DvP mechanism, thereby reducing or
eliminating principal risk in settlement (see also Principle 12 on exchange-of-value settlement systems).

107

In addition, the relevant authorities will have a role in providing the necessary framework to support
immobilisation or dematerialisation.

108

The relevant authorities will have a role in providing the necessary framework to protect the CSD’s
participants’ and their customers’ assets.

109

The customer’s rights and interests to the securities held by the participant or the CSD will depend upon theapplicable legal framework. In some jurisdictions, a CSD may be required to maintain records that would
facilitate the identification of customer securities regardless of the type of holding system in effect.

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CPSS-IOSCO – Principles for financial market infrastructures – April 2012

Other activities
3.11.7. If a CSD provides services other than central safekeeping and administration of
securities, it should identify, measure, monitor, and manage the risks associated with those
activities, particularly credit and liquidity risks, consistent with the respective principles in thisreport. Additional tools may be necessary to address these risks, including the need for the
FMI to separate legally the other activities. For example, a CSD that operates an SSS may
provide a centralised securities lending facility to help facilitate timely settlement and reduce
settlement fails or may otherwise offer services that support the bilateral securities lending
market. If the CSD acts as a principal in a securities lending transaction, it should identify,
monitor, and manage its risks, including potential credit and liquidity risks, under theconditions set in Principles 4 and 7. For example, the securities lent by the CSD may not be
returned when needed because of a counterparty default, operational failure, or legal
challenge. The CSD would then need to acquire the lent securities in the market, perhaps ata cost, thus exposing the CSD to credit and liquidity risks. 110

110

See also CPSS, Strengthening repo clearing and settlement arrangements, September 2010.

CPSS-IOSCO – Principles for financial market infrastructures – April 201275

Principle 12: Exchange-of-value settlement systems
If an FMI settles transactions that involve the settlement of two linked obligations (forexample, securities or foreign exchange transactions), it should eliminate principal
risk by conditioning the final settlement of one obligation upon the final settlement of
the other.
Key consideration
1.

An FMI that is an exchange-of-value settlement system should 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, regardless of whether the FMI
settles on a gross or net basis and when finality occurs.

Explanatory note
3.12.1. The settlement of a financial transaction by an FMI may involve the settlement of
two linked obligations, such as the delivery of securities against payment of cash or
securities or the delivery of one currency against delivery of another currency. 111 In thiscontext, principal risk may be created when one obligation is settled, but the other obligation
is not (for example, the securities are delivered but no cash payment is received). Because
this principal risk involves the full value of the transaction, substantial credit losses as well as
substantial liquidity pressures may result from the default of a counterparty or, moregenerally, the failure to complete the settlement of both linked obligations. Further, asettlement default could result in high replacement costs (that is, the unrealised gain on theunsettled contract or the cost of replacing the original contract at market prices that may bechanging rapidly during periods of stress). An FMI should eliminate or mitigate these risks
through the use of a DvP, DvD, or PvP settlement mechanism. 112
Linking final settlement of obligations
3.12.2. An FMI that is an exchange-of-value settlement system should eliminate principal
risk by linking the final settlement of one obligation to the final settlement of the other throughan appropriate DvP, DvD, or PvP settlement mechanism (see also Principle 4 on credit risk,
Principle 7 on liquidity risk, and Principle 8 on settlement finality). DvP, DvD, and PvP
settlement mechanisms eliminate principal risk by ensuring that the final settlement of one
obligation occurs if and only if the final settlement of the linked obligation occurs. If an FMI
effects settlements using a DvP, DvD, or PvP settlement mechanism, it should settle a highpercentage of obligations through that mechanism. In the securities market, for example, a
DvP settlement mechanism is a mechanism that links a securities transfer and a funds
transfer in such a way as to ensure that delivery occurs if and only if the corresponding
payment occurs. 113 DvP can and should be achieved for both the primary and secondary111

In some cases, the settlement of a transaction can be free of payment, for example, for the purposes ofpledging collateral and repositioning securities. The settlement of a transaction may also involve more than
two linked obligations, for example, for the purposes of some collateral substitutions where there are multiple
securities or for premium payments related to securities lending in two currencies. These cases are notinconsistent with this principle.

112

While DvP, DvD, and PvP settlement mechanisms eliminate principal risk, they do not eliminate the risk thatthe failure of a participant could result in systemic disruptions, including liquidity dislocations.

113

Similarly, a PvP settlement mechanism is a mechanism which ensures that the final transfer of a payment in
one currency occurs if and only if the final transfer of a payment in another currency or currencies takes place.
A DvD settlement mechanism is a securities settlement mechanism which links two or more securities
transfers in such a way as to ensure that delivery of one security occurs if and only if the corresponding
delivery of the other security or securities occurs.

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markets. The settlement of two obligations can be achieved in several ways and varies by
how trades or obligations are settled, either on a gross basis (trade-by-trade) or on a net
basis, and the timing of when finality occurs.
Models of gross or net settlement of obligations
3.12.3. The final settlement of two linked obligations can be achieved either on a grossbasis or on a net basis. 114 For example, an SSS can settle the transfers of both securities
and funds on a gross basis throughout the settlement day. Alternatively, an SSS can settle
securities transfers on a gross basis throughout the day but settle funds transfers on a net
basis at the end of the day or at certain times during the day. An SSS can also settle bothsecurities and funds transfers on a net basis at the end of the day or at certain times during
the day. Regardless of whether an FMI settles on a gross or net basis, the legal, contractual,technical, and risk-management framework should ensure that the settlement of an
obligation is final if and only if the settlement of the corresponding obligation is final.
Timing of settlement
3.12.4. DvP, DvD, and PvP can be achieved through different timing arrangements. Strictly
speaking, DvP, DvD, and PvP do not require a simultaneous settlement of obligations. In
some cases, settlement of one obligation could follow the settlement of the other. For
example, when an SSS does not itself provide cash accounts for settlement, it may first blockthe underlying securities in the account of the seller. 115 The SSS may then request a transfer
of funds from the buyer to the seller at the settlement bank for funds transfers. The securities
are delivered to the buyer or its custodian if and only if the SSS receives confirmation of
settlement of the cash leg from the settlement bank. In such DvP arrangements, however,the length of time between the blocking of securities, the settling of cash, and the subsequent
release and delivery of the blocked securities should be minimised. 116 Further, blocked
securities must not be subject to a claim by a third party (for example, other creditors, tax
authorities, or even the SSS itself) because these claims would give rise to principal risk.

114

For a discussion of stylised models of DvP settlement, see CPSS, Delivery versus payment in securities
systems, September 1992.

115

In this context, DvP could be achieved through a link between an SSS and a payment system. The SSS
settles the securities leg of the transaction while the payment system settles the cash leg. However, in thecontext of these principles this arrangement is not considered an FMI link, but a DvP system.

116

An SSS that settles securities transactions on a net basis with an end-of-day finality arrangement could meetthis requirement by providing a mechanism that allows intraday finality.

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Default management
An FMI should have appropriate policies and procedures to handle participant defaults. A
participant default, if not properly managed, can have serious implications for the FMI, otherparticipants, and the broader financial markets. Further, a CCP needs an appropriate
segregation and portability regime to protect customer positions in the event of a participant
default or insolvency. The following two principles provide guidance on (a) participant-default
rules and procedures for all FMIs and (b) segregation and portability issues for CCPs.
Principle 13: Participant-default rules and procedures
An FMI should have effective and clearly defined rules and procedures to manage aparticipant default. These rules and procedures should be designed to ensure that the
FMI can take timely action to contain losses and liquidity pressures and continue tomeet its obligations.
Key considerations
1.

An FMI should have default rules and procedures that enable the FMI to continue tomeet its obligations in the event of a participant default and that address thereplenishment of resources following a default.

2.

An FMI should be well prepared to implement its default rules and procedures,
including any appropriate discretionary procedures provided for in its rules.

3.

An FMI should publicly disclose key aspects of its default rules and procedures.

4.

An FMI should involve its participants and other stakeholders in the testing andreview of the FMI’s default procedures, including any close-out procedures. Such
testing and review should be conducted at least annually or following materialchanges to the rules and procedures to ensure that they are practical and effective.

Explanatory note
3.13.1. Participant-default rules and procedures facilitate the continued functioning of an
FMI in the event that a participant fails to meet its obligations. These rules and procedures
help limit the potential for the effects of a participant’s failure to spread to other participants
and undermine the viability of the FMI. Key objectives of default rules and procedures should
include (a) ensuring timely completion of settlement, even in extreme but plausible market
conditions; (b) minimising losses for the FMI and for non-defaulting participants; (c) limiting
disruptions to the market; (d) providing a clear framework for accessing FMI liquidity facilities
as needed; and (e) managing and closing out the defaulting participant’s positions andliquidating any applicable collateral in a prudent and orderly manner. In some instances,managing a participant default may involve hedging open positions, funding collateral so thatthe positions can be closed out over time, or both. An FMI may also decide to auction or
allocate open positions to its participants. 117 To the extent consistent with these objectives,an FMI should allow non-defaulting participants to continue to manage their positions asnormal.

117

An OTC derivatives CCP may need to consider requiring participants to agree in advance to bid on thedefaulting participant’s portfolio and, should the auction fail, accept an allocation of the portfolio. Where used,such procedures should include consideration of the risk profile and portfolio of each receiving participant
before allocating positions so as to minimise additional risk for the non-defaulting participants.

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Rules and procedures
3.13.2. An FMI should have default rules and procedures that enable the FMI to continue tomeet its obligations to non-defaulting participants in the event of a participant default. An FMI
should explain clearly in its rules and procedures what circumstances constitute a participant
default, addressing both financial and operational defaults. 118 An FMI should describe themethod for identifying a default. In particular, an FMI should specify whether a declaration ofdefault is automatic or discretionary, and if discretionary, which person or group shall
exercise that discretion. Key aspects to be considered in designing the rules and procedures
include (a) the actions that an FMI can take when a default is declared; (b) the extent towhich such actions are automatic or discretionary; (c) potential changes to the normal
settlement practices, should these changes be necessary in extreme circumstances, toensure timely settlement; (d) the management of transactions at different stages ofprocessing; (e) the expected treatment of proprietary and customer transactions andaccounts; (f) the probable sequencing of actions; (g) the roles, obligations, andresponsibilities of the various parties, including non-defaulting participants; and (h) the
existence of other mechanisms that may be activated to contain the impact of a default. An
FMI should involve its participants, authorities, and other relevant stakeholders in developing
its default rules and procedures (see Principle 2 on governance).
Use and sequencing of financial resources
3.13.3. An FMI’s default rules and procedures should enable the FMI to take timely action tocontain losses and liquidity pressures, before, at, and after the point of participant default(see also Principle 4 on credit risk and Principle 7 on liquidity risk). Specifically, an FMI’s
rules and procedures should allow the FMI to use promptly any financial resources that it
maintains for covering losses and containing liquidity pressures arising from default,
including liquidity facilities. The rules of the FMI should specify the order in which different
types of resources will be used. This information enables participants to assess theirpotential future exposures from using the FMI’s services. Typically, an FMI should first use
assets provided by the defaulting participant, such as margin or other collateral, to provide
incentives for participants to manage prudently the risks, particularly credit risk, they pose to
an FMI. 119 The application of previously provided collateral should not be subject toprevention, stay, or reversal under applicable law and the rules of the FMI. An FMI should
also have a credible and explicit plan for replenishing its resources over an appropriate time
horizon following a participant default so that it can continue to operate in a safe and soundmanner. In particular, the FMI’s rules and procedures should define the obligations of thenon-defaulting participants to replenish the financial resources depleted during a default sothat the time horizon of such replenishment is anticipated by non-defaulting participants
without any disruptive effects.
Proprietary and customer positions
3.13.4. A CCP should have rules and procedures to facilitate the prompt close out ortransfer of a defaulting participant’s proprietary and customer positions. Typically, the longer
these positions remain open on the books of the CCP, the larger the CCP’s potential credit
exposures resulting from changes in market prices or other factors will be. A CCP shouldhave the ability to apply the proceeds of liquidation, along with other funds and assets of the118

An operational default occurs when a participant is not able to meet its obligations due to an operational
problem, such as a failure in information technology systems.

119

The defaulting participant’s assets do not include segregated customer collateral; such segregated collateralshould not be used to cover losses resulting from a participant default, except in the case of a potential closeout of segregated customer positions. See Principle 14 on segregation and portability.

CPSS-IOSCO – Principles for financial market infrastructures – April 201279

defaulting participant, to meet the defaulting participant’s obligations. It is critical that a CCP
has the authority to act promptly to contain its exposure, while having regard for overallmarket effects, such as sharp declines in market prices. A CCP should have the information,
resources, and tools to close out positions promptly. In circumstances where prompt closeout is not practicable, a CCP should have the tools to hedge positions as an interim riskmanagement technique. In some cases, a CCP may use seconded personnel from nondefaulting participants to assist in the close-out or hedging process. The CCP’s rules andprocedures should clearly state the scope of duties and term of service expected fromseconded personnel. In other cases, the CCP may elect to auction positions or portfolios tothe market. The CCP’s rules and procedures should clearly state the scope for such action,
and any participant obligations with regard to such auctions should be clearly set out. The
close out of positions should not be subject to prevention, stay, or reversal under applicablelaw and the rules of the FMI.
Management discretion
3.13.5. An FMI should be well prepared to implement its default rules and procedures,
including any appropriate discretionary procedures provided for in the rules. Management
should ensure that the FMI has the operational capacity, including sufficient well-trained
personnel, to implement its procedures in a timely manner. An FMI’s rules and proceduresshould outline examples of when management discretion may be appropriate and should
include arrangements to minimise any potential conflicts of interests. Management should
also have internal plans that clearly delineate the roles and responsibilities for addressing adefault and provide training and guidance to its personnel on how the procedures should be
implemented. These plans should address documentation, information needs, andcoordination when more than one FMI or authority is involved. In addition, timely
communication with stakeholders, in particular with relevant authorities, is of criticalimportance. The FMI, to the extent permitted, should clearly convey to affected stakeholders
information that would help them to manage their own risks. The internal plan should be
reviewed by management and the relevant board committees at least annually or after any
significant changes to the FMI’s arrangements.
Public disclosure of key aspects of default rules and procedures
3.13.6. To provide certainty and predictability regarding the measures that an FMI may takein a default event, an FMI should publicly disclose key aspects of its default rules andprocedures, including: (a) the circumstances in which action may be taken; (b) who may takethose actions; (c) the scope of the actions which may be taken, including the treatment ofboth proprietary and customer positions, funds, and other assets; (d) the mechanisms toaddress an FMI’s obligations to non-defaulting participants; and (e) where direct relationships
exist with participants’ customers, the mechanisms to help address the defaulting
participant’s obligations to its customers. This transparency fosters the orderly handling ofdefaults, enables participants to understand their obligations to the FMI and to theircustomers, and gives market participants the information they need to make informed
decisions about their activities in the market. An FMI should ensure that its participants andtheir customers, as well as the public, have appropriate access to the FMI’s default rules andprocedures and should promote their understanding of those procedures in order to foster
confidence in the market in the event of a participant default.
Periodic testing and review of default procedures
3.13.7. An FMI should involve its participants and other stakeholders in the testing andreview of its default procedures, including any close-out procedures. Such testing and review
should be conducted at least annually or following material changes to the rules andprocedures to ensure that they are practical and effective. The periodic testing and review ofdefault procedures is important to help the FMI and its participants understand fully theprocedures and to identify any lack of clarity in, or discretion allowed by, the rules and80

CPSS-IOSCO – Principles for financial market infrastructures – April 2012

procedures. Such tests should include all relevant parties, or an appropriate subset, thatwould likely be involved in the default procedures, such as members of the appropriate board
committees, participants, linked or interdependent FMIs, relevant authorities, and any related
service providers. This is particularly important where an FMI relies on non-defaulting
participants or third parties to assist in the close-out process and where the default
procedures have never been tested by an actual default. The results of these tests andreviews should be shared with the FMI’s board of directors, risk committee, and relevant
authorities.
3.13.8. Furthermore, part of an FMI’s participant-default testing should include theimplementation of the resolution regime for an FMI’s participants, as relevant. An FMI shouldbe able to take all appropriate steps to address the resolution of a participant. Specifically,
the FMI, or if applicable a resolution authority, should be able to transfer a defaulting
participant’s open positions and customer accounts to a receiver, third party, or bridgefinancial company.

CPSS-IOSCO – Principles for financial market infrastructures – April 201281

Principle 14: Segregation and portability
A CCP should have rules and procedures that enable the segregation and portabilityof positions of a participant’s customers and the collateral provided to the CCP withrespect to those positions.
Key considerations
1.

A CCP should, at a minimum, have segregation and portability arrangements that
effectively protect a participant’s customers’ positions and related collateral from thedefault or insolvency of that participant. If the CCP additionally offers protection ofsuch customer positions and collateral against the concurrent default of theparticipant and a fellow customer, the CCP should take steps to ensure that suchprotection is effective.

2.

A CCP should employ an account structure that enables it readily to identify
positions of a participant’s customers and to segregate related collateral. A CCP
should maintain customer positions and collateral in individual customer accounts orin omnibus customer accounts.

3.

A CCP should structure its portability arrangements in a way that makes it highly
likely that the positions and collateral of a defaulting participant’s customers will betransferred to one or more other participants.

4.

A CCP should disclose its rules, policies, and procedures relating to the segregationand portability of a participant’s customers’ positions and related collateral. In
particular, the CCP should disclose whether customer collateral is protected on an
individual or omnibus basis. In addition, a CCP should disclose any constraints,
such as legal or operational constraints, that may impair its ability to segregate or
port a participant’s customers’ positions and related collateral.

Explanatory note
3.14.1. Segregation of customers’ positions and collateral plays an important part in thesafe and effective holding and transfer of customers’ positions and collateral, especially inthe event of a participant’s default or insolvency. Segregation refers to a method of protecting
customer collateral and contractual positions by holding or accounting for them separately.
Customer collateral should be segregated from the assets of the participant through which
the customers clear. In addition, individual customer collateral may be held separately fromthe collateral of other customers of the same participant to protect customers from eachother’s default. Where offered by the CCP, such positions and collateral should be protected
effectively from the concurrent default or insolvency of both a customer and the participant.
3.14.2 Effective segregation arrangements can reduce the impact of a participant’s
insolvency on its customers by providing for clear and reliable identification of a participant’s
customer’s positions and related collateral. Segregation also protects a customer’s collateralfrom becoming lost to a participant’s other creditors. In addition, segregation facilitates thetransfer of customers’ positions and collateral. Even if no transfers take place, segregation
can improve a customer’s ability to identify and recover its collateral (or the value thereof),
which, at least to some extent, contributes to retaining customers’ confidence in their clearing
participants and may reduce the potential for “counterparty runs” on a deteriorating clearing
participant.
3.14.3. Portability refers to the operational aspects of the transfer of contractual positions,funds, or securities from one party to another party. By facilitating transfers from one
participant to another, effective portability arrangements lessen the need for closing out
positions, including during times of market stress. Portability thus minimises the costs and82

CPSS-IOSCO – Principles for financial market infrastructures – April 2012

potential market disruption associated with closing out positions and reduces the possible
impact on customers’ ability to continue to obtain access to central clearing.
3.14.4. Effective segregation and portability of a participant’s customers’ positions andcollateral depend not only on the measures taken by a CCP itself but also on applicable legal
frameworks, including those in foreign jurisdictions in the case of remote participants.
Effective segregation and portability also depend on measures taken by other parties, forexample, where customers post additional collateral to the participant. 120
Legal framework
3.14.5. In order to achieve fully the benefits of segregation and portability, the legal
framework applicable to the CCP should support its arrangements to protect and transfer the
positions and collateral of a participant’s customers. 121 The legal framework will influence
how the segregation and portability arrangements are designed and what benefits can beachieved. The relevant legal framework will vary depending upon many factors, including theparticipant’s legal form of organisation, the manner in which collateral is provided (forexample, security interest, title transfer, or full ownership right), and the types of assets (forexample, cash or securities) provided as collateral. Therefore, it is not possible to design asingle model appropriate for all CCPs across all jurisdictions. However, a CCP should
structure its segregation and portability arrangements (including applicable rules) in amanner that protects the interests of a participant’s customers and achieves a high degree oflegal certainty under applicable law. A CCP should also consider potential conflict of laws
when designing its arrangements. In particular, the CCP’s rules and procedures that set out
its segregation and portability arrangements should avoid any potential conflict withapplicable legal or regulatory requirements.
Alternate approach for CCPs serving certain cash markets
3.14.6 In certain jurisdictions, cash market CCPs operate in legal regimes that facilitate
segregation and portability to achieve protection of customer assets by alternate means thatoffer the same degree of protection as the approach required by this principle. Features ofthese regimes are that if a participant fails, (a) the customer positions can be identified
timely, (b) customers will be protected by an investor protection scheme designed to movecustomer accounts from the failed or failing participant to another participant in a timely
manner, and (c) customer assets can be restored. 122 In these cases, the CCP and relevant
authorities for these particular cash markets should evaluate whether the applicable legal or
regulatory framework achieves the same degree of protection and efficiency (see Principle
21 on efficiency and effectiveness) for customers that would otherwise be achieved bysegregation and portability arrangements at the CCP level described in Principle 14.

120

Participants may collect excess collateral from their customers, beyond that which is required by and provided
to the CCP. This excess collateral may be held by the participant or its custodian and outside of thesegregation and portability regime in effect at the CCP.

121

For example, portability arrangements could be undermined if applicable insolvency laws do not protect thetransfer of customer positions and collateral from avoidance (“clawback”) by the participant’s insolvency
officer. Also, in some jurisdictions, it may not be possible to segregate cash.

122

For example, domestic law subjects participants to explicit and comprehensive financial responsibility or
customer protection requirements that obligate participants to make frequent determinations (for example,
daily) that they maintain possession and control of all customers’ fully paid and excess margin securities andto segregate their proprietary activities from those of their customers. Under these regimes, pending securities
purchases do not belong to the customer; thus, there is no customer trade or position entered into the CCP.
As a result, participants provide collateral to the CCP on behalf of their customers regardless of whether they
are acting on a principal or agent basis, and the CCP is not able to identify positions or possess the assets of
its participants’ customers.

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Customer account structures
3.14.7. The segregation and portability principle is particularly relevant for CCPs that clear
positions and hold collateral belonging to customers of a participant. This clearing structure
allows customers (such as buy-side firms) that are not direct participants of a CCP to obtain
access to central clearing where direct access is either not possible (for example, due to an
inability to meet membership criteria) or not considered commercially appropriate (forexample, due to the cost of establishing and maintaining the infrastructure necessary to
perform as a clearing member or contributing to a CCP’s default resources). A CCP should
employ an account structure that enables it readily to identify positions belonging to aparticipant’s customers and to segregate related collateral. Segregation of customer
collateral by a CCP can be achieved in different ways, including through individual oromnibus accounts.
3.14.8 The degree of protection achievable for customer collateral will depend on whether
customers are protected on an individual or omnibus basis and the way initial margin iscollected (gross or net basis) by the CCP. 123 Each of these decisions will have implications
for the risks the CCP faces from its participants and, in some cases, their customers. The
CCP should understand, monitor, and manage these risks. 124 Similarly, there are advantages
and disadvantages to each type of account structure that the CCP should consider when
designing its segregation regime.
Individual account structure
3.14.9. The individual account structure provides a high degree of protection to the clearing
level collateral of customers of participants in a CCP, even in the case where the losses
associated with another customer’s default exceed the resources of the participant (seeparagraph 3.14.10). Under this approach, each customer’s collateral is held in a separate,
segregated individual account at the CCP, and depending on the legal framework applicableto the CCP, a customer’s collateral may only be used to cover losses associated with thedefault of that customer (that is, customer collateral is protected on an individual basis). Thisaccount structure facilitates the clear and reliable identification of a customer’s collateral,
which supports full portability of an individual customer’s positions and collateral or,alternatively, can expedite the return of collateral to the customer. Since all collateralmaintained in the individual customer’s account is used to margin that customer’s positions
only, the CCP should be able to transfer these positions from the customer account of a
defaulting participant to that of another participant with sufficient collateral to cover the
exposures. The use of individual accounts and the collection of margin on a gross basis
provide flexibility in how a customer’s portfolio may be ported to another participant or groupof participants. 125 Maintaining individual accounts, however, can be operationally andresource intensive for the CCP in settling transactions and ensuring accurate bookkeeping.
This approach could impact the overall efficiency of the CCP’s operations. Finally, effectively
achieving the advantages of maintaining individual accounts may depend upon the legal
framework applicable to the insolvency of the participant.

123

Collecting margin on a gross basis means that the amount of margin a participant must post to the CCP on
behalf of its customers is the sum of the amounts of margin required for each such customer. Collecting
margin on a net basis means that the participant may, in calculating the amount of margin it must post to the
CCP on behalf of its customers, offset the amounts of margin associated with the portfolios of different
customers.

124

See also Principle 19 on tiered participation arrangements.

125

As a practical matter, an individual account structure is inconsistent with net collection of margin, since undersuch netting, it is impractical for the CCP to allocate the net margin to individual customers.

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Omnibus account structure
3.14.10. Another approach would be to use an omnibus account structure where all collateralbelonging to all customers of a particular participant is commingled and held in a single
account segregated from that of the participant. This approach can be less operationallyintensive, can be more efficient when porting positions and collateral for a group of
customers of a defaulting participant (where there has been no customer default or where
customer collateral is legally protected on an individual basis), and can be structured toprotect customers’ collateral from being used to cover a default by the direct participant.
3.14.11. However, depending on the legal framework and the CCP’s rules, omnibus accounts
where the customer collateral is protected on an omnibus basis may expose a customer to“fellow-customer risk” – the risk that another customer of the same participant will default andcreate a loss that exceeds both the amount of available collateral supporting the defaulting
customer’s positions and the available resources of the participant. 126 As a result, theremaining commingled collateral of the participant’s non-defaulting customers is exposed to
the loss. Fellow-customer risk is of particular concern because customers have limited, if
any, ability to monitor or to manage the risk of their fellow customers.
3.14.12. One potential solution is for omnibus account structures to be designed in a mannerthat operationally commingles collateral related to customer positions while protecting
customers legally on an individual basis – that is, protecting them from fellow-customer risk.
Such individual protection does require the CCP to maintain accurate books sufficient topromptly ascertain an individual customer’s interest in a portion of the collateral. A failure to
do so can lead to delays or even losses in returning margin and other collateral that has
been provided to the CCP to individual customers in the event a participant becomesinsolvent. 127
3.14.13. The degree to which portability is fostered for a customer whose assets are held inan omnibus account also varies depending on whether the CCP collects margin on a grossor net basis. As with account structure, there are advantages and disadvantages to thealternative ways in which margin may be collected by the CCP that employs an omnibus
account structure. Margin calculated on a gross basis to support individual customer
portfolios results in less netting efficiency at the participant level; however, it is likely topreclude the possibility of under-margined customer positions when ported. As a result,
CCPs can port a participant’s customers’ positions and related margin in bulk or
piecemeal. 128 Gross margining enhances the feasibility of portability, which is desirable since
porting avoids the transactions costs, including bid-offer spreads associated with terminating
and replacing a participant’s customers’ positions. When margin is collected on a grossbasis, it is more likely that there will be sufficient collateral in the omnibus account to cover all
positions of a participant’s customers.
3.14.14. When margin is collected by the CCP on a net basis but held in an omnibus accountstructure, there is a risk that full portability cannot be achieved. 129 Since the collateral126

In some jurisdictions, customers in an omnibus account can include affiliates of the direct participant.

127

Ascertaining each customer’s interest in the omnibus account may require reliance on the participant’s records
containing the sub-accounting for individual customers. Under some legal frameworks, the collateral in theomnibus account is distributed to customers proportionately, based on their net customer claims, andparticipants may be required to provide certain customer information to the CCP.

128

Although portability on a portfolio basis has historically been feasible in the absence of a customer default, it ispossible that such portability may not be achievable due to a lack of willing and able transferees. Such lackmay occur due to stressed market conditions, the complexity or size of the portfolio, or lack of information on
the individual constituents.

129

Collateral exceeding the amount required by the CCP to cover the net positions is often maintained by theparticipant.

CPSS-IOSCO – Principles for financial market infrastructures – April 201285

maintained in the omnibus account covers the net positions across all customers of aparticular participant, upon a participant default, any excess collateral maintained by thedefaulting participant may not be readily available for porting to another participant tocollateralise a customer’s positions on a going-forward basis. Moreover, other than a bulk
transfer of all customer positions of the defaulting participant, along with the aggregate of thecustomer collateral held at the CCP and at the participant, any transfer of a customer’s
positions to another participant would depend on the ability and willingness of customers toprovide additional collateral. Otherwise, porting individual customer portfolios, with their pro
rata share of net margin, to multiple transferee clearing members is likely to result in undermargined customer positions. Transferee clearing members are unlikely to accept such
positions unless the margin shortfall is remedied by the customer.
Factors to consider in choosing the level of protection
3.14.15. In considering whether to offer individual customer collateral protection at theclearing level, the CCP should take into account all relevant circumstances. Suchcircumstances include applicable insolvency regimes, costs of implementation, and riskmanagement challenges associated with the use of individual customer accounts, as well as
the important benefits of individual customer protection. If the CCP determines that individual
customer accounts should be offered, then the CCP should endeavour to offer them atreasonable cost and in an unrestrictive manner and encourage direct participants to offer
those accounts to their customers at a reasonable cost and in an unrestrictive manner.
Transfer of positions and collateral
3.14.16. Efficient and complete portability of a participant’s customers’ positions and related
collateral is important in both pre-default and post-default scenarios but is particularly criticalwhen a participant defaults or is undergoing insolvency proceedings. 130 A CCP’s ability totransfer customers’ positions and related collateral in a timely manner may depend on suchfactors as market conditions, sufficiency of information on the individual constituents, and thecomplexity or sheer size of the portfolio. A CCP should therefore structure its portability
arrangements in a way that makes it highly likely that the positions and collateral of a
defaulting participant’s customers will be effectively transferred to one or more otherparticipants, taking into account all relevant circumstances. In order to achieve a highlikelihood of portability, a CCP will need to have the ability to identify positions that belong tocustomers, identify and assert its rights to related collateral held by or through the CCP,
transfer positions and related collateral to one or more other participants, identify potential
participants to accept the positions, disclose relevant information to such participants so thatthey can evaluate the counterparty credit and market risk associated with the customers andpositions, respectively, and facilitate the CCP’s ability to carry out its default management
procedures in an orderly manner. A CCP’s rules and procedures should require participants
to facilitate the transfer of a participant’s customers’ positions and collateral upon thecustomer’s request, subject to any notice or other contractual requirements. The CCP should
obtain the consent of the direct participant to which positions and collateral are ported. If
there are circumstances where this would not be the case, they should be set out in the
CCP’s rules, policies, or procedures. A CCP’s policies and procedures also should provide
for the proper handling of positions and collateral of customers of a defaulting participant. 131

130

A customer should also be able to transfer its positions and collateral to another participant in the normal
course of business (for example, in the case of a relationship with a new clearing firm or merger of entities),
subject to applicable laws and contractual terms. In addition, portability arrangements can also facilitate anorderly wind down of a participant.

131

See also Principle 13 on participant-default rules and procedures.

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Disclosure
3.14.17. A CCP should state its segregation and portability arrangements, including themethod for determining the value at which customer positions will be transferred, in its rules,
policies, and procedures. 132 A CCP’s disclosure should be adequate such that customers
can understand how much customer protection is provided, how segregation and portability
are achieved, and any risks or uncertainties associated with such arrangements. Disclosure
helps customers to assess the related risks and conduct due diligence when entering intotransactions that are cleared or settled through a direct participant in the CCP. Customers
should have sufficient information about which of its positions and collateral held at or
through a CCP are segregated from positions and collateral of the participant and the CCP.
Disclosure regarding segregation should include (a) whether the segregated assets arereflected on the books and records at the CCP or unaffiliated third-party custodians that holdassets for the CCP; (b) who holds the customer collateral (for example, CCP or third-party
custodian); and (c) under what circumstances customer collateral may be used by the CCP.
In particular, the CCP should disclose whether customer collateral is protected on an
individual or omnibus basis.

132

See Principle 23 on disclosure of rules, key procedures, and market data.

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General business and operational risk management
In addition to the credit, liquidity, and other related risks that it faces from its payment,
clearing, and settlement activities, an FMI also faces general business and operational risks.
The inability of an FMI to continue as a going concern could have systemic risk implications
for its participants and the broader financial markets. The following set of principles provides
guidance on managing (a) general business risk, (b) custody and investment risks, and(c) operational risk.
Principle 15: General business risk
An FMI should identify, monitor, and manage its general business risk and holdsufficient liquid net assets funded by equity to cover potential general businesslosses so that it can continue operations and services as a going concern if thoselosses materialise. Further, liquid net assets should at all times be sufficient to ensure
a recovery or orderly wind-down of critical operations and services.
Key considerations
1.

An FMI should have robust management and control systems to identify, monitor,and manage general business risks, including losses from poor execution ofbusiness strategy, negative cash flows, or unexpected and excessively large
operating expenses.

2.

An FMI should hold liquid net assets funded by equity (such as common stock,disclosed reserves, or other retained earnings) so that it can continue operations
and services as a going concern if it incurs general business losses. The amount ofliquid net assets funded by equity an FMI should hold should be determined by its
general business risk profile and the length of time required to achieve a recovery ororderly wind-down, as appropriate, of its critical operations and services if suchaction is taken.

3.

An FMI should maintain a viable recovery or orderly wind-down plan and should
hold sufficient liquid net assets funded by equity to implement this plan. At aminimum, an FMI should hold liquid net assets funded by equity equal to at least six
months of current operating expenses. These assets are in addition to resources
held to cover participant defaults or other risks covered under the financial
resources principles. However, equity held under international risk-based capital
standards can be included where relevant and appropriate to avoid duplicate capitalrequirements.

4.

Assets held to cover general business risk should be of high quality and sufficiently
liquid in order to allow the FMI to meet its current and projected operating expenses
under a range of scenarios, including in adverse market conditions.

5.

An FMI should maintain a viable plan for raising additional equity should its equity
fall close to or below the amount needed. This plan should be approved by theboard of directors and updated regularly.

Explanatory note
3.15.1. An FMI should have robust management and control systems to identify, monitor,and manage general business risk. General business risk refers to the risks and potential
losses arising from an FMI’s administration and operation as a business enterprise that areneither related to participant default nor separately covered by financial resources under thecredit or liquidity risk principles. General business risk includes any potential impairment of88

CPSS-IOSCO – Principles for financial market infrastructures – April 2012

the FMI’s financial position (as a business concern) as a consequence of a decline in its
revenues or an increase in its expenses, such that expenses exceed revenues and result ina loss that must be charged against capital. Such impairment can be caused by a variety ofbusiness factors, including poor execution of business strategy, negative cash flows, or
unexpected and excessively large operating expenses. Business-related losses also mayarise from risks covered by other principles, for example, legal risk (in the case of legal
actions challenging the FMI’s custody arrangements), investment risk affecting the FMI’s
resources, and operational risk (in the case of fraud, theft, or loss). 133 In these cases, generalbusiness risk may cause an FMI to experience an extraordinary one-time loss as opposed torecurring losses.
Identifying business risk
3.15.2. An FMI should identify and assess the sources of business risk and their potential
impact on its operations and services, taking into account past loss events and financial
projections. An FMI should assess and thoroughly understand its business risk and thepotential effect that this risk could have on its cash flows, liquidity, and capital positions. In
doing so, an FMI should consider a combination of tools, such as risk management andinternal control assessments, scenario analysis, and sensitivity analysis. Internal control
assessments should identify key risks and controls and assess the impact and probability of
the risks and the effectiveness of the controls. Scenario analysis should examine how
specific scenarios would affect the FMI. Sensitivity analysis should test how changes in one
risk affect the FMI’s financial standing, for example, conducting the analysis of how the lossof a key customer or service provider might impact the FMI’s existing business activities. In
some cases, an FMI may want to consider an independent assessment of specific businessrisks.
3.15.3. An FMI should clearly understand its general business risk profile so that it is able toassess its ability either (a) to avoid, reduce, or transfer specific business risks or (b) to accept
and manage those risks. This requires the ongoing identification of risk-mitigation options
that the FMI may use in response to changes in its business environment. When planning an
expansion of activity, an FMI should conduct a comprehensive enterprise risk assessment. In
particular, when considering any major new product, service, or project, the FMI should
project potential revenues and expenses as well as identify and plan how it will cover any
additional capital requirements. Further, an FMI may eliminate or mitigate some risks byinstituting appropriate internal controls or by obtaining insurance or indemnity from a third
party.
Measuring and monitoring business risk
3.15.4. Once an FMI has identified and assessed its business risk, it should measure andmonitor these risks on an ongoing basis and develop appropriate information systems as partof a robust enterprise risk-management program. Key components of a robust enterpriserisk-management program include establishing strong financial and internal control systems
so that the FMI can monitor, manage, and control its cash flows and operating expenses andmitigate any business-related losses (see Principle 3 on framework for the comprehensive
management of risks). In particular, an FMI should minimise and mitigate the probability ofbusiness-related losses and their impact on its operations across a range of adverse
business and market conditions, including the scenario that its viability as a going concern isquestioned. An FMI should also ensure that it has rigorous and appropriate investment
guidelines and monitoring procedures (see Principle 16 on custody and investment risks).

133

See also Principle 1 on legal basis, Principle 16 on custody and investment risks, and Principle 17 on
operational risk.

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Determining sufficient liquid net assets
3.15.5. An FMI should hold liquid net assets funded by equity (such as common stock,disclosed reserves, or retained earnings) so that it can continue operations and services as agoing concern if it incurs general business losses. 134 Equity allows an FMI to absorb losses
on an ongoing basis and should be permanently available for this purpose. The amount ofliquid net assets funded by equity an FMI should hold should be determined by its generalbusiness risk profile and the length of time required to achieve a recovery or orderly winddown, as appropriate, of its critical operations and services if such action is taken. 135
Accordingly, an FMI should maintain a viable plan to achieve recovery and orderly winddown and should hold sufficient liquid net assets funded by equity to implement this plan. 136
The appropriate amount of liquid net assets funded by equity will depend on the content of
the plan and, specifically, on the size of the FMI, the scope of its activities, the types ofactions included in the plan, and the length of time needed to implement them. An FMI
should also take into consideration the operational, technological, and legal requirements forparticipants to establish and move to an alternative arrangement in the event of an orderly
wind-down. At a minimum, however, an FMI should hold liquid net assets funded by equity
equal to at least six months of current operating expenses. 137
3.15.6. In order to estimate the amount of liquid net assets funded by equity that a particular
FMI would need, the FMI should regularly analyse and understand how its revenue andoperating expenses may change under a variety of adverse business scenarios as well as
how it might be affected by extraordinary one-time losses. This analysis should also be
performed when a material change to the assumptions underlying the model occurs, either
because of changes to the FMI’s business model or because of external changes. An FMI
needs to consider not only possible decreases in revenues but also possible increases inoperating expenses, as well as the possibility of extraordinary one-time losses, when
deciding on the amount of liquid net assets to hold to cover general business risk.
3.15.7. Assets held by an FMI to cover risks or losses other than business risk (for example,
the financial resources required under the credit and liquidity risk principles) or to coverlosses from other business lines that are unrelated to its activities as an FMI should not be
included when accounting for liquid net assets available to cover business risk. 138 However,equity held under international risk-based capital standards should be included where
relevant and appropriate to avoid duplicate capital requirements.
3.15.8. Assets held to cover general business risk should be of high quality and sufficiently
liquid, such as cash, cash equivalents, or liquid securities, to allow the FMI to meet its current
and projected operating expenses under a range of scenarios including in adverse market
conditions. To ensure the adequacy of its own resources, an FMI should regularly assess

134

If the FMI’s corporate structure is such that it cannot legally or institutionally raise equity (for example undercertain structures of mutual ownership or when the FMI is run by a central bank) or if the FMI is a new start-up
and cannot initially raise the required level of equity, it should ensure an equal amount of equivalent loss
absorbing financial resources is available.

135

Recovery could include recapitalising, replacing management, merging with another FMI, revising businessstrategies (including cost or fee structures), or restructuring services provided.

136

For the purposes of this principle, the requirement for liquid net assets funded by equity ensures that theassets held for the purposes of this principle are sufficiently liquid to be available to mitigate any potential
business risks in a timely manner, can only be used for business risk purposes, and are funded by equity
rather than long term liabilities.

137

Operating expenses may exclude depreciation and amortization expenses for purposes of this calculation.

138

Depending on the rules of the particular FMI and the insolvency law of the jurisdiction in which it isestablished, the equity of an FMI may ultimately be used if the resources that form the default backing are
insufficient to cover the losses generated in the event of a participant default.

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CPSS-IOSCO – Principles for financial market infrastructures – April 2012

and report its liquid net assets funded by equity relative to its potential business risks to its
regulators.
Maintaining sufficient equity
3.15.9. An FMI should provide a viable capital plan for maintaining an appropriate level of
equity. The capital plan should specify how an FMI would raise new capital if its equity capitalwere to fall close to or below the amount needed. This plan should be approved by the boardof directors (or an appropriate board committee) and updated regularly. An FMI may alsoneed to consult its participants and others during the development of its plan.
3.15.10. In developing a capital plan, an FMI should consider a number of factors, including
its ownership structure and any insured business risks. For example, an FMI should
determine if and to what extent specific business risks are covered by (a) explicit insurance
from a third party or (b) explicit indemnity agreements from a parent, owners, or participants(for example, general loss-allocation provisions and parent guarantees), which would be
realisable within the recovery or orderly wind-down time frame. Given the contingent natureof these resources, an FMI should use conservative assumptions when taking them into
account for its capital plan. Furthermore, these resources should not be taken into accountwhen assessing the FMI’s capital adequacy.

CPSS-IOSCO – Principles for financial market infrastructures – April 201291

Principle 16: Custody and investment risks
An FMI should safeguard its own and its participants’ assets and minimise the risk ofloss on and delay in access to these assets. An FMI’s investments should be in
instruments with minimal credit, market, and liquidity risks.
Key considerations
1.

An FMI should hold its own and its participants’ assets at supervised and regulated
entities that have robust accounting practices, safekeeping procedures, and internal
controls that fully protect these assets.

2.

An FMI should have prompt access to its assets and the assets provided byparticipants, when required.

3.

An FMI should evaluate and understand its exposures to its custodian banks, taking
into account the full scope of its relationships with each.

4.

An FMI’s investment strategy should be consistent with its overall risk-management
strategy and fully disclosed to its participants, and investments should be securedby, or be claims on, high-quality obligors. These investments should allow for quick
liquidation with little, if any, adverse price effect.

Explanatory note
3.16.1. An FMI has the responsibility to safeguard its assets, such as cash and securities,
as well as the assets that its participants have provided to the FMI. Custody risk is the risk ofloss on assets held in custody in the event of a custodian’s (or subcustodian’s) insolvency,
negligence, fraud, poor administration, or inadequate recordkeeping. Assets that are used by
an FMI to support its operating funds or capital funds or that have been provided byparticipants to secure their obligations to the FMI should be held at supervised or regulated
entities that have strong processes, systems, and credit profiles, including other FMIs (forexample, CSDs). In addition, assets should generally be held in a manner that assures the
FMI of prompt access to those assets in the event that the FMI needs to draw on them.
Investment risk refers to the risk of loss faced by an FMI when it invests its own or its
participants’ assets.
Use of custodians
3.16.2. An FMI should mitigate its custody risk by using only supervised and regulated
entities with robust accounting practices, safekeeping procedures, and internal controls thatfully protect its own and its participants’ assets. It is particularly important that assets held incustody are protected against claims of a custodian’s creditors. The custodian should have asound legal basis supporting its activities, including the segregation of assets (see also
Principle 1 on legal basis and Principle 11 on CSDs). The custodian also should have astrong financial position to be able to sustain losses from operational problems or noncustodial activities. An FMI should confirm that its interest or ownership rights in the assets
can be enforced and that it can have prompt access to its assets and the assets provided byparticipants, when required. Timely availability and access should be ensured even if thesesecurities are held in another time zone or jurisdiction. Furthermore, the FMI should confirm it
has prompt access to the assets in the event of a default of a participant.
3.16.3. An FMI should evaluate and understand its exposures to its custodian banks, taking
into account the full scope of its relationships with each custodian bank. For example, afinancial institution may serve as a custodian bank to an FMI as well as a settlement bankand liquidity provider to the FMI. The custodian bank also might be a participant in the FMI
and offer clearing services to other participants. An FMI should carefully consider all of its
relationships with a particular custodian bank to ensure that its overall risk exposure to an

92

CPSS-IOSCO – Principles for financial market infrastructures – April 2012individual custodian remains within acceptable concentration limits. Where feasible, an FMI
could consider using multiple custodians for the safekeeping of its assets to diversify its
exposure to any single custodian. For example, a CCP may want to use one custodian for its
margin assets and another custodian for its prefunded default arrangement. Such a CCP,
however, may need to balance the benefits of risk diversification against the benefits ofpooling resources at one or a small number of custodians. In any event, an FMI should
monitor the concentration of risk exposures to, and financial condition of, its custodian banks
on an ongoing basis.
Investment strategy
3.16.4. An FMI’s strategy for investing its own and its participants’ assets should beconsistent with its overall risk-management strategy and fully disclosed to its participants.
When making its investment choices, the FMI should not allow pursuit of profit tocompromise its financial soundness and liquidity risk management. Investments should besecured by, or be claims on, high-quality obligors to mitigate the credit risk to which the FMI
is exposed. Also, because the value of an FMI’s investments may need to be realised
quickly, investments should allow for quick liquidation with little, if any, adverse price effect.
For example, an FMI could invest in overnight reverse repo agreements backed by liquid
securities with low credit risk. An FMI should carefully consider its overall credit risk
exposures to individual obligors, including other relationships with the obligor that create
additional exposures such as an obligor that is also a participant or an affiliate of a participant
in the FMI. In addition, an FMI should not invest participant assets in the participant’s own
securities or those of its affiliates. If an FMI’s own resources can be used to cover losses andliquidity pressures resulting from a participant default, the investment of those resources
should not compromise the FMI’s ability to use them when needed.

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Principle 17: Operational risk
An FMI should identify the plausible sources of operational risk, both internal andexternal, and mitigate their impact through the use of appropriate systems, policies,
procedures, and controls. Systems should be designed to ensure a high degree of
security and operational reliability and should have adequate, scalable capacity.
Business continuity management should aim for timely recovery of operations andfulfilment of the FMI’s obligations, including in the event of a wide-scale or major
disruption.
Key considerations
1.

An FMI should establish a robust operational risk-management framework withappropriate systems, policies, procedures, and controls to identify, monitor, andmanage operational risks.

2.

An FMI’s board of directors should clearly define the roles and responsibilities foraddressing operational risk and should endorse the FMI’s operational riskmanagement framework. Systems, operational policies, procedures, and controls
should be reviewed, audited, and tested periodically and after significant changes.

3.

An FMI should have clearly defined operational reliability objectives and should havepolicies in place that are designed to achieve those objectives.

4.

An FMI should ensure that it has scalable capacity adequate to handle increasingstress volumes and to achieve its service-level objectives.

5.

An FMI should have comprehensive physical and information security policies that
address all potential vulnerabilities and threats.

6.

An FMI should have a business continuity plan that addresses events posing asignificant risk of disrupting operations, including events that could cause a widescale or major disruption. The plan should incorporate the use of a secondary siteand should be designed to ensure that critical information technology (IT) systems
can resume operations within two hours following disruptive events. The plan should
be designed to enable the FMI to complete settlement by the end of the day of the
disruption, even in case of extreme circumstances. The FMI should regularly test
these arrangements.

7.

An FMI should identify, monitor, and manage the risks that key participants, other
FMIs, and service and utility providers might pose to its operations. In addition, an
FMI should identify, monitor, and manage the risks its operations might pose toother FMIs.

Explanatory note
3.17.1. Operational risk is the risk that deficiencies in information systems, internal
processes, and personnel or disruptions from external events will result in the reduction,
deterioration, or breakdown of services provided by an FMI. Operational failures can damage
an FMI’s reputation or perceived reliability, lead to legal consequences, and result in financial
losses incurred by the FMI, participants, and other parties. In certain cases, operational
failures can also be a source of systemic risk. An FMI should establish a robust framework to
manage its operational risks with appropriate systems, policies, procedures, and controls. As
part of an FMI’s operational risk-management framework, the FMI should identify theplausible sources of operational risk; deploy appropriate systems; establish appropriate
policies, procedures, and controls; set operational reliability objectives; and develop abusiness continuity plan. An FMI should take a holistic approach when establishing its
operational risk-management framework.

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Identifying sources of operational risk
3.17.2. An FMI should actively identify, monitor, and manage the plausible sources ofoperational risk and establish clear policies and procedures to address them. Operationalrisk can stem from both internal and external sources. Internal sources of operational risk
include inadequate identification or understanding of risks and the controls and procedures
needed to limit and manage them, inadequate control of systems and processes, inadequate
screening of personnel, and, more generally, inadequate management. External sources ofoperational risk include the failure of critical service providers or utilities or events affecting awide metropolitan area such as natural disasters, terrorism, and pandemics. Both internaland external sources of operational risk can lead to a variety of operational failures that
include (a) errors or delays in message handling, (b) miscommunication, (c) service
degradation or interruption, (d) fraudulent activities by staff, and (e) disclosure of confidential
information to unauthorised entities. If an FMI provides services in multiple time zones, it may
face increased operational risk due to longer operational hours and less downtime formaintenance. An FMI should identify all potential single points of failure in its operations. 139
Additionally, an FMI should assess the evolving nature of the operational risk it faces on an
ongoing basis (for example, pandemics and cyber-attacks), so that it can analyse its potential
vulnerabilities and implement appropriate defence mechanisms.
3.17.3. A TR typically serves as a single source of information for a particular market, and it
may be the central registry for certain trades. Therefore, a TR’s failure to perform as
expected could cause significant disruption. The key risk of a TR is operational. Deficiencies
in business continuity management, data integrity, and the safeguarding of data are aparticular concern. Inadequate disclosure or faulty delivery of data by a TR to relevant
authorities or the public could undermine the primary purpose of the TR. Access to timely
and reliable data provides greater insights into the derivatives market and improves theability of relevant authorities to oversee the markets it serves and its participants. Data
recorded by a TR may also be used as inputs by the TR’s participants and potentially byother relevant infrastructures and service providers. Therefore, continuous availability of datastored in a TR is critical. 140 Also, a TR should carefully assess the additional operational risks
related to its links to ensure the scalability and reliability of IT and related resources. Where a
TR provides access to another type of FMI, such as a CCP, the linked FMIs may be exposed
to additional risks if the interface is not properly designed. FMIs establishing a link to a TR
should ensure that the system and communication arrangements between the linked entities
are reliable and secure such that the operation of the link does not pose significant reliability
and security risks.
Operational risk management
3.17.4. An FMI should establish clear policies, procedures, and controls that mitigate andmanage its sources of operational risk. Overall, operational risk management is a continuous
process encompassing risk assessment, defining an acceptable tolerance for risk, andimplementing risk controls. This process results in an FMI accepting, mitigating, or avoiding
risks consistent with its operational reliability objectives. An FMI’s governance arrangements
are pertinent to its operational risk-management framework (see also Principle 2 ongovernance). In particular, an FMI’s board should explicitly define the roles and139

A single point of failure is any point in a system, whether a service, activity, or process, that, if it fails to work
correctly, leads to the failure of the entire system.

140

The mitigation of operational risk is particularly important because the information maintained by a TR can
support bilateral netting and be used to provide services directly to market participants or other providers (forexample, portfolio compression), including other linked FMIs.

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responsibilities for addressing operational risk and endorse the FMI’s operational riskmanagement framework.
3.17.5. To ensure the proper functioning of its risk controls, an FMI should have soundinternal controls. For example, an FMI should have adequate management controls, such as
setting operational standards, measuring and reviewing performance, and correcting
deficiencies. There are many relevant international, national, and industry-level standards,
guidelines, or recommendations that an FMI may use in designing its operational riskmanagement framework. Conformity with commercial standards can help an FMI reach its
operational objectives. For example, commercial standards exist for information security,business continuity, and project management. An FMI should regularly assess the need tointegrate the applicable commercial standards into its operational risk-management
framework. In addition, an FMI should seek to comply with relevant commercial standards ina manner commensurate with the FMI’s importance and level of interconnectedness.
3.17.6. An FMI’s arrangements with participants, operational policies, and operational
procedures should be periodically, and whenever necessary, tested and reviewed, especiallyafter significant changes occur to the system or a major incident occurs. In order to minimise
any effects of the testing on operations, tests should be carried out in a “testing
environment.” This testing environment should, to the extent possible, replicate theproduction environment (including the implemented security provisions, in particular, thoseregarding data confidentiality). Additionally, key elements of an FMI’s operational riskmanagement framework should be audited periodically and whenever necessary. In addition
to periodic internal audits, external audits may be necessary, depending on the FMI’s
importance and level of interconnectedness. Consistent with the evolving nature ofoperational risk management, an FMI’s operational objectives should be periodicallyreviewed to incorporate new technological and business developments.
3.17.7. Because the proper performance of an FMI’s employees is a core aspect of any
operational risk-management framework, an FMI should employ sufficient, well-qualified
personnel. An FMI’s personnel should be able to operate the system safely and efficiently
and consistently follow operational and risk-management procedures during normal andabnormal circumstances. An FMI should implement appropriate human resources policies tohire, train, and retain qualified personnel, thereby mitigating the effects of high rates of
personnel turnover or key-person risk. Additionally, an FMI should have appropriate humanresources and risk-management policies to address fraud prevention.
3.17.8. The FMI’s operational risk-management framework should include formal changemanagement and project-management processes to mitigate operational risk arising frommodifications to operations, policies, procedures, and controls. Change-management
processes should provide mechanisms for preparing, approving, tracking, testing, andimplementing all changes to the system. Project-management processes, in the form ofpolicies and procedures, should mitigate the risk of any inadvertent effects on an FMI’s
current or future activities due to an upgrade, expansion, or alteration to its service offerings,
especially for major projects. In particular, these policies and procedures should guide themanagement, documentation, governance, communication, and testing of projects,
regardless of whether projects are outsourced or executed in-house.
Operational reliability
3.17.9. An FMI should have clearly defined operational reliability objectives and should havepolicies in place that are designed to achieve those objectives. These objectives serve as
benchmarks for an FMI to evaluate its efficiency and effectiveness and evaluate its
performance against expectations. These objectives should be designed to promote
confidence among the FMI’s participants. Operational reliability objectives should include the
FMI’s operational performance objectives and committed service-level targets. Operational
performance objectives and service-level targets should define both qualitative andquantitative measures of operational performance and should explicitly state the96

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performance standards the FMI is intending to meet. The FMI should monitor and assess
regularly whether the system is meeting its established objectives and service-level targets.
The system’s performance should be reported regularly to senior management, relevantboard committees, participants, and authorities. In addition, an FMI’s operational objectives
should be periodically reviewed to incorporate new technological and businessdevelopments.
Incident management
3.17.10. An FMI should have comprehensive and well-documented procedures in place torecord, report, analyse, and resolve all operational incidents. After every significant
disruption, an FMI should undertake a “post-incident” review to identify the causes and any
required improvement to the normal operations or business continuity arrangements. Suchreviews should, where relevant, include the FMI’s participants.
Operational capacity
3.17.11. An FMI should ensure that it has scalable capacity adequate to handle increasingstress volumes and to achieve its service-level objectives, such as the required processing
speed. A TR, in particular, should have scalable capacity adequate to maintain historical data
as required. Capacity management requires that the FMI monitor, review, and test (including
stress test) the actual capacity and performance of the system on an ongoing basis. The FMI
should carefully forecast demand and make appropriate plans to adapt to any plausible
change in the volume of business or technical requirements. These plans should be basedon a sound, comprehensive methodology so that the required service levels andperformance can be achieved and maintained. As part of its capacity planning, an FMI
should determine a required level of redundant capacity, taking into account the FMI’s levelof importance and interconnectedness, so that if an operational outage occurs, the system isable to resume operations and process all remaining transactions before the end of the day.
Physical and information security
3.17.12. An FMI should have comprehensive physical and information security policies that
address all potential vulnerabilities and threats. In particular, an FMI should have policies
effective in assessing and mitigating vulnerabilities in its physical sites from attacks,
intrusions, and natural disasters. An FMI also should have sound and robust information
security policies, standards, practices, and controls to ensure an appropriate level ofconfidence and trust in the FMI by all stakeholders. These policies, standards, practices, andcontrols should include the identification, assessment, and management of security threats
and vulnerabilities for the purpose of implementing appropriate safeguards into its systems.
Data should be protected from loss and leakage, unauthorised access, and other processing
risks, such as negligence, fraud, poor administration, and inadequate recordkeeping. An
FMI’s information security objectives and policies should conform to commerciallyreasonable standards for confidentiality, integrity, authentication, authorisation, nonrepudiation, availability, and auditability (or accountability).
Business continuity management
3.17.13. Business continuity management is a key component of an FMI’s operational riskmanagement framework. A business continuity plan should have clearly stated objectives
and should include policies and procedures that allow for the rapid recovery and timely
resumption of critical operations following a disruption to a service, including in the event of awide-scale or major disruption. An FMI should explicitly assign responsibility for business
continuity planning and devote adequate resources to this planning. The plan should identify
and address events that pose a significant risk of disrupting operations, including events that
could cause a wide-scale or major disruption, and should focus on the impact on theoperation of critical infrastructures and services. An FMI’s business continuity plan should

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ensure that the FMI can continue to meet agreed-upon service levels in such events. Bothinternal and external threats should be considered in the business continuity plan, and theimpact of each threat should be identified and assessed. In addition to reactive measures, an
FMI’s business continuity plan may need to include measures that prevent disruptions ofcritical operations. All aspects of the business continuity plan should be clearly and fully
documented.
3.17.14. The objectives of an FMI’s business continuity plan should include the system’s
recovery time and recovery point. An FMI should aim to be able to resume operations within
two hours following disruptive events; however, backup systems ideally should commence
processing immediately. The plan should be designed to enable the FMI to complete
settlement by the end of the day even in case of extreme circumstances. Depending on theirrecovery-time objectives and designs, some FMIs may be able to resume operations withsome data loss; however, contingency plans for all FMIs should ensure that the status of alltransactions at the time of the disruption can be identified with certainty in a timely manner.
3.17.15. An FMI should set up a secondary site with sufficient resources, capabilities, andfunctionalities and appropriate staffing arrangements that would not be affected by a widescale disruption and would allow the secondary site to take over operations if needed. 141 The
secondary site should provide the level of critical services necessary to perform the functions
consistent with the recovery time objective and should be located at a geographical distancefrom the primary site that is sufficient to have a distinct risk profile. 142 Depending on the FMI’s
importance and level of interconnectedness, the need and possibilities for a third site could
be considered, in particular to provide sufficient confidence that the FMI’s business continuity
objectives will be met in all scenarios. An FMI should also consider alternative arrangements(for example, manual paper-based procedures) to allow for the processing of time-criticaltransactions in extreme circumstances.
3.17.16. An FMI’s business continuity plan should also include clearly defined procedures forcrisis and event management. The plan, for example, should address the need for rapid
deployment of a multi-skilled crisis and event-management team as well as procedures to
consult and inform participants, interdependent FMIs, authorities, and others (such asservice providers and, where relevant, the media) quickly. Communication with regulators,
supervisors, and overseers is critical in case of a major disruption to an FMI’s operations or awider market distress that affects the FMI, particularly where relevant authorities might rely
on data held by the FMI for crisis management. Depending on the nature of the problem,
communication channels with local civil authorities (for physical attacks or natural disasters)
or computer experts (for software malfunctions or cyber-attacks) may also need to be
activated. If an FMI has global importance or critical linkages to one or more interdependent
FMIs, it should set up, test, and review appropriate cross-system or cross-border crisismanagement arrangements.
3.17.17. An FMI’s business continuity plan and its associated arrangements should be
subject to periodic review and testing. Tests should address various scenarios that simulate
wide-scale disasters and intersite switchovers. An FMI’s employees should be thoroughly
trained to execute the business continuity plan and participants, critical service providers,
and linked FMIs should be regularly involved in the testing and be provided with a general141

A particular site may be primary for certain functions and secondary for others. It is not intended that an FMI
would be required to have numerous separate secondary sites for each of its essential functions.

142

An FMI should conduct a comparative risk analysis of the secondary site. The secondary site should in
principle not be affected by an event that affects the primary site, with the exception of some very specificthreats, such as a coordinated attack. Each site should have robust resilience based on the duplication ofsoftware and hardware, and the technology in place to replicate data between the various sites should beconsistent with the chosen recovery-point objectives.

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summary of the testing results. The FMI should also consider the need to participate inindustry-wide tests. An FMI should make appropriate adjustments to its business continuity
plans and associated arrangements based on the results of the testing exercises.
Interdependencies
3.17.18. An FMI is connected directly and indirectly to its participants, other FMIs, and its
service and utility providers. Accordingly, the FMI should identify both direct and indirect
effects on its ability to process and settle transactions in the normal course of business andmanage risks that stem from an external operational failure of connected entities. These
effects include those transmitted through its participants, which may participate in multiple
FMIs. In addition, an FMI should also identify, monitor, and manage the risks it faces fromand poses to other FMIs (see Principle 20 on FMI links). To the extent possible,
interdependent FMIs should coordinate business continuity arrangements. An FMI also
should consider the risks associated with its service and utility providers and the operational
effect on the FMI if service or utility providers fail to perform as expected. An FMI should
provide reliable service, not only for the benefit of its direct participants, but also for all
entities that would be affected by its ability to process transactions.
3.17.19. To manage the operational risks associated with its participants, an FMI should
consider establishing minimum operational requirements for its participants (see also
Principle 18 on access and participation requirements). For example, an FMI may want todefine operational and business continuity requirements for participants in accordance withthe participant’s role and importance to the system. In some cases, an FMI may want to
identify critical participants based on the consideration of transaction volumes and values,
services provided to the FMI and other interdependent systems, and, more generally, thepotential impact on other participants and the system as a whole in the event of a significant
operational problem. Critical participants may need to meet some of the same operationalrisk-management requirements as the FMI itself. An FMI should have clear and transparent
criteria, methodologies, or standards for critical participants to ensure that their operationalrisks are managed appropriately.
3.17.20. An FMI that relies upon or outsources some of its operations to another FMI or athird-party service provider (for example, data processing and information systems
management) should ensure that those operations meet the same requirements they would
need to meet if they were provided internally. The FMI should have robust arrangements forthe selection and substitution of such providers, timely access to all necessary information,and the proper controls and monitoring tools. Some service providers may be critical, suchas those that generate environmental interdependencies, because several FMIs or some of
their key participants rely upon their services. 143 A contractual relationship should be in place
between the FMI and the critical service provider allowing the FMI and relevant authorities tohave full access to necessary information. The contract should ensure that the FMI’s
approval is mandatory before the critical service provider can itself outsource material
elements of the service provided to the FMI, and that in the event of such an arrangement,
full access to the necessary information is preserved. Clear lines of communication shouldbe established between the outsourcing FMI and the critical service provider to facilitate theflow of functions and information between parties in both ordinary and exceptional
circumstances.

143

Environmental interdependencies result from indirect relationships between two or more systems that arise
from broader factors, including a common reliance on a service provider or financial market. Examples
include common third-party IT or network providers, common elements of the physical infrastructure (power,
water, etc.), common financial markets, or even common risk management procedures. See CPSS, Theinterdependencies of payment and settlement systems, June 2008.

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3.17.21. An FMI that outsources operations to critical service providers should disclose thenature and scope of this dependency to its participants. In addition to these service providers(such as financial messaging providers), an FMI is also typically dependent on the adequate
functioning of utilities (such as power and telecommunication companies). As a result, an
FMI should identify the risks from its critical service providers and utilities and takeappropriate actions to manage these dependencies through appropriate contractual andorganisational arrangements. An FMI should inform its relevant authorities about any suchdependencies on critical service providers and utilities and take measures to allow theseauthorities to be informed about the performance of these critical service providers andutilities. To that end, the FMI can contractually provide for direct contacts between the criticalservice provider and the relevant authority, contractually ensure that the relevant authority
can obtain specific reports from the critical service provider, or the FMI may provide full
information to the authority.
3.17.22. The relevant authority of the FMI may establish expectations specifically targeted at
critical service providers, as presented in Annex F. Adherence to these expectations can beachieved in one of two ways, at the discretion of the authority: (a) the authority monitors
adherence to the expectations itself in a direct relationship with the critical service provider or(b) the authority communicates the standards to the FMI, which obtains assurances from its
critical service providers that they comply with the expectations. These expectations may
also be relevant to an FMI as it reviews its contracts with critical service providers.

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Access
Fair and open access to an FMI by direct participants, indirect participants, and other FMIs is
important because of the critical role many FMIs play in the markets they serve. The
following set of principles provides guidance on (a) access and participation requirements,(b) the management of tiered participation arrangements, and (c) the management of FMI
links.
Principle 18: Access and participation requirements
An FMI should have objective, risk-based, and publicly disclosed criteria forparticipation, which permit fair and open access.
Key considerations
1.

An FMI should allow for fair and open access to its services, including by direct and,
where relevant, indirect participants and other FMIs, based on reasonable riskrelated participation requirements.

2.

An FMI’s participation requirements should be justified in terms of the safety andefficiency of the FMI and the markets it serves, be tailored to and commensuratewith the FMI’s specific risks, and be publicly disclosed. Subject to maintaining
acceptable risk control standards, an FMI should endeavour to set requirements thathave the least-restrictive impact on access that circumstances permit.

3.

An FMI should monitor compliance with its participation requirements on an ongoingbasis and have clearly defined and publicly disclosed procedures for facilitating thesuspension and orderly exit of a participant that breaches, or no longer meets, theparticipation requirements.

Explanatory note
3.18.1. Access refers to the ability to use an FMI’s services and includes the direct use of
the FMI’s services by participants, including other market infrastructures (for example,
trading platforms) and, where relevant, service providers (for example, matching and portfolio
compression service providers). In some cases, this includes the rules governing indirect
participation. An FMI should allow for fair and open access to its services. 144 It should control
the risks to which it is exposed by its participants by setting reasonable risk-related
requirements for participation in its services. An FMI should ensure that its participants andany linked FMIs have the requisite operational capacity, financial resources, legal powers,
and risk-management expertise to prevent unacceptable risk exposure for the FMI and otherparticipants. An FMI’s participation requirements should be clearly stated and publicly
disclosed so as to eliminate ambiguity and promote transparency.
Fair and open access to payment systems, CSDs, SSSs, and CCPs
3.18.2. Fair and open access to FMI services encourages competition among market
participants and promotes efficient and low-cost payment, clearing, and settlement. Because
an FMI often benefits from economies of scale, there is typically only one FMI, or a small

144

Central banks, however, may exclude certain categories of financial institutions (such as non-deposit-taking
institutions) from the FMIs that they operate, such as LVPS, because of legislative constraints or broader
policy objectives.

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number of FMIs, for a particular market. As a result, participation in an FMI may significantly
affect the competitive balance among market participants. In particular, limiting access to an
FMI’s services may disadvantage some market participants (and their customers), other
FMIs (for example, a CCP that needs access to a CSD), and service providers that do nothave access to the FMI’s services. Further, access to one or more FMIs may play animportant role in a marketwide plan or policy for the safe and efficient clearing of certainclasses of financial instruments and the promotion of efficient financial markets (including thereporting and recording of transaction data). An FMI’s participation requirements should
therefore allow for fair and open access, in all relevant jurisdictions, based on reasonablerisk-related participation requirements. Moreover, open access may reduce theconcentrations of risk that may result from highly tiered arrangements for payment, clearing,and settlement.
Fair and open access to TRs
3.18.3. For a TR, ensuring fair and open access may be essential because a wide set ofstakeholders may need, or be required by law to have, access to the TR’s data warehousing
services, both to store and retrieve data. This may be even more relevant when one TR isserving a particular market and serves multiple jurisdictions. Access is critical for participants
reporting trade information to the TR and for platforms that may submit transaction data on
behalf of participants, including exchanges, electronic trading venues, and confirmation ormatching service providers. In addition, other FMIs or platforms that offer ancillary services
may need to obtain trade information from the TR to use as an input to these services.
3.18.4. In addition, a TR should provide terms of use that are commercially reasonable andare designed to support interconnectivity with other FMIs and service providers, where
requested, so that competition and innovation in post-trade processing are not impaired as aresult of centralising recordkeeping activity. A TR should not engage in anti-competitive
practices such as product or service tying, setting overly restrictive terms of use, or anticompetitive price discrimination. A TR also should not develop closed, proprietary interfacesthat result in vendor lock-in or barriers to entry with respect to competing service providers
that rely on the data maintained by the TR.
Risk-related participation requirements
3.18.5. An FMI should always consider the risks that an actual or prospective participant
may pose to the FMI and other participants. Accordingly, an FMI should establish risk-relatedparticipation requirements adequate to ensure that its participants meet appropriate
operational, financial, and legal requirements to allow them to fulfil their obligations to the
FMI, including the other participants, on a timely basis. Where participants act for otherentities (indirect participants), it may be appropriate for the FMI to impose additional
requirements to ensure that the direct participants have the capacity to do so (see also
Principle 19 on tiered participation arrangements). Operational requirements may include
reasonable criteria relating to the participant’s ability and readiness (for example, its IT
capabilities) to use an FMI’s services. Financial requirements may include reasonable riskrelated capital requirements, contributions to prefunded default arrangements, andappropriate indicators of creditworthiness. Legal requirements may include appropriate
licences and authorisations to conduct relevant activities as well as legal opinions or otherarrangements that demonstrate that possible conflict of laws issues would not impede theability of an applicant (for example, a foreign entity) to meet its obligations to the FMI. An FMI
also may require participants to have appropriate risk-management expertise. If an FMI
admits non-regulated entities, it should take into account any additional risks that may arise
from their participation and design its participation requirements and risk-management
controls accordingly.

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3.18.6. An FMI’s participation requirements should be justified in terms of the safety andefficiency of the FMI and the markets it serves, be tailored to the FMI’s specific risks, be
imposed in a manner commensurate with such risks, and be publicly disclosed. 145 The
requirements should be objective and should not unnecessarily discriminate against
particular classes of participants or introduce competitive distortions. For example,
participation requirements based solely on a participant’s size are typically insufficiently
related to risk and deserve careful scrutiny. Subject to maintaining acceptable risk control
standards, an FMI should endeavour to set requirements that have the least-restrictive
impact on access that circumstances permit. While restrictions on access should generally
be based on reasonable risk-related criteria, such restrictions may also be subject to theconstraints of local laws and policies of the jurisdiction in which the FMI operates. 146
Requirements should also reflect the risk profile of the activity; an FMI may have different
categories of participation based on the type of activity. For example, a participant in theclearing services of a CCP may be subject to a different set of requirements than aparticipant in the auctioning process of the same CCP.
3.18.7. To help address the balance between open access and risk, an FMI should manage
its participant-related risks through the use of risk-management controls, risk-sharing
arrangements, and other operational arrangements that have the least-restrictive impact onaccess and competition that circumstances permit. For example, an FMI can use credit limits
or collateral requirements to help it manage its credit exposure to a particular participant. The
permitted level of participation may be different for participants maintaining different levels ofcapital. Where other factors are equal, participants holding greater levels of capital may bepermitted less-restrictive risk limits or be able to participate in more functions within the FMI.
The effectiveness of such risk-management controls may mitigate the need for an FMI to
impose onerous participation requirements that limit access. An FMI could also differentiate
its services to provide different levels of access at varying levels of cost and complexity. For
example, an FMI may want to limit direct participation to certain types of entities and provide
indirect access to others. 147 Participation requirements (and other risk controls) can be
tailored to each tier of participants based on the risks each tier poses to the FMI and its
participants.
Monitoring
3.18.8. An FMI should monitor compliance with its participation requirements on an ongoingbasis through the receipt of timely and accurate information. Participants should be obligatedto report any developments that may affect their ability to comply with an FMI’s participation
requirements. An FMI should have the authority to impose more-stringent restrictions orother risk controls on a participant in situations where the FMI determines the participant
poses heightened risk to the FMI. For example, if a participant’s creditworthiness declines,
the FMI may require the participant to provide additional collateral or reduce the participant’s
credit limit. An FMI should consider additional reporting requirements for non-regulated

145

Efficiency considerations may affect open access. For example, in some instances, factors such as minimumtransaction volumes are relevant to operational efficiency. However, considerations based solely on efficiency
should not be used to justify participation requirements that in fact act as unjustifiable barriers to entry.

146

For example, certain categories of financial institutions (such as non-deposit-taking institutions) may be
excluded from certain FMIs, such as LVPS, because of local banking laws or policies. Conversely, some local
laws, such as securities and antitrust laws, may require broader inclusion of classes of participants in certain
types of FMIs, such as CCPs.

147

For example, an FMI may accept direct receipt of settlement instructions from indirect participants, which
settle on the books of a direct participant. Indirect participants may or may not be explicitly recognised in an
FMI’s rules and subject to risk controls. In all cases, an indirect participant has a bilateral agreement with adirect participant.

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institutions. An FMI should also have clearly defined and publicly disclosed procedures forfacilitating the suspension and orderly exit of a participant that breaches, or no longer meets,the participation requirements of the FMI.

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Principle 19: Tiered participation arrangements
An FMI should identify, monitor, and manage the material risks to the FMI arising fromtiered participation arrangements.
Key considerations
1.

An FMI should ensure that its rules, procedures, and agreements allow it to gather
basic information about indirect participation in order to identify, monitor, andmanage any material risks to the FMI arising from such tiered participation
arrangements.

2.

An FMI should identify material dependencies between direct and indirect
participants that might affect the FMI.

3.

An FMI should identify indirect participants responsible for a significant proportion oftransactions processed by the FMI and indirect participants whose transaction
volumes or values are large relative to the capacity of the direct participants throughwhich they access the FMI in order to manage the risks arising from thesetransactions.

4.

An FMI should regularly review risks arising from tiered participation arrangements
and should take mitigating action when appropriate.

Explanatory note
3.19.1. Tiered participation arrangements occur when some firms (indirect participants) relyon the services provided by other firms (direct participants) to use the FMI’s central payment,
clearing, settlement, or recording facilities. 148
3.19.2. The dependencies and risk exposures (including credit, liquidity, and operationalrisks) inherent in these tiered arrangements can present risks to the FMI and its smoothfunctioning as well as to the participants themselves and the broader financial markets. 149
For example, if an FMI has few direct participants but many indirect participants with large
values or volumes of transactions, it is likely that a large proportion of the transactions
processed by the FMI depend on a few direct participants. This will increase the severity ofthe effect on the FMI of a default of a direct participant or an operational disruption at a direct
participant. The credit exposures in tiered relationships can also affect the FMI. If the value of
an indirect participant’s transactions is large relative to the direct participant’s capacity to
manage the risks, this may increase the direct participant’s default risk. In some cases, forexample, CCPs offering indirect clearing will face credit exposures to indirect participants orarising from indirect participants’ positions if a direct participant defaults. There may also be
legal or operational risk to the FMI if there is uncertainty about the liability for indirect
participant transactions and how these transactions will be handled in the event of a
default. 150

148

For the purposes of this principle, an FMI can have two types of relationships that affect tiered participation
arrangements. The first type of relationship is with participants in the FMI that are bound by the FMI’s rules
and agreements. Such “direct participants” and the management of the risks they present should be fully
covered by the rules and agreements of the FMI and are generally dealt with in other principles in this report.
The second type of relationship is with entities that are not bound by the rules of the FMI, but whosetransactions are cleared, settled, or recorded by or through the FMI. These entities are defined as “indirect
participants” in the FMI in this principle.

149

The risk issues will vary depending on the type of FMI. For TRs, only operational risk will be relevant.

150

See Principle 1 on legal basis.

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3.19.3. The nature of these risks is such that they are most likely to be material where there
are indirect participants whose business through the FMI is a significant proportion of the
FMI’s overall business or is large relative to that of the direct participant through which they
access the FMI’s services. Normally, the identification, monitoring, and management of risks
from tiered participation will therefore be focused on financial institutions that are theimmediate customers of direct participants and depend on the direct participant for access to
an FMI’s services. 151 In exceptional cases, however, tiered participation arrangements may
involve a complex series of financial intermediaries or agents, which may require the FMI tolook beyond the direct participant and its immediate customer.
3.19.4. There are limits on the extent to which an FMI can, in practice, observe or influence
direct participants’ commercial relationships with their customers. However, an FMI will often
have access to information on transactions undertaken on behalf of indirect participants andcan set direct participation requirements that may include criteria relating to how direct
participants manage relationships with their customers in-so-far as these criteria are relevant
for the safe and efficient operation of the FMI. At a minimum, an FMI should identify thetypes of risk that could arise from tiered participation and should monitor concentrations ofsuch risk. If an FMI or its smooth operation is exposed to material risk from tiered
participation arrangements, the FMI should seek to manage and limit such risk.
Gathering and assessing information on risks arising from tiered participation arrangements
3.19.5. An FMI may be able to obtain information relating to tiered participation through its
own systems or by collecting it from direct participants. An FMI should ensure that its
procedures, rules, and agreements with direct participants allow it to gather basic information
about indirect participants in order to identify, monitor, and manage any material risks to the
FMI arising from such tiered participation arrangements. This information should enable the
FMI, at a minimum, to identify (a) the proportion of activity that direct participants conduct onbehalf of indirect participants, (b) direct participants that act on behalf of a material number ofindirect participants, (c) indirect participants with significant volumes or values of transactionsin the system, and (d) indirect participants whose transaction volumes or values are large
relative to those of the direct participants through which they access the FMI. 152
Understanding material dependencies in tiered participation arrangements
3.19.6. An FMI should identify material dependencies between direct and indirect
participants that can affect the FMI. Indirect participants will often have some degree of
dependency on the direct participant through which they access the FMI. In the case of an
FMI with few direct participants but many indirect participants, it is likely that a large
proportion of the transactions processed by the FMI would depend on the operational
performance of those few direct participants. Disruption to the services provided by the direct
participants – whether for operational reasons or because of a participant’s default – could
therefore present a risk to the smooth functioning of the system as a whole. The FMI should
identify and monitor material dependencies of indirect participants on direct participants sothat the FMI has readily available information on which significant indirect participants may
be affected by problems at a particular direct participant.
3.19.7. In some cases, issues at an indirect participant could affect the FMI. This is most
likely to occur where a large indirect participant accesses an FMI’s facilities through a

151

CCPs that face credit exposures arising from the positions of indirect participants in the event of a direct
participant’s default, should identify, monitor, and manage material exposures to non-financial institutions.

152

If satisfying this key consideration requires the collection of sensitive information that may advantage one
party over another, the FMI should ensure that the sensitive information is appropriately protected and used
only for risk purposes rather than commercial purposes.

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relatively small direct participant. Failure of this significant indirect participant to perform as
expected, such as by failing to meet its payment obligations, or stress at the indirect
participant, such as that which causes others to delay payments to the indirect participant,may affect the direct participant’s ability to meet its obligations to the FMI. FMIs should
therefore identify and monitor the material dependencies of direct participants on indirect
participants so that the FMI has readily available information on how the FMI may be affectedby problems at an indirect participant, including which direct participants may be affected.
Credit and liquidity risks in tiered participation arrangements
3.19.8. Tiered participation arrangements typically create credit and liquidity exposures
between direct and indirect participants. The management of these exposures is the
responsibility of the participants and, where appropriate, subject to supervision by theirregulators. An FMI is not expected to manage the credit and liquidity exposures between
direct and indirect participants, although the FMI may have a role in applying credit orposition limits in agreement with the direct participant. An FMI should, however, have accessto information on concentrations of risk arising from tiered participation arrangements that
may affect the FMI, allowing it to identify indirect participants responsible for a significant
proportion of the FMI’s transactions or whose transaction volumes or values are large
relative to those of the direct participants through which they access the FMI. An FMI should
identify and monitor such risk concentrations.
3.19.9. In a CCP, direct participants are responsible for the performance of their customers'
financial obligations to the CCP. The CCP may, however, face an exposure to indirect
participants (or arising from indirect participants’ positions) if a direct participant defaults, atleast until such time as the defaulting participant’s customers’ positions are ported to anotherparticipant or closed out. If a participant default would leave the FMI with a potential credit
exposure related to an indirect participant’s positions, the FMI should ensure it understands
and manages the exposure it would face. For example, the FMI may set participation
requirements that require the direct participant, on the FMI’s request, to demonstrate that it isadequately managing relationships with its customers to the extent that they may affect the
FMI. An FMI should also consider establishing concentration limits on exposures to indirect
participants, where appropriate.
Indirect participation and default scenarios
3.19.10. Default scenarios can create uncertainty about whether indirect participants’transactions have been settled or will be settled and whether any settled transactions will be
unwound. Default scenarios can also raise legal and operational risks for the FMI if there is
uncertainty about whether the indirect or direct participant is liable for completing thetransaction. An FMI should ensure that a default, whether by a direct participant or by anindirect participant, does not affect the finality of indirect participants’ transactions that havebeen processed and settled by the FMI. An FMI should ensure that its rules and procedures
are clear regarding the status of indirect participants’ transactions at each point in thesettlement process (including the point at which they become subject to the rules of thesystem and the point after which the rules of the system no longer apply) and whether suchtransactions would be settled in the event of an indirect or direct participant default. An FMI
should also ensure that it adequately understands its direct participants' processes andprocedures for managing an indirect participant’s default. For example, the FMI should knowwhether the indirect participant’s queued payments can be removed or future-dated
transactions rescinded and whether such processes and procedures would expose the FMI
to operational, reputational, or other risks.
Encouraging direct participation
3.19.11. Direct participation in an FMI usually provides a number of benefits, some of which
may not be available to indirect participants, such as real-time gross settlement, exchange-

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of-value settlement, or settlement in central bank money. Moreover, indirect participants arevulnerable to the risk that their access to an FMI, their ability to make and receive payments
and their ability to undertake and settle other transactions is lost if the direct participant onwhom these indirect participants rely defaults or declines to continue their business
relationship. If these indirect participants have large values or volumes of business throughthe FMI, this may affect the smooth functioning of the FMI. For these reasons, where an
indirect participant accounts for a large proportion of the transactions processed by an FMI, it
may be appropriate to encourage direct participation. For example, an FMI may in somecases establish objective thresholds above which direct participation would normally be
encouraged (provided that the firm satisfies the FMI’s access criteria). Setting such
thresholds and encouraging direct participation should be based on risk considerations rather
than commercial advantage. 153
Regular review of risks in tiered participation arrangements
3.19.12. An FMI should regularly review risks to which it may be exposed as a result of tiered
participation arrangements. If material risks exist, the FMI should take mitigating action whenappropriate. The results of the review process should be reported to the board of directors
and updated periodically and after substantial amendments to an FMI’s rules.

153

See CGFS, The macrofinancial implications of alternative configurations for access to central counterparties in
OTC derivatives markets, November, 2011, which notes that overly tiered arrangements can potentially
increase systemic risk because of the concentration of credit and operational risk in direct participants.

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Principle 20: FMI links
An FMI that establishes a link with one or more FMIs should identify, monitor, andmanage link-related risks.
Key considerations
1.

Before entering into a link arrangement and on an ongoing basis once the link isestablished, an FMI should identify, monitor, and manage all potential sources ofrisk arising from the link arrangement. Link arrangements should be designed suchthat each FMI is able to observe the other principles in this report.

2.

A link should have a well-founded legal basis, in all relevant jurisdictions, that
supports its design and provides adequate protection to the FMIs involved in the
link.

3.

Linked CSDs should measure, monitor, and manage the credit and liquidity risks
arising from each other. Any credit extensions between CSDs should be covered
fully with high-quality collateral and be subject to limits.

4.

Provisional transfers of securities between linked CSDs should be prohibited or, at aminimum, the retransfer of provisionally transferred securities should be prohibited
prior to the transfer becoming final.

5.

An investor CSD should only establish a link with an issuer CSD if the arrangement
provides a high level of protection for the rights of the investor CSD’s participants.

6.

An investor CSD that uses an intermediary to operate a link with an issuer CSD
should measure, monitor, and manage the additional risks (including custody, credit,
legal, and operational risks) arising from the use of the intermediary.

7.

Before entering into a link with another CCP, a CCP should identify and manage thepotential spill-over effects from the default of the linked CCP. If a link has three ormore CCPs, each CCP should identify, assess, and manage the risks of thecollective link arrangement.

8.

Each CCP in a CCP link arrangement should be able to cover, at least on a daily
basis, its current and potential future exposures to the linked CCP and its
participants, if any, fully with a high degree of confidence without reducing the
CCP’s ability to fulfil its obligations to its own participants at any time.

9.

A TR should carefully assess the additional operational risks related to its links toensure the scalability and reliability of IT and related resources.

Explanatory note
3.20.1. A link is a set of contractual and operational arrangements between two or more
FMIs that connect the FMIs directly or through an intermediary. An FMI may establish a linkwith a similar type of FMI for the primary purpose of expanding its services to additional
financial instruments, markets, or institutions. 154 For example, a CSD (referred to as aninvestor CSD) may establish a link to another CSD in which securities are issued or
immobilised (referred to as an issuer CSD) to enable a participant in the investor CSD toaccess the services of the issuer CSD through the participant’s existing relationship with the154

FMIs in all link arrangements should meet the requirement in key consideration 1 of Principle 18. Open accessto other FMIs can be a pre-condition for the establishment of links between FMIs of the same type.

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investor CSD. 155 A CCP may establish a link with another CCP to enable a participant in thefirst CCP to clear trades with a participant in the second CCP through the participant’s
existing relationship with the first CCP. An FMI may also establish a link with a different typeof FMI. For example, a CCP for securities markets must establish and use a link to a CSD toreceive and deliver securities. This principle covers links between CSDs, CCPs, and TRs, aswell as CSD-CCP links and links between TRs and other FMIs. 156 If an FMI establishes alink, it should identify, monitor, and manage its links-related risks, including legal, operational,
credit, and liquidity risks. 157 Further, an FMI that establishes multiple links should ensure thatthe risks generated in one link do not affect the soundness of the other links and linked FMIs.
Mitigation of such spill-over effects requires the use of effective risk-management controls,
including additional financial resources or the harmonisation of risk-management frameworks
across linked FMIs.
Identifying link-related risks
3.20.2. Before entering into a link arrangement and on an ongoing basis once the link isestablished, an FMI should identify and assess all potential sources of risk arising from thelink arrangement. The type and degree of risk varies according to the design and complexityof the FMIs and the nature of the relationship between them. In a simple case of a verticallink, for example, an FMI may provide basic services to another FMI, such as a CSD thatprovides securities transfer services to an SSS. Such links typically pose only operationaland custody risks. Other links, such as an arrangement in which a CCP provides clearing
services to another CCP, may be more complex and may pose additional risk to FMIs, suchas credit and liquidity risk. 158 Cross-margining by two or more CCPs may also pose additionalrisk because the CCPs may rely on each other’s risk-management systems to measure,monitor, and manage credit and liquidity risk (see Principle 6 on margin). In addition, links
between different types of FMIs may pose specific risks to one or all of the FMIs in the linkarrangement. For example, a CCP may have a link with a CSD that operates an SSS for thedelivery of securities and settlement of margins. If the CCP poses risks to the CSD, the CSD
should manage those risks. In all cases, link arrangements should be designed such thateach FMI is able to observe the other principles in this report.
Managing legal risks
3.20.3. A link should have a well-founded legal basis, in all relevant jurisdictions, that
supports its design and provides adequate protection to the FMIs involved in the link. Crossborder links may present legal risk arising from differences between the laws and contractualrules governing the linked FMIs and their participants, including those relating to rights andinterests, collateral arrangements, settlement finality, and netting arrangements (seePrinciple 1 on legal basis). For example, differences in law and rules governing settlement
finality may lead to a scenario where a transfer is regarded as final in one FMI but not final in
the linked FMI. In some jurisdictions, differences in laws may create uncertainties regarding

155

The term CSD in this principle generally refers to a CSD that also operates an SSS. The use of this broader
definition for CSD in this principle mirrors market convention in the discussion of FMI links.

156

Links to payment systems are not addressed by this principle because these links are addressed in Principle 9
on money settlements.

157

Prior to entering a link arrangement, an FMI should inform its participants of the expected effects on the FMI’s
risk profile. See also Principle 23 on disclosure of rules, key procedures, and market data.

158

A link between two or more CCPs may enable participants in a CCP in one market to clear transactions inanother market through their existing arrangements. By broadening trading opportunities for market
participants, without imposing all of the costs normally associated with establishing clearing relationships, links
can deepen the liquidity in the affected markets. A link may also reduce the costs of systems development andoperation faced by CCPs because it enables them to share these expenses.

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the enforceability of CCP obligations assumed by novation, open offer, or other similar legal
device. Differences in insolvency laws may unintentionally give a participant in one CCP aclaim on the assets or other resources of the linked CCP in the event of the first CCP’s
default. To limit these uncertainties, the respective rights and obligations of the linked FMIs
and, where necessary, their participants should be clearly defined in the link agreement. The
terms of the link agreement should also set out, in cross-jurisdictional contexts, anunambiguous choice of law that will govern each aspect of the link.
Managing operational risk
3.20.4. Linked FMIs should provide an appropriate level of information about theiroperations to each other in order for each FMI to perform effective periodic assessments of
the operational risk associated with the link. In particular, FMIs should ensure that riskmanagement arrangements and processing capacity are sufficiently scalable and reliable tooperate the link safely for both the current and projected peak volumes of activity processedover the link (see Principle 17 on operational risk). Systems and communication
arrangements between linked FMIs also should be reliable and secure so that the link does
not pose significant operational risk to the linked FMIs. Any reliance by a linked FMI on a
critical service provider should be disclosed as appropriate to the other FMI. In addition, alinked FMI should identify, monitor, and manage operational risks due to complexities orinefficiencies associated with differences in time zones, particularly as these affect staff
availability. Governance arrangements and change-management processes should ensurethat changes in one FMI will not inhibit the smooth functioning of the link, related riskmanagement arrangements, or non-discriminatory access to the link (see Principle 2 ongovernance and Principle 18 on access and participation requirements).
Managing financial risk
3.20.5. FMIs in a link arrangement should effectively measure, monitor, and manage theirfinancial risk, including custody risk, arising from the link arrangement. FMIs should ensurethat they and their participants have adequate protection of assets in the event of theinsolvency of a linked FMI or a participant default in a linked FMI. Specific guidance on
mitigating and managing these risks in CSD-CSD links and CCP-CCP links is provided
below.
CSD-CSD links
3.20.6. As part of its activities, an investor CSD may choose to establish a link with another
CSD. If such a link is improperly designed, the settlement of transactions across the link
could subject participants to new or increased risks. In addition to legal and operational risks,
linked CSDs and their participants could also face credit and liquidity risks. For example, anoperational failure or default in one CSD may cause settlement failures or defaults in a linked
CSD and expose participants in the linked CSD, including participants that did not settle
transactions across the link, to unexpected liquidity pressures or outright losses. A CSD’s
default procedures, for example, could affect a linked CSD through loss-sharing
arrangements. Linked CSDs should identify, monitor, and manage the credit and liquidity
risks arising from the linked entity. In addition, any credit extensions between CSDs should
be covered fully by high-quality collateral and be subject to limits. 159 Further, some practices
deserve particularly rigorous attention and controls. In particular, provisional transfers of

159

In exceptional cases, other adequate collateral may be used to secure credit extensions between CSDs
subject to the review and assessment by the relevant authorities. See also principle 4 on credit risk, principle 5
on collateral, and principle 7 on liquidity risk.

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securities between linked CSDs should be prohibited or, at a minimum, the retransfer ofprovisionally transferred securities should be prohibited prior to the transfer becoming final.
3.20.7. An investor CSD should only establish links with an issuer CSD if the linkarrangement provides a high level of protection for the rights of the investor CSD’s
participants. In particular, the investor CSD should use issuer CSDs that provide adequate
protection of assets in the event that the issuer CSD becomes insolvent (see Principle 11 onCSDs). In some cases, securities held by an investor CSD can be subject to attachment by
the creditors of the CSD or its participants and, as such, can also be subject to freezing or
blocking instructions from local courts or other authorities. Further, if an investor CSD
maintains securities in an omnibus account at an issuer CSD and a participant at the investor
CSD defaults, the investor CSD should not use the securities belonging to other participants
to settle subsequent local deliveries of the defaulting participant. The investor CSD shouldhave adequate measures and procedures to avoid effects on the use of securities belonging
to non-defaulting participants in a participant-default scenario.
3.20.8. Furthermore, linked CSDs should have robust reconciliation procedures to ensurethat their respective records are accurate and current. Reconciliation is a procedure to verify
that the records held by the linked CSDs match for transactions processed across the link.
This process is particularly important when three or more CSDs are involved in settlingtransactions (that is, the securities are held in safekeeping by one CSD or custodian while
the seller and the buyer participate in one or more of the linked CSDs) (see also Principle 11
on CSDs).
Indirect CSD-CSD links
3.20.9. If an investor CSD uses an intermediary to operate a link with an issuer CSD, theinvestor CSD should measure, monitor, and manage the additional risks (including custody,
credit, legal, and operational risks) arising from the use of the intermediary. In an indirect
CSD-CSD link, an investor CSD uses an intermediary (such as a custodian bank) to accessthe issuer CSD. In such cases, the investor CSD faces the risk that the custodian bank may
become insolvent, act negligently, or commit fraud. Although an investor CSD may not face aloss on the value of the securities, the ability of the investor CSD to use its securities might
temporarily be impaired. The investor CSD should measure, monitor, and manage on an
ongoing basis its custody risk (see also Principle 16 on custody and investment risks) andprovide evidence to the relevant authorities that adequate measures have been adopted tomitigate this custody risk. In addition, the investor CSD should ensure that it has adequate
legal, contractual, and operational protections to ensure that its assets held in custody aresegregated and transferable (see Principle 11 on CSDs). Similarly, an investor CSD should
ensure that its settlement banks or cash correspondents can perform as expected. In that
context, the investor CSD should have adequate information on the business continuity plansof its intermediary and the issuer CSD to achieve a high degree of confidence that both
entities will perform as expected during a disruptive event.
CCP-CCP links
3.20.10. A CCP may establish links with one or more other CCPs. Although the details of
individual link arrangements among CCPs differ significantly because of the varied designsof CCPs and the markets they serve, there are currently two basic types of CCP links: peerto-peer links and participant links.
3.20.11. In a peer-to-peer link, a CCP maintains special arrangements with another CCP and
is not subject to normal participant rules. Typically, however, the CCPs exchange margin andother financial resources on a reciprocal basis. The linked CCPs face current and potential
future exposures to each other as a result of the process whereby they each net the trades
cleared between their participants so as to create novated (net) positions between the CCPs.
Risk management between the CCPs is based on a bilaterally approved framework, which isdifferent from that applied to a normal participant.
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3.20.12. In a participant link, one CCP (the participant CCP) is a participant in another CCP(the host CCP) and is subject to the host CCP’s normal participant rules. In such cases, thehost CCP maintains an account for the participant CCP and would typically require theparticipant CCP to provide margin, as would be the case for a participant that is not a CCP. A
participant CCP should mitigate and manage its risk from the link separately from the risks in
its core clearing and settlement activities. For example, if the host CCP defaults, theparticipant CCP may not have adequate protection because the participant CCP does nothold collateral from the host CCP to mitigate the counterparty risk posed to it by the host
CCP. Risk protection in a participant link is one-way, unlike in a peer-to-peer link. The
participant CCP that provides margin but does not collect margin from another linked CCP
should therefore hold additional financial resources to protect itself against the default of thehost CCP.
3.20.13. Both types of links – peer-to-peer and participant links – may present new orincreased risks that should be measured, monitored, and managed by the CCPs involved in
the link. The most challenging issue with respect to CCP links is the risk management of thefinancial exposures that potentially arise from the link arrangement. Before entering into alink with another CCP, a CCP should identify and assess the potential spillover effects fromthe default of the linked CCP. If a link has three or more CCPs, each CCP should identify
and assess the risks of the collective link arrangement. A network of links between CCPs
that does not properly acknowledge and address the inherent complexity of multi-CCP links
could have significant implications for systemic risk.
3.20.14. Exposures faced by one CCP from a linked CCP should be identified, monitored,
and managed with the same rigour as exposures from a CCP’s participants to prevent a
default at one CCP from triggering a default at a linked CCP. Such exposures should becovered fully, primarily through the use of margin or other equivalent financial resources. In
particular, each CCP in a CCP link arrangement should be able to cover, at least on a daily
basis, its current and potential future exposures to the linked CCP and its participants, if any,
fully with a high degree of confidence without reducing the CCP’s ability to fulfil its obligations
to its own participants at any time (see Principle 6 on margin). Financial resources used tocover inter-CCP current exposures should be prefunded with highly liquid assets that exhibit
low credit risk. Best practice is for CCPs to have near real time inter-CCP risk management.
However, at a minimum, financial exposures among linked CCPs should be marked tomarket and covered on a daily basis. CCPs also need to consider and address the risks
arising from links in designing their stress tests and calibrating their prefunded default
arrangements. Linked CCPs should also take into account the effects that possible
contributions to each other’s prefunded default arrangements, exchange of margin, common
participants, major differences in their risk-management tools, and other relevant features
may have on their risk-management frameworks, especially in relation to the legal, credit,
liquidity, and operational risks they face.
3.20.15. Because of the different possible types of link arrangements, different types of
CCPs, and differences in the legal and regulatory frameworks in which CCPs may operate,
different combinations of risk-management tools may be used by the CCP. When linked
CCPs have materially different risk-management frameworks, the risks stemming from thelink are more complex. In this case, the linked CCPs should carefully assess theeffectiveness of their risk-management models and methodologies, including their default
procedures, in order to determine whether and to what extent their inter-CCP riskmanagement frameworks should be harmonised or whether additional risk-mitigation
measures would be sufficient to mitigate risks arising from the link.
3.20.16. A CCP (the first CCP) will usually have to provide margin to a linked CCP for open
positions. In some cases, the first CCP may not be able to provide margin that it hascollected from its participants to the linked CCP because the first CCP’s rules may prohibit
the use of its participants’ margin for any purpose other than to cover losses from a default ofa participant in the first CCP, or the first CCP’s legal or regulatory requirements may not

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permit such reuse of its participants’ collateral. As such, the CCP would need to use
alternative financial resources to cover its counterparty risk to the linked CCP, which isnormally covered by margin. If a CCP is allowed to reuse its participants’ collateral to meetan inter-CCP margin requirement, such collateral provided by the first CCP must be
unencumbered and its use by the linked CCP in the event of the default of the first CCP mustnot be constrainable by actions taken by the participants of the first CCP. The credit andliquidity risk arising from the reuse of margin should be adequately mitigated by the CCPs.
This can be achieved through segregation, protection, and custody of margin exchanged
between CCPs in a manner that allows for its swift and timely return to the CCP in case of adecrease in the exposures and that allows for supplemental margin (and, if necessary,
supplemental default fund contributions) needed to cover the counterparty risk between thelinked CCPs to be charged directly to the participants who use the link service, if applicable.
3.20.17. Linked CCPs should maintain arrangements that are effective in managing the risks
arising from the link; such arrangements often involve a separate default fund to cover thatrisk. In principle, the risk-management measures related to the link should not reduce theresources that a CCP holds to address other risks. The most direct way to achieve thisoutcome is for CCPs not to participate in each other’s default funds, which may in turn meanthat the CCP will need to provide additional margin. However, in arrangements in which
CCPs have agreed, consistent with their regulatory framework, to contribute to each other’s
default funds, the linked CCPs should assess and mitigate the risks of making suchcontributions via specific conditions. In particular, funds used by a CCP to contribute toanother CCP's default fund must represent prefunded additional financial resources andmust not include resources used by the CCP to satisfy its regulatory requirements to holdsufficient capital or participant margin funds (or any other funds, including independent
default fund resources) held by the CCP to mitigate the counterparty risk presented by its
participants. The contributing CCP should further ensure that any consequent exposure of its
own participants to the risk of a participant default in the linked CCP is fully transparent toand understood by its participants. The contributing CCPs may, for example, consider it
appropriate to ensure the default fund contribution is made only by those of its participantsthat use the link, if applicable. Moreover, the resources provided by one CCP to anothershould be held in such a way that they are ring fenced from other resources provided to that
CCP. For example, securities could be held in a separate account at a custodian. Cashwould need to be held in segregated accounts to be considered as acceptable collateral inthis case. 160 Finally, in case of a participant default in the first CCP, the use of the linked
CCP’s contribution to the default fund of the first CCP could be restricted or limited. For
example, the linked CCP’s contribution to the default fund could be put at the bottom of thefirst CCP’s default waterfall.
3.20.18. Link arrangements between CCPs will expose each CCP to sharing in potentially
uncovered credit losses if the linked CCP’s default waterfall has been exhausted. For
example, a CCP may be exposed to loss mutualisation from defaults of a linked CCP’s
participants. This risk will be greater to the extent that the first CCP is unable directly tomonitor or control the other CCP’s participants. Such contagion risks can be even more
serious in cases where more than two CCPs are linked, directly or indirectly, and a CCP
considering such a link should satisfy itself that it can manage such risks adequately. Each
CCP should ensure that the consequent exposure of its own participants to a share in these
uncovered losses is fully understood and disclosed to its participants. CCPs may consider it
appropriate to devise arrangements to avoid sharing in losses that occur in products otherthan those cleared through the link and to confine any loss sharing to only participants that160

In some jurisdictions, the legal framework will not protect the segregation of cash on the books of acommercial bank.

114

CPSS-IOSCO – Principles for financial market infrastructures – April 2012clear products through the link. Depending on how losses would be shared, CCPs may needto increase financial resources to address this risk.
3.20.19. Any default fund contributions or allocation of uncovered losses should be structured
to ensure that (a) no linked CCP is treated less favourably than the participants of the other
CCP and (b) each CCP’s contribution to the loss sharing arrangements of the other is no
more than proportionate to the risk the first CCP poses to the linked CCP.
Special considerations for TR links
3.20.20. A TR should carefully assess the additional operational risks related to its links toensure the scalability and reliability of IT and related resources. A TR can establish links withanother TR or with another type of FMI. Such links may expose the linked FMIs to additionalrisks if not properly designed. Besides legal risks, a link to either another TR or to anothertype of FMI may involve the potential spillover of operational risk. The mitigation ofoperational risk is particularly important because the information maintained by a TR can
support bilateral netting and be used to provide services directly to market participants,
service providers (for example, portfolio compression service providers), and other linked
FMIs. FMIs establishing a link to a TR should ensure that the system and communication
arrangements between the linked entities are reliable and secure such that the operation of
the link does not pose significant reliability and security risks. Moreover, given the role that a
TR may play at the beginning of the clearing and settlement process for derivatives
transactions, a TR should have governance arrangements that ensure the management of
the linked entities would not inhibit the smooth functioning of the link, related riskmanagement arrangements, and non-discriminatory access to the link. Therefore, thescalability of IT and related resources may be especially important.

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Efficiency
Efficiency and safety are important to an FMI in performing its payment, clearing, settlement,
and recording functions. The following two principles provide guidance to FMIs on(a) efficiency and effectiveness and (b) communication procedures and standards, which is
one traditional aspect of efficiency.
Principle 21: Efficiency and effectiveness
An FMI should be efficient and effective in meeting the requirements of its participants
and the markets it serves.
Key considerations
1.

An FMI should be designed to meet the needs of its participants and the markets it
serves, in particular, with regard to choice of a clearing and settlement arrangement;
operating structure; scope of products cleared, settled, or recorded; and use oftechnology and procedures.

2.

An FMI should have clearly defined goals and objectives that are measurable andachievable, such as in the areas of minimum service levels, risk-management
expectations, and business priorities.

3.

An FMI should have established mechanisms for the regular review of its efficiency
and effectiveness.

Explanatory note
3.21.1. An FMI should be efficient and effective in meeting the requirements of its
participants and the markets it serves, while also maintaining appropriate standards of safety
and security as outlined in the principles in this report. 161 “Efficiency” refers generally to theresources required by the FMI to perform its functions, while “effectiveness” refers to whether
the FMI is meeting its intended goals and objectives. An FMI that operates inefficiently orfunctions ineffectively may distort financial activity and the market structure, increasing not
only the financial and other risks of an FMI’s participants, but also the risks of their customers
and end users. If an FMI is inefficient, a participant may choose to use an alternatearrangement that poses increased risks to the financial system and the broader economy.
The primary responsibility for promoting the efficiency and effectiveness of an FMI belongs to
its owners and operators.
Efficiency
3.21.2. Efficiency is a broad concept that encompasses what an FMI chooses to do, how it
does it, and the resources required. An FMI’s efficiency depends partly on its choice of aclearing and settlement arrangement (for example, gross, net, or hybrid settlement; real timeor batch processing; and novation or guarantee scheme); operating structure (for example,
links with multiple trading venues or service providers); scope of products cleared, settled, or
recorded; and use of technology and procedures (for example, communication procedures
and standards). In designing an efficient system, an FMI should also consider the practicality
and costs for participants, their customers, and other relevant parties (including other FMIs

161

There may be different ways for an FMI to meet a particular principle, but the objective of a particular principle
should not be compromised.

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and service providers). 162 Furthermore, the FMI’s technical arrangements should be
sufficiently flexible to respond to changing demand and new technologies. Fundamentally, an
FMI should be designed and operated to meet the needs of its participants and the markets it
serves. 163 An FMI’s efficiency will ultimately affect the use of the FMI by its participants andtheir customers as well as these entities’ ability to conduct robust risk management, which
may affect the broader efficiency of financial markets.
3.21.3. Efficiency also involves cost control. An FMI should establish mechanisms for the
regular review of its efficiency, including its costs and pricing structure. 164 An FMI should
control its direct costs, such as those stemming from transaction processing, money
settlement, and settlement-entry preparation and execution. An FMI also should consider
and control its indirect costs. These include infrastructure, administrative, and other types ofcosts associated with operating the FMI. Some indirect costs (and risks) may be lessapparent. For example, an FMI may need to consider its participants’ liquidity costs, which
include the amount of cash or other financial instruments that a participant must provide to
the FMI, or other parties, in order to process its transactions, and the opportunity cost ofproviding such assets. An FMI’s design has a significant impact on the liquidity costs borneby participants, which, in turn, affect the FMI’s costs and risks. Cost considerations, however,should always be balanced against appropriate standards of safety and security as outlinedin the principles in this report.
3.21.4. Competition can be an important mechanism for promoting efficiency. Where thereis effective competition and participants have meaningful choices among FMIs, suchcompetition may help to ensure that FMIs are efficient. FMIs should ensure, however, thatthey adhere to appropriate standards of safety and security as outlined in the principles inthis report. Both private and central bank operators of FMIs should make use of market
disciplines, as appropriate, to promote efficiency in the FMI’s operations. For example, an
FMI could use competitive tendering to select service providers. Where competition may bedifficult to maintain because of economies of scale or scope, and an FMI therefore enjoys
some form of market power over the service it provides, relevant authorities may have a
responsibility to review the costs imposed on the FMI’s participants and the markets it
serves.
Effectiveness3.21.5. An FMI is effective when it reliably meets its obligations in a timely manner andachieves the public policy goals of safety and efficiency for participants and the markets it
serves. In the context of oversight and auditing, an FMI’s effectiveness may also involve
meeting service and security requirements. To facilitate assessments of effectiveness, an
FMI should have clearly defined goals and objectives that are measureable and achievable.
For example, an FMI should set minimum service-level targets (such as the time it takes toprocess a transaction), risk-management expectations (such as the level of financial
resources it should hold), and business priorities (such as the development of new services).

162

For a system to be practical for users, it needs to take into account the structure of the local market and its
history and conventions. The system also must reflect the current and prospective costs of the inputs used aswell as evolving technologies. Designing a system that appropriately meets the needs of its users will often
require an understanding of local practices and technologies.

163

One mechanism an FMI might use to gauge its success in meeting the needs of its participants and themarkets it serves are periodic satisfaction surveys of its participants and other relevant institutions in themarket.

164

A review of an FMI’s efficiency or cost-effectiveness could include an evaluation of both the productivity ofoperational processes and the relative benefits of the processing method given the corresponding costs. For
example, an efficiency review could include analysing the number of transactions that could be processed in agiven period or by measuring the processing cost per transaction.

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117

An FMI should establish mechanisms for the regular review of its effectiveness, such as
periodic measurement of its progress against its goals and objectives.
3.21.6. For a TR to be effective, its goals and objectives should include timeliness andaccuracy. A TR should promptly record the transaction information it receives from its
participants. To ensure the accuracy and timeliness of data, a TR should employ efficient
recordkeeping procedures to document changes to recorded transaction information
resulting from subsequent post-trade events. Ideally, a TR should set a service-level target torecord to its central registry transaction information it receives from participants in real time,and at a minimum, within one business day. A TR should have adequate procedures andtimelines for making data available for any downstream processing and should implement
quality controls to ensure the accuracy, validity, and integrity of the data it stores anddisseminates. In addition, a TR should have effective processes and procedures for theprovision of data to relevant authorities (see also Principle 24).

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Principle 22: Communication procedures and standards
An FMI should use, or at a minimum accommodate, relevant internationally accepted
communication procedures and standards in order to facilitate efficient payment,
clearing, settlement, and recording.
Key consideration
1.

An FMI should use, or at a minimum accommodate, internationally accepted
communication procedures and standards.

Explanatory note
3.22.1. The ability of participants to communicate with an FMI in a timely, reliable, andaccurate manner is key to achieving efficient payment, clearing, settlement, and recording.
An FMI’s adoption of internationally accepted communication procedures and standards for
its core functions can facilitate the elimination of manual intervention in clearing andsettlement processing, reduce risks and transaction costs, improve efficiency, and reducebarriers to entry into a market. Therefore, an FMI should use, or at a minimum
accommodate, relevant internationally accepted communication procedures and standards toensure effective communication between the FMI and its participants, their customers, andothers that connect to the FMI. An FMI is encouraged but not required to use oraccommodate internationally accepted communication procedures and standards for purely
domestic transactions.
Communication procedures
3.22.2. An FMI should use, or at a minimum accommodate, internationally accepted
communication procedures to facilitate effective communication between the FMI’s
information systems, and those of its participants, their customers, and others that connect to
the FMI (such as third-party service providers and other FMIs). Standardised communication
procedures (or protocols) provide a common set of rules across systems for exchanging
messages. These rules allow for a broad set of systems and institutions in various locations
to communicate efficiently and effectively. Reducing the need for intervention and technicalcomplexity when processing transactions can help to reduce the number of errors, avoid
information losses, and ultimately reduce the resources needed for data processing by the
FMI, its participants, and markets generally.
Communication standards
3.22.3. An FMI should use, or at a minimum accommodate, internationally accepted
communication standards, such as standardised messaging formats and reference data
standards for identifying financial instruments and counterparties. The use of internationallyaccepted standards for message formats and data representation will generally improve thequality and efficiency of the clearing and settlement of financial transactions. If an FMI does
not itself use internationally accepted communication standards, it should typicallyaccommodate systems that translate or convert data from international standards into thedomestic equivalent and vice versa.
Cross-border considerations
3.22.4. An FMI that conducts payment, clearing, settlement, or recording activities acrossborders should use internationally accepted communication procedures and standards or, ata minimum, accommodate them. An FMI that, for example, settles a chain of transactions
processed through multiple FMIs or provides services to users in multiple jurisdictions should
strongly consider using internationally accepted communication procedures and standards toachieve efficient and effective cross-border financial communication. Furthermore, adopting

CPSS-IOSCO – Principles for financial market infrastructures – April 2012119

these communication procedures can facilitate interoperability between the information
systems or operating platforms of FMIs in different jurisdictions, which allows market
participants to obtain access to multiple FMIs without facing technical hurdles (such as
having to implement or support multiple local networks with different characteristics). An FMI
that operates across borders also should be able to support and use well-establishedcommunication procedures, messaging standards, and reference data standards relating tocounterparty identification and securities numbering processes. For example, relevant
standards promulgated by the International Organization for Standardization should be
carefully considered and adopted by an FMI. If an FMI that operates across borders does not
fully adopt international procedures and standards, it can still potentially interoperate with theinformation systems or operating platforms of other FMIs by developing systems to translate
or convert international procedures and standards into the domestic equivalent, and viceversa.
Use of internationally accepted procedures and standards by TRs
3.22.5. Communication procedures and standards are particularly important for TRs thatserve as a central data source for a variety of stakeholders potentially located in many
jurisdictions. A TR should support technologies that are widely accepted in the market,
including applicable market standards for reporting and recording trade information. A TR
also should apply consistent application interfaces and communication links that enable
technical interconnectivity with other FMIs and service providers. A TR should be able todirectly exchange trade information not only with market participants but also with otherentities such as exchanges, electronic trading venues, confirmation-matching platforms,
CCPs, and other service providers. A TR should use industry standards for data
representation, including those related to the unique identification of counterparties (such aslegal entity identifiers) to facilitate the use and aggregation of data stored in the repository,
especially by authorities. 165

165

Legal entity identifiers (LEIs) contribute to the ability of authorities to fulfil the systemic risk mitigation,transparency, and market abuse protection goals established by the G20 commitments related to OTC
derivatives and would improve efficiency and transparency in many other areas. See CPSS-IOSCO, Reporton OTC derivatives data reporting and aggregation requirements, January 2012.

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Transparency
Transparency helps ensure that relevant information is provided to an FMI’s participants,
authorities, and the public to inform sound decision making and foster confidence. The
following two principles provide guidance to (a) all FMIs on the disclosure of rules, key
procedures, and market data to enable participants and other interested parties to have aclear understanding of the risks and controls on risks associated with an FMI, as well as feesand other costs incurred by participation in the FMI; and (b) TRs on the disclosure of market
data to allow participants, authorities, and the public to make timely assessments of OTC
derivatives markets and, if relevant, other markets served by the TR.
Principle 23: Disclosure of rules, key procedures, and market data
An FMI should have clear and comprehensive rules and procedures and should
provide sufficient information to enable participants to have an accurate
understanding of the risks, fees, and other material costs they incur by participating in
the FMI. All relevant rules and key procedures should be publicly disclosed.
Key considerations
1.

An FMI should adopt clear and comprehensive rules and procedures that are fully
disclosed to participants. Relevant rules and key procedures should also be publicly
disclosed.

2.

An FMI should disclose clear descriptions of the system’s design and operations, aswell as the FMI’s and participants’ rights and obligations, so that participants canassess the risks they would incur by participating in the FMI.

3.

An FMI should provide all necessary and appropriate documentation and training tofacilitate participants’ understanding of the FMI’s rules and procedures and the risks
they face from participating in the FMI.

4.

An FMI should publicly disclose its fees at the level of individual services it offers aswell as its policies on any available discounts. The FMI should provide clear
descriptions of priced services for comparability purposes.

5.

An FMI should complete regularly and disclose publicly responses to the CPSSIOSCO Disclosure framework for financial market infrastructures. An FMI also
should, at a minimum, disclose basic data on transaction volumes and values.

Explanatory note
3.23.1. An FMI should provide sufficient information to its participants and prospective
participants to enable them to identify clearly and understand fully the risks andresponsibilities of participating in the system. To achieve this objective, an FMI should adopt
and disclose written rules and procedures that are clear and comprehensive and that include
explanatory material written in plain language so that participants can fully understand thesystem’s design and operations, their rights and obligations, and the risks of participating inthe system. An FMI’s rules, procedures, and explanatory material need to be accurate, up-todate, and readily available to all current and prospective participants. Moreover, an FMI
should disclose to participants and the public information on its fee schedule, basic
operational information, and responses to the CPSS-IOSCO Disclosure framework forfinancial market infrastructures.

CPSS-IOSCO – Principles for financial market infrastructures – April 2012121

Rules and procedures
3.23.2. An FMI should adopt clear and comprehensive rules and procedures that are fully
disclosed to participants. Relevant rules and key procedures should also be publicly
disclosed. An FMI’s rules and procedures are typically the foundation of the FMI and provide
the basis for participants’ understanding of the risks they incur by participating in the FMI. As
such, relevant rules and procedures should include clear descriptions of the system’s designand operations, as well as the FMI’s and participants’ rights and obligations, so thatparticipants can assess the risk they would incur by participating in the FMI. 166 They should
clearly outline the respective roles of participants and the FMI as well as the rules andprocedures that will be followed in routine operations and non-routine, though foreseeable,
events, such as a participant default (see Principle 13 on participant-default rules andprocedures). In particular, an FMI should have clear and comprehensive rules andprocedures for addressing financial and operational problems within the system.
3.23.3. In addition to disclosing all relevant rules and key procedures, an FMI should have aclear and fully disclosed process for proposing and implementing changes to its rules andprocedures and for informing participants and relevant authorities of these changes.
Similarly, the rules and procedures should clearly disclose the degree of discretion that an
FMI can exercise over key decisions that directly affect the operation of the system, including
in crises and emergencies (see also Principle 1 on legal basis and Principle 2 ongovernance). For example, an FMI’s procedures may provide for discretion regarding theextension of operating hours to accommodate unforeseen market or operational problems.
An FMI also should have appropriate procedures to minimise any conflict-of-interest issues
that may arise when authorised to exercise its discretion.
Participants’ understanding of rules, procedures, and risks
3.23.4. Participants bear primary responsibility for understanding the rules, procedures, andrisks of participating in an FMI as well as the risks they may incur when the FMI has links
with other FMIs. An FMI, however, should provide all documentation, training, andinformation necessary to facilitate participants’ understanding of the FMI’s rules andprocedures and the risks they face from participating in the FMI. New participants should
receive training before using the system, and existing participants should receive, as needed,
additional periodic training. An FMI should disclose to each individual participant stress test
scenarios used, individual results of stress tests, and other data to help each participant
understand and manage the potential financial risks stemming from participation in the
FMI. 167 Other relevant information that should be disclosed to participants, but typically not tothe public, includes key highlights of the FMI’s business continuity arrangements. 168
3.23.5. An FMI is well placed to observe the performance of its participants and should
promptly identify those participants whose behaviour demonstrates a lack of understandingof, or compliance with, applicable rules, procedures, and risks of participation. In such cases,
an FMI should take steps to rectify any perceived lack of understanding by the participant
and take other remedial action necessary to protect the FMI and its participants. This may
include notifying senior management within the participant institution. In cases in which the

166

Information should be disclosed to the extent it would not risk prejudicing the security and integrity of the FMI
or divulging commercially sensitive information, such as trade secrets or other intellectual property.

167

In disclosing stress-test information, FMIs should avoid revealing information regarding the positions ofindividual participants.

168

Information on business continuity that can undermine an FMI’s safety and soundness, such as the locationsof back-up sites, should not be disclosed to the public. However, this information should be disclosed to therelevant authorities.

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participant’s actions present significant risk or present cause for the participant’s suspension,
the FMI should notify the appropriate regulatory, supervisory, and oversight authorities.
Fees and other material costs to participants
3.23.6. An FMI should publicly disclose its fees at the level of the individual services it offers
as well as its policies on any available discounts. The FMI should provide clear descriptionsof priced services for comparability purposes. In addition, an FMI should disclose informationon the system design, as well as technology and communication procedures, that affect thecosts of operating the FMI. These disclosures collectively help participants evaluate the total
cost of using a particular service, compare these costs to those of alternative arrangements,and select only the services that they wish to use. For example, large-value payment
systems typically have higher values and lower volumes than retail payment systems, and,as a result, processing costs can be less important to participants than the costs of providing
liquidity to fund payments throughout the day. The FMI’s design will influence not only how
much liquidity participants need to hold in order to process payments but also opportunity
costs of holding such liquidity. An FMI should provide timely notice to participants and the
public of any changes to services and fees.
Disclosure framework and other information
3.23.7. An FMI should complete regularly, and disclose publicly, responses to the CPSSIOSCO Disclosure framework for financial market infrastructures. The FMI should provide
comprehensive and appropriately detailed disclosures to improve the overall transparency of
the FMI, its governance, operations, and risk-management framework. In order for thedisclosures to reflect correctly the FMI’s current rules, procedures, and operations, the FMI
should update its responses following material changes to the system or its environment. At
a minimum, an FMI should review its responses to the CPSS-IOSCO Disclosure frameworkfor financial market infrastructures every two years to ensure continued accuracy andusefulness.
3.23.8. Other relevant information for participants and, more generally, the public could
include general information on the FMI’s full range of activities and operations, such as thenames of direct participants in the FMI, key times and dates in FMI operations, and its overallrisk-management framework (including its margin methodology and assumptions). 169 An FMI
also should disclose its financial condition, financial resources to withstand potential losses,
timeliness of settlements, and other performance statistics. With respect to data, an FMI
should, at a minimum, disclose basic data on transaction volumes and values. 170
Forms of disclosure
3.23.9. An FMI should make the relevant information and data it discloses as set forth in thisreport readily available through generally accessible media, such as the Internet, in alanguage commonly used in financial markets in addition to the domestic language(s) of thejurisdiction in which the FMI is located. The data should be accompanied by robust
explanatory documentation that enables users to understand and interpret the data correctly.

169

A clear description of the typical lifecycle of the transaction clearing and settlement process under normal
circumstances may also be useful for participants and the public. This information would highlight how the FMI
processes a transaction, including the timeline of events, the validation and checks to which a transaction is
subjected, and the responsibilities of the parties involved.

170

TRs should also disclose data consistent with Principle 24.

CPSS-IOSCO – Principles for financial market infrastructures – April 2012123Principle 24: Disclosure of market data by trade repositories
A TR should provide timely and accurate data to relevant authorities and the public inline with their respective needs.
Key considerations
1.

A TR should provide data in line with regulatory and industry expectations torelevant authorities and the public, respectively, that is comprehensive and at a levelof detail sufficient to enhance market transparency and support other public policy
objectives.

2.

A TR should have effective processes and procedures to provide data to relevant
authorities in a timely and appropriate manner to enable them to meet theirrespective regulatory mandates and legal responsibilities.

3.

A TR should have robust information systems that provide accurate current andhistorical data. Data should be provided in a timely manner and in a format that
permits it to be easily analysed.

Explanatory note
3.24.1. TRs may play a fundamental role in providing market transparency and areparticularly important in the OTC derivatives markets. From a public policy perspective, thedata maintained and generated by the operations of a TR and on behalf of its participants
should promote market transparency and foster public policy objectives, subject to relevantlaws governing disclosures of information maintained by a TR. Market transparency supports
investor protection as well as the exercise of market discipline. Transparency to the broader
public helps build greater confidence in, and understanding of, markets and informs andbuilds support for sound public policies. Authorities may identify other policy objectives
specific to an individual TR’s role in supporting market transparency in addition to these corepolicy objectives.
Disclosure of data
3.24.2. A TR should provide data in line with regulatory and industry expectations torelevant authorities and the public, respectively, that is comprehensive and at a level of detailsufficient to enhance market transparency and support other public policy objectives.
Accordingly, it is critical that TRs provide effective access to data to relevant authorities andthe public. 171 The scope and level of detail of the data that a TR provides will vary dependingon the respective information needs of the relevant authorities, the TR’s participants, and the
public. At a minimum, a TR should provide aggregate data on open positions and transaction
volumes and values and categorised data (for example, aggregated breakdowns of trading
counterparties, reference entities, or currency breakdowns of products), as available andappropriate, to the public. Relevant authorities should have access to additional data
recorded in a TR, including participant-level data, that is relevant to their respective
regulatory mandates and legal responsibilities, which may include market regulation andsurveillance, oversight of market infrastructures, prudential supervision, resolution of failed
institutions, and systemic risk regulation.

171

See CPSS-IOSCO, Report on OTC derivatives data reporting and aggregation requirements, January 2012,
which develops both for market participants reporting to TRs and for TRs reporting to the public: (a) minimum
data reporting requirements and standardised formats and (b) the methodology and mechanism for theaggregation of data on a global basis.

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Processes and procedures
3.24.3. A TR should have effective processes and procedures to provide data to relevant
authorities in a timely and appropriate manner to enable them to meet their respective
regulatory mandates and legal responsibilities. For example, a TR should have procedures tofacilitate enhanced monitoring, special actions, or official proceedings taken by relevant
authorities in relation to data on troubled or failed participants by making relevant informationin the TR available in a timely and effective manner. The provision of data from a TR torelevant authorities should be supported from a legal, procedural, operational, andtechnological perspective. 172
Information systems
3.24.4. To meet the information needs of participants, authorities, and the public, a TR
should have robust information systems that provide accurate current and historical data. A
TR should collect, store, and provide data to participants, authorities, and the public in atimely manner and in a format that can facilitate prompt analysis. Data should be madeavailable that permits both comparative and historical analysis of the relevant markets. The
criticality of a TR’s or its market’s role should be a consideration in the frequency and speedwith which data and other information are disclosed. If a TR is one of several providing
services to a particular market, the TR should provide basic data and other information in amanner that can be easily analysed and compared to and aggregated with information
provided by others serving the market. A TR should consult with relevant authorities indeveloping and maintaining a reporting framework that facilitates analysis, comparison, andaggregation of data from other TRs.
Forms of disclosure
3.24.5. A TR should make the data and other relevant information it discloses as set forth in
this report readily available through generally accessible media, such as the Internet, in alanguage commonly used in financial markets in addition to the domestic language(s) of thejurisdiction in which the TR is located. The data should be accompanied by robust
explanatory documentation that enables users to understand and interpret the data correctly.

172

Authorities may need to cooperate in order to ensure timely access to trade data (see key consideration 8 of
Responsibility E).

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125

4.0

Responsibilities of central banks, market regulators, and otherrelevant authorities for financial market infrastructures

Responsibility A: Regulation, supervision, and oversight of FMIs
FMIs should be subject to appropriate and effective regulation, supervision, andoversight by a central bank, market regulator, or other relevant authority.
Key considerations
1.

Authorities should clearly define and publicly disclose the criteria used to identify
FMIs that should be subject to regulation, supervision, and oversight.

2.

FMIs that have been identified using these criteria should be regulated, supervised,and overseen by a central bank, market regulator, or other relevant authority.

Explanatory note
4.1.1.
FMIs are critical components of domestic and international financial
markets and help to maintain and promote financial stability in periods of market stress. FMIs
provide a number of services that are vital to a well-functioning financial system, including
facilitating the exchange of money for goods, services, and financial assets and providing asafe and efficient means through which authorities can manage systemic risk and central
banks can implement monetary policy. By design, FMIs concentrate payment, clearing, andsettlement activities and trade data in order to manage risk better and to reduce payment,
clearing, settlement, and recording costs and delays. Well-functioning FMIs can vastly
improve the efficiency, transparency, and safety of financial systems. However, FMIs often
concentrate risk and may even act as a source of systemic risk. Therefore, appropriate
regulation, supervision, and oversight is critical to achieving the public policy goals set out inthis report.
Criteria for regulation, supervision, and oversight
4.1.2.
Authorities should clearly define and publicly disclose the criteria used to
identify FMIs that should be subject to regulation, supervision, and oversight. The precise
framework for making such decisions may vary across jurisdictions. In some countries, forexample, there is a statutory framework, while in others, the central bank or other relevant
authorities have greater discretion to set the criteria used. A basic criterion, however, is thefunction of the FMI. Systemically important payment systems, CSDs, SSSs, CCPs, and TRs
are typically subject to regulation, supervision, and oversight because of the critical role thatthey play in the financial system. Criteria that are often considered in determining the needfor or degree of regulation, supervision, and oversight for various types of FMIs include(a) the number and value of transactions processed, (b) the number and type of participants,(c) the markets served, (d) the market share controlled, (e) the interconnectedness with other
FMIs and other financial institutions, and (f) the available alternatives to using the FMI atshort notice. Authorities may also want to designate FMIs as systemically important on thebasis of other criteria relevant in their jurisdictions for the purposes of applying the CPSSIOSCO Principles for financial market infrastructures.
Responsibilities for regulation, supervision, and oversight
4.1.3.
FMIs that have been identified using these criteria should be regulated,supervised, and overseen by a central bank, market regulator, or other relevant authority.
The division of powers or responsibilities among authorities for regulating, supervising, andoverseeing FMIs may vary depending on the applicable legal and institutional framework and126

CPSS-IOSCO – Principles for financial market infrastructures – April 2012

the sources of such powers or responsibilities may take different forms. Preferably,legislation will clearly specify which authority or authorities have responsibility. For example,
one or more authorities may have regulatory, supervisory, or oversight responsibility for an
FMI registered, chartered, licensed, or designated as an entity that falls within a specificlegislative mandate. However, in the national context, an FMI also may be overseen by anauthority that does not derive responsibility from a specific legislative mandate. 173 Relevant
authorities should address any existing gaps in regulation, supervision, and oversight of FMIs
(see Responsibility E which addresses cooperation among different authorities, particularly in
the international setting).

173

This includes traditional use of moral suasion by central banks.

CPSS-IOSCO – Principles for financial market infrastructures – April 2012127

Responsibility B: Regulatory, supervisory, and oversight powers and resources
Central banks, market regulators, and other relevant authorities should have thepowers and resources to carry out effectively their responsibilities in regulating,supervising, and overseeing FMIs.
Key considerations
1.

Authorities should have powers or other authority consistent with their relevant
responsibilities, including the ability to obtain timely information and to inducechange or enforce corrective action.

2.

Authorities should have sufficient resources to fulfil their regulatory, supervisory, andoversight responsibilities.

Explanatory note
4.2.1. While the primary responsibility for ensuring an FMI’s safety and efficiency lies withthe system’s owners and operator, central banks, market regulators, and other relevant
authorities generally share the common objective of ensuring the safety and efficiency of
FMIs. However, regulation, supervision, and oversight of an FMI are needed to ensure that
the FMI fulfils this responsibility, to address negative externalities that can be associated with
the FMI, and to foster financial stability generally. Further, authorities should have theappropriate powers and resources in order to administer their regulatory, supervisory, andoversight responsibilities effectively. An authority’s powers, which may be statutory or nonstatutory, should be consistent with its relevant responsibilities.
Powers to obtain information
4.2.2. Authorities should have powers or other authority consistent with their relevant
responsibilities to obtain timely information necessary for effective regulation, supervision,and oversight. In particular, authorities should use these powers to access information thatenables them to understand and assess (a) an FMI’s various functions, activities, and overall
financial condition; (b) the risks borne or created by an FMI and, where appropriate, itsparticipants; (c) an FMI’s impact on its participants and the broader economy; and (d) an
FMI’s adherence to relevant regulations and policies. Key sources of information include
official system documents and records, regular or ad-hoc reports, internal reports from board
meetings and internal auditors, on-site visits and inspections, information on operations
outsourced to third parties, and dialogue with an FMI’s board, management, or
participants. 174 Authorities should have appropriate legal safeguards to protect all confidential
and non-public information obtained from an FMI. Authorities, however, should be able toshare relevant confidential or non-public information with other authorities, as appropriate, tominimise gaps and reduce duplication in regulation, supervision, and oversight.
Powers to induce change or enforce corrective action
4.2.3. Authorities also should have powers or other authority consistent with their relevant
responsibilities to induce change or enforce corrective action in an FMI that is not complying
with relevant regulations or policies. Other mechanisms may also be used to effect change,
including the use of moral suasion. Discussions with FMIs, their participants, and, in somecases, their participants’ customers play an important part in achieving regulatory,

174

Official system documentation includes the FMI’s rules, procedures, and business continuity plans. Regular or
ad hoc reporting includes daily volume and value of transactions reports, operating performance reports,
stress test results, and the scenarios and methodology employed in estimating exposures.

128

CPSS-IOSCO – Principles for financial market infrastructures – April 2012supervisory, and oversight objectives. In many cases, an authority may be able to rely on
moral suasion to promote public policy interests for FMIs and their stakeholders. These
techniques, however, work best when there are credible regulatory or other remedies
available to authorities. Where appropriate and legally permissible, authorities may want toconsider publicly disclosing their assessments of certain FMIs as a means to induce change
at those FMIs and promote transparency.
Sufficient resources
4.2.4. Authorities should have sufficient resources to fulfil their regulatory, supervisory, andoversight responsibilities. Sufficient resources include adequate funding, qualified andexperienced personnel, and appropriate ongoing training. In addition, authorities should
adopt an organisational structure that uses these resources effectively. It should be clear
where the responsibility for regulatory, supervisory, and oversight functions lies within an
authority or authorities. These functions may include gathering information on FMIs,
assessing the operation and design of FMIs, assessing interdependencies among FMIs,
taking action to promote FMIs’ observance of relevant policies and standards, andconducting on-site visits or inspections when necessary. Where relevant, personnel shouldhave the appropriate legal protections to carry out their responsibilities.

CPSS-IOSCO – Principles for financial market infrastructures – April 2012129

Responsibility C: Disclosure of policies with respect to FMIs
Central banks, market regulators, and other relevant authorities should clearly define
and disclose their regulatory, supervisory, and oversight policies with respect to FMIs.
Key considerations
1.

Authorities should clearly define their policies with respect to FMIs, which include
the authorities’ objectives, roles, and regulations.

2.

Authorities should publicly disclose their relevant policies with respect to theregulation, supervision, and oversight of FMIs.

Explanatory note
4.3.1. Central banks, market regulators, and other relevant authorities should clearly
define their regulatory, supervisory, and oversight policies with respect to FMIs, which
include the authorities’ objectives, roles, and regulations. A clear definition of authorities’
objectives provides a basis for consistent policymaking and a benchmark by whichauthorities can evaluate their effectiveness. Typically, the primary objectives of authorities
with respect to FMIs are to promote safety and efficiency. Some authorities may also haveadditional relevant public policy objectives for the FMIs they regulate, supervise, or oversee.
These objectives are usually implemented through specific regulations and other policies,
such as risk-management standards or expectations for FMIs. The policies of authorities
should be consistent with their legislative framework. In addition, authorities may find it
beneficial to consult with the market, key stakeholders, and the broader public regarding theirpolicies. In many countries, these consultations may be required by law.
4.3.2. Authorities should publicly disclose their relevant policies with respect to theregulation, supervision, and oversight of FMIs, as public disclosure promotes consistentpolicies. Such disclosure typically involves communicating the authorities’ regulatory,
supervisory, and oversight standards for FMIs and helps to establish clear expectations andfacilitate compliance with those standards. Furthermore, disclosing policies publicly
communicates the responsibilities and expectations of authorities to the wider public andthereby promotes the accountability of those authorities. Authorities can publicly disclose
their policies in a variety of forms, including plain-language documents, policy statements,
and relevant supporting material. Such materials should be readily available. 175 These
disclosures, however, do not shift the responsibility of ensuring the safe and efficient
operation of FMIs from the FMI to authorities. Authorities should emphasise that primary
responsibility for complying with the regulatory, supervisory, and oversight policies rests with
the FMIs themselves.

175

For example, an authority can publicly disclose its policies by posting them to a public website.

130

CPSS-IOSCO – Principles for financial market infrastructures – April 2012

Responsibility D: Application of the principles for FMIs
Central banks, market regulators, and other relevant authorities should adopt the
CPSS-IOSCO Principles for financial market infrastructures and apply themconsistently.
Key considerations
1.

Authorities should adopt the CPSS-IOSCO Principles for financial market
infrastructures.

2.

Authorities should ensure that these principles are, at a minimum, applied to all
systemically important payment systems, CSDs, SSSs, CCPs, and TRs.

3.

Authorities should apply these principles consistently within and across jurisdictions,
including across borders, and to each type of FMI covered by the principles.

Explanatory note
4.4.1. Central banks, market regulators, and other relevant authorities should adopt the
CPSS-IOSCO Principles for financial market infrastructures. The adoption and application ofthese principles can greatly enhance regulatory, supervisory, and oversight efforts byrelevant authorities and support the establishment of important minimum standards for risk
management. While the precise means through which the principles are applied will varyfrom jurisdiction to jurisdiction, all CPSS and IOSCO members are expected to apply theprinciples to the relevant FMIs in their jurisdictions to the fullest extent allowed by the legal
framework in their jurisdiction. 176 The principles draw on the collective experience of many
central banks, market regulators, and other relevant authorities and have been subject topublic consultation. The use of these principles helps to ensure that FMIs are safe andefficient.
Scope of application of principles
4.4.2. Authorities should ensure that these principles are, at a minimum, applied to all
systemically important payment systems, CSDs, SSSs, CCPs, and TRs. A payment system
is systemically important if it has the potential to trigger or transmit systemic disruptions; thisincludes, among other things, systems that are the sole payment system in a country or the
principal system in terms of the aggregate value of payments, and systems that mainly
handle time-critical, high-value payments or settle payments used to effect settlement inother FMIs. The presumption is that all CSDs, SSSs, CCPs, and TRs are systemicallyimportant because of their critical roles in the markets they serve. 177 Authorities should
disclose which FMIs they do not regard as systemically important and to which they do notintend to apply the principles and provide a comprehensive and clear rationale. Conversely,
authorities may disclose which FMIs they regard as systemically important. 178

176

In some cases, specific legislation may be used or needed to set out the precise regulatory framework andrules applicable to FMIs. In other cases, the relevant authorities may not need statutory authority to adopt
them, though they may still need to create more detailed policies, rules, or regulations to implement them.

177

In some jurisdictions, national law will dictate the criteria to determine whether an FMI is systemicallyimportant.

178

See also key consideration 1 of Responsibility A, which requires authorities to clearly define and publicly
disclose the criteria used to identify FMIs that should be subject to regulation, supervision, and oversight.

CPSS-IOSCO – Principles for financial market infrastructures – April 2012131

Consistent application of principles
4.4.3. Authorities should apply the principles consistently within and across jurisdictions,
including across borders, and to each type of FMI covered by these principles. Consistent
application of these principles is important because different systems may be dependent oneach other, in direct competition with each other, or both. The principles also represent
common interests which make it easier for different authorities to work cooperatively andenhance the effectiveness and consistency of regulation, supervision, and oversight. This isparticularly important because many FMIs operate across multiple jurisdictions. Authorities
may apply more demanding requirements if and when they deem it appropriate to do so.
Observance of internationally accepted principles
4.4.4. If a systemically important FMI does not observe the applicable principles, relevant
authorities should ensure, as far as possible within their responsibilities and powers, that the
FMI takes appropriate and timely action to remedy its deficiencies within a timeframe
consistent with the type or impact of the risks, concerns, or other issues associated with theidentified gaps and shortcomings. Authorities should closely monitor newly formed FMIs andthose undergoing significant changes. 179 Where central banks themselves own or operate
FMIs or key components of FMIs, they should apply, to the extent applicable, the sameinternational standards to their own systems with the same rigor as other overseen systems.
If a central bank is an owner or operator of an FMI as well as the overseer of private-sector
FMIs, it needs to consider how best to address any possible conflicts of interest. In particular,
it should avoid disadvantaging private-sector FMIs relative to those it owns and operates.

179

In these instances, authorities should engage with the FMI at an early stage to foster public policy goals andidentify opportunities to enhance safety and efficiency.

132

CPSS-IOSCO – Principles for financial market infrastructures – April 2012

Responsibility E: Cooperation with other authorities
Central banks, market regulators, and other relevant authorities should cooperate witheach other, both domestically and internationally, as appropriate, in promoting thesafety and efficiency of FMIs.
Key considerations
1.

Relevant authorities should cooperate with each other, both domestically andinternationally, to foster efficient and effective communication and consultation inorder to support each other in fulfilling their respective mandates with respect to
FMIs. Such cooperation needs to be effective in normal circumstances and should
be adequately flexible to facilitate effective communication, consultation, or
coordination, as appropriate, during periods of market stress, crisis situations, andthe potential recovery, wind-down, or resolution of an FMI.

2.

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 observanceof the CPSS-IOSCO Principles for financial market infrastructures.

3.

Cooperation may take a variety of forms. The form, degree of formalization andintensity of cooperation should promote the efficiency and effectiveness of thecooperation, 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 andeffectiveness of the cooperation with respect to the number of authorities
participating in such arrangements.

4.

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 noother authority accepts this responsibility, the presumption is the authority or
authorities with primary responsibility in the FMI’s home jurisdiction should accept
this responsibility.

5.

At least one authority should ensure that the FMI is periodically assessed against
the principles and should, in developing these assessments, consult with otherauthorities that conduct the supervision or oversight of the FMI and for which the
FMI is systemically important.

6.

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 theviews 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 andprocedures, the central bank should consider the views of the authority or authorities
with primary responsibility with respect to the FMI.

7.

Relevant authorities should provide advance notification, where practicable andotherwise as soon as possible thereafter, regarding pending material regulatorychanges and adverse events with respect to the FMI that may significantly affectanother authority’s regulatory, supervisory, or oversight interests.

8.

Relevant authorities should coordinate to ensure timely access to trade data
recorded in a TR.

CPSS-IOSCO – Principles for financial market infrastructures – April 2012

133

9.

Each authority maintains its discretion to discourage the use of an FMI or theprovision of services to such an FMI if, in the authority’s judgment, the FMI is notprudently designed or managed or the principles are not adequately observed. An
authority exercising such discretion should provide a clear rationale for the action
taken both to the FMI and to the authority or authorities with primary responsibility
for the supervision or oversight of the FMI.

10.

Cooperative arrangements between authorities in no way prejudice the statutory or
legal or other powers of each participating authority, nor do these arrangements
constrain in any way an authority’s powers to fulfil its statutory or legislative mandateor its discretion to act in accordance with those powers.

Explanatory note
4.5.1. Central banks, market regulators, and other relevant authorities should cooperatewith each other, domestically and internationally (that is, on a cross-border basis), in order tosupport each other in fulfilling their respective regulatory, supervisory, or oversight mandates
with respect to FMIs. Relevant authorities should explore, and where appropriate, develop
cooperative arrangements that take into consideration (a) their statutory responsibilities,(b) the systemic importance of the FMI to their respective jurisdictions, (c) the FMI’s
comprehensive risk profile (including consideration of risks that may arise frominterdependent entities), and (d) the FMI’s participants. The objective of such arrangements
is to facilitate comprehensive regulation, supervision, and oversight and provide amechanism whereby the responsibilities of multiple authorities can be fulfilled efficiently andeffectively. Authorities are encouraged to cooperate with each other to reduce the probabilityof gaps in regulation, supervision, and oversight that could arise if they did not coordinate
and to minimise the potential duplication of effort and the burden on the FMIs or thecooperating authorities. Relevant authorities should also cooperate with resolution authorities
and the supervisors of direct participants, as appropriate and necessary, to enable each tofulfil its respective responsibilities.
4.5.2. Cooperative arrangements need to foster efficient and effective communication andconsultation among relevant authorities. Such arrangements need to be effective in normal
circumstances and 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. Inadequate
cooperation, especially during times of market stress and crisis situations, can impede
significantly the work of relevant authorities.
Identification of FMIs and relevant authorities
4.5.3. 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 CPSSIOSCO Principles for financial market infrastructures. To determine whether such notification
is appropriate, the authority should consider (to the extent it has such information) the natureand scope of other relevant authorities’ regulatory, supervisory, or oversight responsibilities
with respect to the FMI and the FMI’s systemic importance in those authorities’ jurisdictions.
Cooperation arrangements
4.5.4. Cooperation may take a variety of forms, including formal arrangements that areorganised under memoranda of understanding, protocols, or other documentation as well as

134

CPSS-IOSCO – Principles for financial market infrastructures – April 2012

informal ad hoc arrangements and regular communications. 180 The relevant authorities
should agree on the form of cooperative arrangement or such multiple arrangements as they
deem most appropriate in light of the FMI’s specific circumstances. Flexibility as to the formof cooperation allows relevant authorities to continue to adapt to a dynamic environment asfinancial markets and systems evolve. All authorities involved in cooperative arrangements
should have the powers and resources needed to carry out their responsibilities under thearrangements.
4.5.5. The appropriate degree of formalisation and the intensity of the cooperation in
relation to any given FMI will depend on the relevant authorities’ statutory responsibilities andmay also depend on the FMI’s systemic importance to their respective jurisdictions. The
degree of formalisation may vary depending on each set of circumstances. For example,
using an ad hoc arrangement to address promptly an emerging supervisory issue may be
preferable to establishing a more-formal arrangement. Similarly, the intensity of cooperation
may vary among arrangements, ranging from information sharing to more-extensive
consultation and cooperation arrangements. 181 Information sharing may include theexchange of supervisory and oversight information (both public and non-public); theexchange of perspectives on risk-management controls, safety, and soundness; or plans forthe potential recovery, wind-down, or resolution of the FMI. 182 Relevant authorities shouldseek to achieve a cooperative arrangement that employs an appropriate combination of formand scope to achieve an effective outcome. Cooperative arrangements should be managed
to ensure the efficiency and effectiveness of the cooperation with respect to the number ofauthorities participating in such cooperative arrangements.
4.5.6. For an FMI where cooperative arrangements are appropriate, at least one authority
should accept responsibility for establishing efficient and effective cooperation arrangements
among all relevant authorities. In international cooperative arrangements where no otherauthority accepts this responsibility, the presumption is the authority or authorities withprimary responsibility in the FMI’s home jurisdiction should accept this responsibility.
Cooperation with other authorities should be guided by relevant international principles oncooperative arrangements for the regulation, supervision, and oversight of FMIs, such as the
CPSS’s Central bank oversight of payment and settlement systems report and IOSCO’s
Principles regarding cross-border supervisory cooperation. This responsibility addresses
cooperation among authorities in the application of the principles and is intended tocomplement, but does not replace or supersede, any relevant guiding documents that exist
for CPSS and IOSCO.
4.5.7. The acceptance of responsibility for establishing the cooperation arrangement for an
FMI does not in itself confer any rights, supersede any national laws, or prejudice anybilateral or multilateral information sharing arrangements. The duties of an authority withsuch responsibility would typically include (a) proactively proposing arrangements forcooperation that would best meet the relevant authorities’ objectives, (b) facilitating
coordination and cooperation among the authorities, (c) ensuring transparency in thearrangements, (d) acting, where relevant, as a central point for the information exchanged
between the FMI and the relevant authorities, and (e) undertaking or coordinating periodic

180

Such arrangements can be either bilateral or multilateral and may be implemented through colleges,
regulatory networks, oversight committees, or other cooperative arrangements (for example, statements ofintent or official exchanges of letters) or through ad hoc communication.

181

These arrangements may define the roles and responsibilities of the relevant authorities in specific (forexample, crisis) scenarios.

182

In the resolution context, relevant authorities also may exchange information regarding the resolvability of aparticular FMI.

CPSS-IOSCO – Principles for financial market infrastructures – April 2012135

assessments of the FMI against the principles in consultation with other authorities that have
responsibilities with respect to the FMI.
4.5.8. Where several authorities have responsibilities in relation to the same FMI, at least
one authority should accept responsibility for ensuring that the FMI is periodically assessedagainst the principles. Authorities should consult with each other, where practicable, andshare assessments to support authorities with primary responsibility for the FMI’s supervisionor oversight and for which the FMI is systemically important. Information sharing and open
discussion with respect to the principles should help authorities avoid sending the FMI
conflicting messages or imposing unnecessarily burdensome requirements on the FMI.
Assessments and the related consultation and information sharing should be conductedwithout prejudice to the relevant authorities’ statutory powers or legal frameworks.
Payment and settlement arrangements
4.5.9. An FMI's payment and settlement arrangements and its related liquidity riskmanagement procedures in any currency for which the FMI's settlements are systemicallyimportant should be assessed against the principles by the authority or authorities withprimary regulation, supervision, or oversight responsibility with respect to the FMI. When
conducting these reviews, the authority or authorities should consider the views of the central
banks of issue. Central banks of issue may have an interest in an FMI’s payment andsettlement arrangements and its related liquidity risk-management procedures because of
their roles in implementing monetary policy and maintaining financial stability. Further, if acentral bank of issue is required under its responsibilities to conduct its own assessment ofthese arrangements and procedures, the central bank should consider the views of theauthority or authorities with primary responsibility with respect to the FMI.
Advance notification
4.5.10. Relevant authorities should provide advance notification, where practicable andotherwise as soon as possible thereafter, regarding pending material regulatory changes andadverse events with respect to the FMI that may significantly affect another authority’s
regulatory, supervisory, and oversight interests. In particular, for cross-border or
multicurrency FMIs, where other authorities may have an interest in the FMI's observance ofthe principles, advance notification arrangements should take into account the authorities’
responsibilities with respect to the FMI's potential systemic importance to their jurisdictions.
The views of other authorities put forward through consultations should be considered, as
appropriate, in connection with regulatory actions taken with respect to the FMI, including
when the FMI is in a recovery, wind-down, or resolution scenario.
Timely access to trade data
4.5.11. Authorities primarily responsible for the regulation, supervision, and oversight of a
TR that maintains data pertaining to other jurisdictions should coordinate with other relevant
authorities to ensure timely and effective access to trade data and establish an appropriate
data access process that is fair and consistent with the responsibilities of the other relevant
authorities, to the extent legally permissible. All relevant authorities should mutually support
each other’s access to trade data in which they have a material interest in furtherance of theirregulatory, supervisory, and oversight responsibilities, regardless of the particularorganizational form or geographic location of a TR.
No pre-emption of statutory authority
4.5.12. Each authority maintains its discretion to discourage the use of an FMI located inanother jurisdiction or the provision of services to such an FMI if, in the authority’s judgment,
the FMI is not prudently designed or managed or the principles are not adequately observed.
This would be an option that would only be considered in extreme circumstances, andtypically after consultation with the authority or authorities with primary responsibility for the136

CPSS-IOSCO – Principles for financial market infrastructures – April 2012supervision or oversight of the FMI. An example of such a circumstance would be if theauthority concerned had been unable to secure changes to the FMI’s risk controls which it
regarded as necessary given the FMI’s systemic importance in its jurisdiction. An authority
exercising such discretion should provide a clear rationale for the action taken both to the
FMI and to the authority or authorities with direct responsibility for the supervision or
oversight of the FMI.
4.5.13. Cooperative arrangements between authorities in no way prejudice the statutory or
legal or other powers of each participating authority, nor do these arrangements constrain inany way an authority’s powers to fulfil its statutory or legislative mandate or its discretion toact in accordance with those powers. International cooperation for enforcement activities
regarding persons other than FMIs is not covered by this responsibility. For IOSCO
members, international cooperation for enforcement activities is governed by the Multilateralmemorandum of understanding for cooperation concerning consultation and cooperation andthe exchange of information. 183

183

See IOSCO, Multilateral memorandum of understanding for cooperation concerning consultation andcooperation and the exchange of information, May 2002.

CPSS-IOSCO – Principles for financial market infrastructures – April 2012137

Annex A:
Mapping of CPSIPS, RSSS, and RCCP standards
to the principles in this report

Previous international standards

PFMI

The table below maps the CPSIPS, RSSS, and RCCP standards to the principles in thisreport. For example, Core Principle III of the Core Principles for Systemically Important
Payment Systems is covered by Principles 3, 4, and 7 in this report.

Core principles for systemically important payment systems
Core Principle I:
Core Principle II:
Core Principle III:
Core Principle IV:
Core Principle V:
Core Principle VI:
Core Principle VII:
Core Principle VIII:
Core Principle IX:
Core Principle X:
Responsibility A:
Responsibility B:
Responsibility C:
Responsibility D:

Legal basis
Understanding financial risks
Management of financial risks
Prompt final settlement
Settlement in multilateral netting systems
Settlement assets
Security and operational reliability
Efficiency
Access criteria
Governance
Disclosure of objectives, role and major policies
Compliance of central bank systems
Oversight of non-central bank systems
Cooperation with other authorities

1
23
3, 4, 7
8
4, 5, 7
9
17
21
18
2
A, C
D
B, D
E

Recommendations for securities settlement systems
Recommendation 1:
Recommendation 2:
Recommendation 3:
Recommendation 4:
Recommendation 5:
Recommendation 6:
Recommendation 7:
Recommendation 8:
Recommendation 9:
Recommendation 10:
Recommendation 11:
Recommendation 12:

Legal framework
Trade confirmation
Settlement cycles
Central counterparties (CCPs)
Securities lending
Central securities depositories (CSDs)
Delivery versus payment (DVP)
Timing of settlement finality
CSD risk controls to address participants’ failure tosettleCash settlement assets
Operational reliability
Protection of customers’ securities

Recommendation 13:
Recommendation 14:
Recommendation 15:
Recommendation 16:
Recommendation 17:
Recommendation 18:

Governance
Access
Efficiency
Communication procedures and standards
Transparency
Regulation and oversight

Recommendation 19:

Risks in cross-border links

138

1
Annex C
Annex C
Annex C
Annex C1112
8
4, 5, 79
17
11, 14, 16,
Annex C
2
18
21
22
23
Responsibilities
A-E
20

CPSS-IOSCO – Principles for financial market infrastructures – April 2012

PFMI

Previous international standards (cont)
Recommendations for central counterparties
Recommendation 1:
Recommendation 2:
Recommendation 3:
Recommendation 4:
Recommendation 5:
Recommendation 6:
Recommendation 7:
Recommendation 8:
Recommendation 9:
Recommendation 10:
Recommendation 11:
Recommendation 12:
Recommendation 13:
Recommendation 14:
Recommendation 15:

Legal risk
Participation requirements
Measurement and management of credit exposures
Margin requirements
Financial resources
Default procedures
Custody and investment risks
Operational risk
Money settlements
Physical deliveries
Risks in links between CCPs
Efficiency
GovernanceTransparency
Regulation and oversight

CPSS-IOSCO – Principles for financial market infrastructures – April 2012

1
18
4
5, 6
4, 5, 6, 7
13
16
17
9
10, 1220
21
2
23
Responsibilities
A-E

139

Annex B:
Mapping of the principles in this report to CPSIPS,
RSSS, RCCP, and other guidance

RSSS

RCCP

Principles for FMIs

CPSIPS

The table below illustrates how the principles in this report relate to the CPSIPS, RSSS, and
RCCP standards, as well as other guidance. For example, Principle 18 in this reportharmonises and builds upon CPSIPS Principle 9, RSSS Recommendation 14, and RCCP
Recommendation 2.

1
10
3

1
13
–

1
13
–

3, 5
5
–
3, 5
4
6
–
–
–
–
–
–
–
7
9
–
–
8
–
2

9
9
–
9
8
10
–
6, 11, 12
7
–
12
–
12
11
14
–
19
15
16
17

3, 5
4, 5
4, 5
5
–
9
10
–
10
6
–
–
7
8
2
–
11
12
–
14

–

–

–

Principles for FMIs
Principle 1:
Principle 2:
Principle 3:
Principle 4:
Principle 5:
Principle 6:
Principle 7:
Principle 8:
Principle 9:Principle 10:
Principle 11:
Principle 12:
Principle 13:
Principle 14:
Principle 15:
Principle 16:
Principle 17:
Principle 18:
Principle 19:
Principle 20:
Principle 21:
Principle 22:
Principle 23:
Principle 24:

Legal basis
Governance
Framework for the comprehensive
management of risks
Credit risk
Collateral
MarginLiquidity risk
Settlement finality
Money settlements
Physical deliveries
Central securities depositories
Exchange-of-value settlement systems
Participant-default rules and procedures
Segregation and portability
General business risk
Custody and investment risks
Operational risk
Access and participation requirements
Tiered participation arrangements
FMI links
Efficiency and effectivenessCommunication procedures and standards
Disclosure of rules, key procedures, andmarket data
Disclosure of market data by trade repositories

Responsibilities of central banks, market regulators, and other relevant authorities for FMIs
Responsibility A:
Responsibility B:
Responsibility C:
Responsibility D:
Responsibility E:

Regulation, supervision, and oversight of FMIs
Regulatory, supervisory and oversight powers
and resources
Disclosure of objectives and policies
Application of the principles for FMIs
Cooperation with other authorities

A
C

18
18

15
15

A
B, C
D

18
–
18

15
–
15

Note: Additional source documents for the section on responsibilities of central banks, market regulators, andother relevant authorities include: CPSS, Central bank oversight of payment and settlement systems, May
2005, and IOSCO, Principles regarding cross-border supervisory cooperation, May 2010.

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Annex C:
Selected RSSS marketwide recommendations

The RSSS marketwide recommendations on trade confirmation, settlement cycle, CCPs, andsecurities lending were not part of the CPSS and Technical Committee of IOSCO’s review ofstandards for FMIs. As a result, these marketwide recommendations remain in effect and areprovided below as reference.
Recommendation 2: Trade confirmation
Confirmation of trades between direct market participants should occur as soon as possible
after trade execution, but no later than trade date (T+0). Where confirmation of trades byindirect market participants (such as institutional investors) is required, it should occur assoon as possible after trade execution, preferably on T+0, but no later than T+1.
3.10
The first step in settling a securities trade is to ensure that the buyer and the seller
agree on the terms of the transaction, a process referred to as trade confirmation. Often abroker-dealer or member of an exchange (a direct market participant) acts as anintermediary in executing trades on behalf of others (indirect market participants). In suchcircumstances, trade confirmation often occurs on two separate tracks: confirmation of theterms of the trade between direct participants and confirmation (sometimes termed“affirmation”) of the intended terms between each direct participant and the indirect
participant for whom the direct participant is acting. (Generally, indirect market participants
for whom confirmations are required include institutional investors and cross-border clients.)
On both tracks, agreement of trade details should occur as soon as possible so that errors
and discrepancies can be discovered early in the settlement process. Early detection should
help to avoid errors in recording trades, which could result in inaccurate books and records,
increased and mismanaged market risk and credit risk, and increased costs. While thisprocess is occurring, the back offices of the direct market participants, indirect market
participants and custodians that act as agents for the indirect market participants need toprepare settlement instructions, which should be matched prior to the settlement date.
Speedy, accurate verification of trades and matching settlement instructions is an essential
precondition for avoiding settlement failures, especially when the settlement cycle isrelatively short. (See Recommendation 3 regarding the length of settlement cycles.)3.11
Trade confirmation systems are increasingly becoming automated. Many markets
already have in place systems for the automatic comparison of trades between direct market
participants. (In many markets, the use of electronic trading systems obviates the need for
direct market participants to match the terms of the trade.) Automated matching systems arealso being proposed and implemented for trade confirmation between direct market
participants and indirect market participants and for the matching of settlement instructions.
Automation improves processing times by eliminating the requirement to send informationback and forth manually between parties and by avoiding the errors inherent in manual
processing.
3.12
At its most sophisticated, automation allows manual intervention to be eliminatedfrom post-trade processing through the implementation of straight through processing (STP),
that is, procedures that require trade data to be entered only once and then use those samedata for all post-trade requirements related to settlement. Many practitioners believe thatmarket-wide achievement of STP is essential, both for maintaining high settlement rates asvolumes increase and for ensuring timely settlement of cross-border trades, particularly if
reductions in settlement cycles are to be achieved. STP systems may use a common
message format or use a translation facility that either converts different message formats
into a common format or translates between different formats. Several initiatives aim to

CPSS-IOSCO – Principles for financial market infrastructures – April 2012141

achieve STP. These initiatives should be encouraged, and direct and indirect market
participants should achieve the degree of internal automation necessary to take fulladvantage of whatever solutions emerge.
Recommendation 3: Settlement cycles
Rolling settlement should be adopted in all securities markets. Final settlement should occur
no later than T+3. The benefits and costs of a settlement cycle shorter than T+3 should be
evaluated.
3.13
Under a rolling settlement cycle, trades settle a given number of days after the tradedate rather than at the end of an “account period”, thereby limiting the number of outstanding
trades and reducing aggregate market exposure. The longer the period from trade execution
to settlement, the greater the risk that one of the parties may become insolvent or default on
the trade, the larger the number of unsettled trades, and the greater the opportunity for the
prices of the securities to move away from the contract prices, thereby increasing the riskthat non-defaulting parties will incur a loss when replacing the unsettled contracts. In 1989,
the G30 recommended that final settlement of cash transactions should occur on T+3, that is,three business days after the trade date. However, the G30 recognised that “to minimisecounterparty risk and market exposure associated with securities transactions; same day
settlement is the final goal”.
3.14
This recommendation retains T+3 settlement as a minimum standard. Markets thathave not yet achieved a T+3 settlement cycle should identify impediments to achieving T+3
and actively pursue the removal of those impediments. Many markets already are settling ata shorter interval than T+3. For example, many government securities already settle on T+1
or even T+0, and some equity markets are currently considering a T+1 settlement cycle. The
standard judged appropriate for a type of security or market will depend upon factors such astransaction volume, price volatility and the extent of cross-border trading in the instrument.
Each securities market should evaluate whether a cycle shorter than T+3 is appropriate,given the risk reduction benefits that could be achieved, the costs that would be incurred andthe availability of alternative means of limiting pre-settlement risk, such as trade netting
through a CCP (see Recommendation 4 below). Depending on these factors, some markets
may conclude that different types of securities should have different settlement cycles.
3.15
Reducing the cycle is neither costless nor without certain risks. This is especiallytrue for markets with significant cross-border activity because differences in time zones andnational holidays, and the frequent involvement of multiple intermediaries, make timely tradeconfirmation more difficult. In most markets, a move to T+1 (perhaps even to T+2) would
require a substantial reconfiguration of the trade settlement process and an upgrade ofexisting systems. For markets with a significant share of cross-border trades, substantial
system improvements may be essential for shortening settlement cycles. Without suchinvestments, a move to a shorter cycle could generate increased settlement fails, with ahigher proportion of participants unable to agree and exchange settlement data or to acquire
the necessary resources for settlement in the time available. Consequently, replacement costrisk would not be reduced as much as anticipated and operational risk and liquidity risk could
increase.
3.16
Regardless of the settlement cycle, the frequency and duration of settlement failures
should be monitored closely. In some markets, the benefits of T+3 settlement are not being
fully realised because the rate of settlement on the contractual date falls significantly short of100%. In such circumstances, the risk implications of the fail rates should be analysed andactions identified that could reduce the rates or mitigate the associated risks. For example,
monetary penalties for failing to settle could be imposed contractually or by market
authorities; alternatively, failed trades could be marked to market and, if not resolved within a
specified timeframe, closed out at market prices.

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Recommendation 4: Central counterparties (CCPs)
The benefits and costs of a CCP should be evaluated. Where such a mechanism isintroduced, the CCP should rigorously control the risks it assumes.
3.17
A central counterparty (CCP) interposes itself between trade counterparties,
becoming the buyer to every seller and the seller to every buyer. Thus, from the point of viewof market participants the credit risk of the CCP is substituted for the credit risk of the otherparticipants. (In some markets many of the benefits of a CCP are achieved by establishingan entity that indemnifies market participants against losses from counterparty defaults
without actually acting as CCP.) If a CCP manages its risks effectively, its probability ofdefault may be less than that of all or most of the market participants. Moreover, a CCP often
bilaterally nets its obligations vis-à-vis its participants, which achieves multilateral netting ofeach participant’s obligations vis-à-vis all of the other participants. This can reduce
substantially the potential losses in the event of the default of a participant, both on tradesthat have not reached settlement (replacement cost exposures) and on trades in the processof settlement (principal exposures). In addition, netting reduces the number and value ofdeliveries and payments needed to settle a given set of trades, thereby reducing liquidity
risks and transaction costs.
3.18
Introduction of a CCP is another tool, in addition to shortening settlement cycles, for
reducing counterparty credit risks. It is especially effective for reducing risks vis-à-vis active
market participants, who often buy and sell the same security for settlement on the samedate. In addition to these risk reduction benefits, the growing demand for CCP arrangementsin part reflects the increasing use of anonymous electronic trading systems, where orders arematched according to the rules of the system and participants cannot always manage their
credit risks bilaterally through their choice of counterparty.
3.19
Nevertheless, a CCP will not be appropriate in all markets. Establishing a CCP is
not without costs. In particular, establishing the kind of robust risk-management system thata CCP must have (see discussion below) generally requires significant initial investments
and ongoing expenses. Thus, individual markets should assess carefully the balance of thebenefits and costs of a CCP. This balance will depend on factors such as the volume andvalue of transactions, trading patterns among counterparties, and the opportunity costs
associated with settlement liquidity. A growing number of markets have determined that thebenefits of implementing a CCP outweigh the costs.
3.20
If a CCP is established, it is important that it have sound risk management because
the CCP assumes responsibility for risk management and reallocates risk among its
participants through its policies and procedures. As a result, if a CCP does not perform risk
management well, the CCP could increase risk to market participants. The ability of thesystem as a whole to withstand the default of individual participants depends crucially on therisk-management procedures of the CCP and its access to resources to absorb financial
losses. The failure of a CCP would almost certainly have serious systemic consequences,
especially where multiple markets are served by one CCP. Consequently, a CCP’s ability tomonitor and control the credit, liquidity, legal and operational risks it incurs and to absorb
losses is essential to the sound functioning of the markets it serves. A CCP must be able towithstand severe shocks, including defaults by one or more of its participants, and its
financial support arrangements should be evaluated in this context. Furthermore, there must
be a sound and transparent legal basis for the netting arrangements, whether by novation orotherwise. For example, netting must be enforceable against the participants in bankruptcy.
Without such legal underpinnings, net obligations may be challenged in judicial oradministrative insolvency proceedings. If these challenges are successful, the CCP or theoriginal counterparty may face additional settlement exposure. The CCP must also be
operationally sound and must ensure that its participants have the incentive and the ability to
manage the risks they assume.

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143

3.21
CCPs adopt a variety of means to control risk. The precise means reflects themarket served and the nature of the risks incurred. Access criteria are essential (see[Principle 18, formerly] Recommendation 14 on access). The CCP’s exposures should becollateralised. Most CCPs require members to deposit collateral to cover potential market
movements on open positions or unsettled transactions. Positions are also generally marked
to market one or more times daily, with the CCP taking additional cash or collateral to cover
any changes in the net value of the open positions of participants since the previous
valuation and settlement. During volatile periods, CCPs may collect additional collateral tominimise further their exposure. CCPs should also have rules specifying clearly how defaults
will be handled and how losses will be shared in the event that a defaulting firm’s collateral
fails to cover its exposure. For example, CCPs may require their members to contribute todefault clearing funds, typically composed of cash or high-quality, liquid securities andcalculated using a formula based on the volume of the participant’s settlement activity. Those
funds are often augmented through insurance or other financial support. Liquidity demands
are usually met by some combination of clearing fund assets and firmly committed bankcredit lines. Rules and procedures for handling defaults should be transparent to enable
members and other market participants to assess the risks they assume because of theirmembership in and use of a CCP.
3.22
CCPs are currently developing global risk-management standards that draw on theircommon experience and expertise. In February 2001, senior executives of the European
Association of Central Counterparty Clearing Houses (EACH) developed risk-management
standards for their organisations. Subsequently, CCP-12, a group that includes CCPs from
Asia and the Americas as well as Europe, has been working to revise the EACH standards
and broaden their acceptance among CCPs. 184 Once CCP-12’s work is finalised, national
authorities should consider using it as a starting point when evaluating the risk-management
procedures of a CCP.
Recommendation 5: Securities lending
Securities lending and borrowing (or repurchase agreements and other economicallyequivalent transactions) should be encouraged as a method for expediting the settlement of
securities transactions. Barriers that inhibit the practice of lending securities for this purpose
should be removed.
3.23
Mature and liquid securities lending markets (including markets for repurchaseagreements and other economically equivalent transactions) generally improve thefunctioning of securities markets by allowing sellers ready access to securities needed tosettle transactions where those securities are not held in inventory, by offering an efficientmeans of financing securities portfolios, and by supporting participants’ trading strategies. 185
The existence of liquid markets for securities lending reduces the risks of failed settlements
because market participants with an obligation to deliver securities that they have failed toreceive and do not hold in inventory can borrow these securities and complete delivery.
Securities lending markets also enable market participants to cover transactions that havealready failed, thereby curing the failure sooner. In cross-border transactions, particularly

184

The CCP-12 is composed of the following entities: (1) the Australian Stock Exchange; (2) the Brazilian
Clearing and Depository Corporation; (3) Eurex Clearing; (4) the Chicago Mercantile Exchange; (5) Clearnet;(6) Hong Kong Exchanges and Clearing Limited; (7) the London Clearing House; (8) S D Indeval, SA de C V;
(9) Singapore Exchange Limited; (10) The Canadian Depository for Securities Limited; (11) The Depository
Trust & Clearing Corporation; (12) The Options Clearing Corporation; and (13) the Tokyo Stock Exchange.

185

For a thorough discussion of securities lending and repo agreements, see Technical Committee of IOSCO and
CPSS, Securities lending transactions: market development and implications, 1999; CGFS, Implications ofrepo markets for central banks, 1999.

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back-to-back transactions, it is often more efficient and cost-effective for a market participant
to borrow a security for the delivery than to deal with the risk and costs associated with asettlement failure.
3.24
Liquid securities lending markets are therefore to be encouraged, subject toappropriate limits on their use for purposes prohibited by regulation or law. For example,
borrowing to support short sales is illegal in some circumstances in some markets. Even injurisdictions that restrict securities lending because of other public policy concerns,
authorities should consider permitting lending to reduce settlement failures. Impediments tothe development and functioning of securities lending markets should, as far as possible, beremoved. In many markets, the processing of securities lending transactions involves
manually intensive procedures. In the absence of robust and automated procedures, errors
and operational risks increase, and it may be difficult to achieve timely settlement of
securities lending transactions, which often need to settle on a shorter cycle than regulartrades. The scope for improvement in the processing of cross-border borrowing and lendingtransactions is particularly large. Some CSDs seek to overcome these impediments byproviding centralised lending facilities; others offer services intended to support the bilateral
lending market. The needs of individual markets will differ, and market participants and CSDs
should evaluate the usefulness of the different types of facilities.
3.25
Other impediments might arise from tax or accounting policies, from legal
restrictions on lending, from an inadequate legal underpinning for securities lending or fromambiguities about the treatment of such transactions in a bankruptcy. One of the mostsignificant barriers to development may be related to taxation of securities lendingtransactions. A tax authority’s granting of tax neutrality to the underlying transaction and theelimination of certain transaction taxes have served to increase activity in several
jurisdictions. Accounting standards also have an influence on the securities lending market,
particularly with respect to whether, and under what conditions, collateral must be reflectedon the balance sheet. Authorities in some jurisdictions restrict the types or amounts of
securities that may be loaned, the types of counterparties that may lend securities, or thepermissible types of collateral. Uncertainty about the legal status of transactions, for example
their treatment in insolvency situations, also inhibits development of a securities lending
market. The legal and regulatory structure must be clear so that all parties involved
understand their rights and obligations.
3.26
While securities lending may be a useful tool, it presents risk to both the borrower
and the lender. The securities lent or the collateral may not be returned when needed,because of counterparty default, operational failure or legal challenge, for example. Those
securities would then need to be acquired in the market, perhaps at a cost. Counterparties tosecurities loans should employ appropriate risk-management policies, including conducting
credit evaluations, collateralising exposures, marking exposures and collateral to market
daily, and employing master legal agreements.
Recommendation 6: Central securities depositories (CSDs)
Securities should be immobilised or dematerialised and transferred by book entry in CSDs to
the greatest extent possible.
3.27
There are several different ways for beneficial owners to hold securities. In somejurisdictions, physical securities circulate and beneficial owners may keep securities in theirpossession, although beneficial owners typically employ a custodian to hold them to reducerisks and safekeeping costs. The costs and risks associated with owning and trading
securities may be reduced considerably through immobilisation of physical securities, which
involves concentrating the location of physical securities in a depository (or CSD). To
promote immobilisation of all certificates of a particular issue, a jurisdiction could encourage
the issuance of a global note, which represents the whole issue. A further step away fromcirculating physical securities is full dematerialisation of a securities issue. In this approach,
CPSS-IOSCO – Principles for financial market infrastructures – April 2012145

there is no global note issued, as the rights and obligations stem from book entries in anelectronic register.
3.28
In addition to differences in physical arrangements for holding securities, there areimportant differences in the legal arrangements. Holding systems may be categorised
generally as direct or indirect (see [Annex D, formerly] Annex 2 [of the RSSS]). Each type ofsystem has advantages and disadvantages and either type of system can be designed in amanner that complies with these Recommendations. In jurisdictions that operate a direct
holding system but in which the CSD is not the official registrar of the issuer, a transfer of
securities in the CSD should result automatically in the transfer of legal title to the securities
in the official register of the issuer.
3.29
The immobilisation or dematerialisation of securities and their transfer by book entry
within a CSD significantly reduces the total costs associated with securities settlements andcustody. By centralising the operations associated with custody and transfer within a single
entity, costs can be reduced through economies of scale. In addition, efficiency gains can beachieved through increased automation, which reduces the errors and delays inherent inmanual processing. By reducing costs and improving the speed and efficiency of settlement,book entry settlement also supports the development of securities lending markets, including
markets for repurchase agreements and other economically equivalent transactions. These
activities, in turn, enhance the liquidity of securities markets and facilitate the use of
securities collateral to manage counterparty risks, thereby increasing the efficiency of trading
and settlement. Effective governance (see [Principle 2, formerly] Recommendation 13) isnecessary, however, to ensure that these benefits are not lost as a result of monopolistic
behaviour by the CSD.
3.30
The immobilisation or dematerialisation of securities also reduces or eliminates
certain risks, for example destruction or theft of certificates. The transfer of securities by bookentry is a precondition for the shortening of the settlement cycle for securities trades, which
reduces replacement cost risks. Book entry transfer also facilitates delivery versus payment,
thereby eliminating principal risks.
3.31
Thus, for both safety and efficiency reasons, securities should be immobilised or
dematerialised in CSDs to the greatest extent possible. In practice, retail investors may not
be prepared to give up their certificates. However, it is not necessary to achieve complete
immobilisation to realise the benefits of CSDs. It may be sufficient that the most active
market participants immobilise their holdings. Less active investors that insist on holding
certificates should bear the costs of their decisions.
Recommendation 12: Protection of customers’ securities
Entities holding securities in custody should employ accounting practices and safekeeping
procedures that fully protect customers’ securities. It is essential that customers’ securities
be protected against the claims of a custodian’s creditors.
3.60
Custody risk is the risk of a loss on securities held in custody occasioned by acustodian’s (or subcustodian’s) insolvency, negligence, misuse of assets, fraud, poor
administration, inadequate record keeping, or failure to protect a customer’s interests insecurities (including voting rights and entitlements). 186 Although custodians are
predominantly commercial banks, CSDs also hold and administer securities on behalf of theirdirect participants, and thus present custody risk. (Direct participants in a CSD may holdsecurities both for their own account and on behalf of customers.)

186

For a thorough discussion of custody issues, see Technical Committee of IOSCO, Client Asset Protection,
1996.

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3.61
A custodian should employ procedures ensuring that all customer assets areappropriately accounted for and kept safe whether it holds them directly or through a
subcustodian. Because customer securities must also be protected against the claims of acustodian’s creditors, a customer’s claims against a custodian are typically given priority or
are given preferential treatment under insolvency law. (Nonetheless, customer assets could
be subject to liens in favour of the custodian if, for example, the customer has pledged themto secure an obligation to the custodian.) One way that a customer can be protected in theevent of a custodian’s insolvency is through segregation (identification) of customer
securities on the books of the custodian (and of all subcustodians, and ultimately, the CSD).
Even when customer securities are segregated from a custodian’s own securities, customers
may still be at risk of a loss if the custodian does not hold sufficient securities to satisfy all
customer claims or if an individual customer’s securities cannot be readily identified. Thus,
entities that hold securities in custody (or maintain records of balances of securities) should
reconcile their records regularly to keep them current and accurate. Other ways to safeguardor protect customers against misappropriation and theft include internal controls andinsurance or other compensation schemes.
3.62
Ideally, a customer’s securities are immune from claims made by third-party
creditors of the custodian. Although the ideal is not realised in all circumstances, when theentities through which securities are held are performing their responsibilities effectively, thelikelihood of a successful legal claim made on a customer’s securities by a third-party
creditor is minimised. In addition, in the event of a custodian’s or subcustodian’s insolvency,
it should be highly improbable that a customer’s securities could be frozen or madeunavailable for an extended period of time. If that were to happen, the customer could comeunder liquidity pressures, suffer price losses or fail to meet its obligations. Segregation is acommon device that facilitates the movement of a customer’s positions by a receiver to asolvent custodian, thereby enabling customers to manage their positions and meet theirsettlement obligations. To bring these results about, it is essential that the legal framework
support segregation of customer assets or other arrangements for prioritising claims inbankruptcy that serve to protect customers’ holdings. It is also important for supervisory
authorities to enforce effective segregation of customer assets by custodians.
3.63
Cross-border holdings of securities often involve several layers of intermediaries
acting as custodians. For example, an institutional investor may hold its securities through a
global custodian, which, in turn, holds securities in a subcustodian that is a member of thelocal CSD. Or a broker-dealer may hold its securities through its home country CSD or aninternational CSD, which, in turn, holds its securities through a cross-border link with thelocal CSD or through a local custodian. Mechanisms to protect customer assets may varydepending on the type of securities holding system instituted in a jurisdiction. Beneficial
owners of securities should understand the extent of a custodian’s responsibility forsecurities held through intermediate custodians.
3.64
To prevent unexpected losses, a global custodian should determine whether the legal
framework in the jurisdiction of each of its local subcustodians has appropriate mechanisms toprotect customer assets. Alternatively, a global custodian should keep its customers apprised of
the custody risk arising from holding securities in a particular jurisdiction. Global custodiansshould also ascertain whether their local subcustodians employ appropriate accounting,safekeeping and segregation procedures for customer securities. Likewise, when home country
CSDs and ICSDs establish links to other CSDs, they should ensure that those other CSDs
protect customer securities adequately. With complex cross-border arrangements, it is imperativethat sound practices and procedures be used by all entities in the chain of custodians so that theinterests of beneficial owners are protected from legal actions relating to the insolvency of, or thecommission of fraud by, any one of the custodians. Each jurisdiction should take the attributes of
its securities holding system into account in judging whether its legal framework includes
appropriate mechanisms to protect a custodian’s customer against loss upon the insolvency of,or the commission of fraud by, a custodian.

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Annex D:
Summary of designs of payment systems, SSSs, and CCPs

This annex provides a high-level description of various institutional designs associated withpayment systems, securities settlement systems (SSSs), and central counterparties (CCPs).
Payment systems
A payment system is a set of instruments, procedures, and rules for the transfer of funds
between or among participants; the system includes the participants and the entity operating
the arrangement. A payment system is typically based on an agreement between or among
participants and the operator, and the transfer of funds is effected using an agreed-upon
operational infrastructure. A payment system is generally categorised as either a retailpayment system or a large-value payment system (LVPS). 187 A retail payment system is afunds transfer system that typically handles a large volume of relatively low-value payments
in such forms as cheques, credit transfers, direct debits, and payment card transactions. An
LVPS is a funds transfer system that typically handles large-value and high-priority
payments.
Organisational structures
A payment system can take on different organizational forms. A system may include a
central entity that acts as the payment system operator (that is, it runs the infrastructure thatprocesses payment obligations, settlement obligations, or both; communicates withparticipants; and, in some cases, calculates net obligations), as a settlement institution (thatis, it debits and credits the balances in settlement accounts on its books), or as both. Further,
the settlement institution may act as a type of central counterparty to each payment
obligation (henceforth, payment), provide a guarantee of finality or settlement for eachpayment accepted to the system, or offer no form of settlement guarantee and let any
associated risks remain with the participants. Other possible arrangements include anoperating entity that is different from the settlement institution and operates some or all of thetechnical elements of the payment system on behalf of the participants or the settlement
institution. In some cases, the operator will operate the system on behalf of a broader
industry group, statutory body, or other organization as part of a payment scheme. 188 Stillother arrangements may involve multilateral clearing and settlement systems with very
limited roles for central entities.
Institutional designs
Payment systems can be categorised generally into real-time gross settlement (RTGS)
systems, deferred (or designated-time) net settlement (DNS) systems, and “hybrid” systems.
The key distinctions among these three systems involve the form and timing of settlement.

187

See also, CPSS, New developments in large-value payment systems, May 2005

188

Some countries may have payment schemes for one or more types of payments in which there exists a rulemaking body that sets rules or provides some form of governance applicable to the operator, the participants,
or a broader set of parties.

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Real-time gross settlement systems
RTGS systems settle payments continuously in real time (that is, without deferral) and on agross basis, typically on a payment-by-payment basis. A payment is accepted by the systemonce it successfully passes the system’s validity and conditionality checks (such as that thesender has sufficient funds or credit available to send the payment) and is typicallyunconditional and irrevocable. 189 If the payment cannot be validated, it is generally rejectedback to the sender. If the payment is validated but does not pass the conditionality checks,
the payment is either queued or rejected back to the sender (although other alternatives may
exist in some systems). RTGS systems provide the advantage that payments are settled withfinality on a payment-by-payment basis in the course of the day, thus reducing intraday credit
and liquidity exposures between participants. A downside of RTGS systems is that theyrequire participants to have sufficient liquidity to cover the principal amount of each payment
and can therefore require large amounts of intraday liquidity from participants.
Deferred net settlement systems
In DNS systems, payments are accumulated and netted throughout the day (or possibly once
per day), and settlement of the net amount takes place at the end of the day, if not more
frequently intraday. By netting payment values among participants, DNS systems requiresignificantly less liquidity for settlement, as compared to RTGS systems. However, DNS
systems may expose participants to credit and liquidity risks for the period during which
settlement is deferred. Settlement finality is only achieved at the end of the day (or atdesignated times during the day) in DNS systems and thus if there is no settlement
guarantee, either by the system or its participants, there is no certainty that the payments will
be settled until that point in time. If a participant fails to meet its payment obligation whendue, some or all processed payments could be unwound, thereby exposing participants toliquidity risk and possibly credit risk depending on the design, rules, and legal framework of
the payment system.
Hybrid systems and liquidity-saving mechanisms
In recent years, distinctions between RTGS and DNS systems have become less clear.
Some DNS systems have increased the frequency of intraday final settlement to reduce risks
associated with delayed settlement. Many RTGS systems have incorporated liquidity-savingfeatures akin to netting in DNS systems in order to economise on participants’ use of
liquidity. A range of system designs with liquidity-saving mechanisms and settlement priority
options are sometimes classified as hybrid systems.
In general, liquidity-saving mechanisms include frequent netting or offsetting of payments
during the course of the operating day. A typical approach is to hold payments in a central
queue and to net or offset those payments on a bilateral or multilateral basis at frequentintervals. To the extent that resulting potential net debit positions are fully covered, thepayments can be settled immediately. Liquidity-saving mechanisms reduce the amount ofliquidity needed relative to traditional RTGS systems by using the potential liquidity from aparticipant’s incoming payments to settle outgoing payments via netting or offsetting.
Liquidity-saving mechanisms also reduce settlement risk relative to DNS systems byproviding intraday final settlement after each round of netting. However, systems with thesemechanisms may require more liquidity than pure DNS systems, which typically conduct
settlement once per day, and may involve greater settlement delays for some payments thanpure RTGS systems.

189

Some systems may have a legal or technical sequence of events that differs from this description yet achieves
the same purposes.

CPSS-IOSCO – Principles for financial market infrastructures – April 2012149

Other payment system enhancements include the integration of recurrent netting or offsettingwith real-time settlement functionality and the addition of prioritisation options for payment
processing or settlement. Such functionality allows a participant either to settle a particular
payment in real time (or near real time) or to place the payment in a queue for deferred
settlement. In many cases, systems have adopted complex algorithms for settling payments.
For example, some systems first attempt to settle a payment on a gross basis. If grosssettlement is not possible (for example, due to insufficient funds or lack of available credit),the system attempts to bilaterally or multilaterally offset the payment against other pending
payments, thereby reducing or eliminating the amount of liquidity required to settle thepayment. A number of different optimisation routines can be used to match, offset, or net
queued payments, and the complexity of these algorithms varies greatly. Some systems also
allow participants to set settlement or processing priorities among different payments or
payment types.
Payment process
Regardless of their design, payment systems typically have four conceptual stages ofprocessing: submission, validation, conditionality, and settlement (see also Box 3). 190
Submission
The first stage of the payment process is the submission of a payment to the payment
system. A payment can take on a number of forms based on the type of payment being
submitted (for example, time-critical versus non time-critical payments; balances of ancillarysystems or cash legs of securities transactions for LVPS; or ACH, debit or credit transfers forretail payment systems). Payments may differ based on the direction of funds flows (forexample, credit transfers or debit transfers), format, legal status, and medium (for example,
in electronic form or physical form). Also, some payments may be submitted as individual
payments or as part of a file of payments.
Validation
Once a payment is submitted, it must pass through the payment system’s validation
procedures before it can be accepted for final settlement. The type of validation the payment
system performs depends on its specific design, but typically includes verifying that thepayment instruction includes certain key data elements. These validation procedures may
also include security measures in addition to those employed by the network provider toverify the identity of the sender of the payment as well as to ensure the integrity and nonrepudiation of the payment itself. In the event that the payment system cannot validate apayment, it is usually returned to the sending participant and is not considered eligible forsettlement. If the validation is successful, the payment system subjects the payment toconditionality requirements.
Conditionality
Another key feature of a payment system’s design is the set of conditions that a payment
must meet in order for it to be accepted by the system and be settled. In the moststraightforward case, after the payment has been validated, the only condition for settlement
is whether the sender has sufficient funds available (or access to intraday credit). 191 If the190

See also CPSS, New developments in large-value payment systems, May 2005.

191

Additional conditions for settlement may be created by limits set either by a participant or by the system. Whilelimits typically restrict credit exposures, a recent feature in some systems providing continuous intraday finality
is the introduction of position or sender limits in order to control the outflow of settlement funds.

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payment exceeds the amount of funds available, the payment system may reject thepayment. Alternatively, the system may temporarily place the payment in a system queue.
The queued payment will be released from the queue at a later stage when all relevant
conditions for settlement are satisfied. Even in systems without a queue, other options
beside rejection may be possible. For example, in the case that a payment cannot be settled
under a sender’s limit, it is possible that the payment may still be settled subject to thesender undergoing a programme of ex-post counselling.
Settlement
A payment is final at the point in time when it becomes irrevocable and unconditional. This
precise moment typically depends on the underlying legal regime and the rules of thepayment system itself. In some systems, a payment becomes irrevocable as soon as thesystem validates it (that is, queued payment orders cannot be revoked by the sender).
However, the payment may not provide funds irrevocably and unconditionally to the receiveror the beneficiary until settlement occurs and is final. In other systems, payments remain
revocable until settlement takes place and, lastly, in some systems a payment can only be
revoked with the receiver’s consent. In general, however, in an RTGS system, a payment
becomes final after it is validated by the payment system and has passed the necessary
conditionality checks.
In a DNS system, a payment is typically considered final upon final settlement at thedesignated time(s). However, in DNS systems, it is possible for settlement of the net amountto be final, while individual payments are not finally settled or paid. Some DNS systems may
also provide an explicit settlement guarantee, either from the operator of the system or fromthe participants as a group. Such systems would also have financial mechanisms to support
such a guarantee.

CPSS-IOSCO – Principles for financial market infrastructures – April 2012151

Box 3
Conceptual stages of payment processing
Submission

Validation

Conditionality

Settlement• Sender submits
payment to thepayment system.

• The payment
system validates
payment’s key
data elements.

• The payment
system checks
that necessary
conditions forsettlement aresatisfied (such as
sufficient funds
availability andconsistency withany establishedlimits).

• Settlement finality
occurs when theaccount of thereceiver within thepayment system
has been credited
and settlement is
unconditional andirrevocable.

• If the payment
passes validation,
the system
accepts it subject
to conditionality.
• If the payment
fails any of thevalidation checks,
it is rejected backto the sender.

• A payment thatfails conditionality
checks is either
placed back in thequeue until thenecessary
validation checks
are passed or isrejected back tosender.

In an RTGS
system, final
settlement follows
immediately after
the conditionality
tests are passed.
• In a DNS system,
the payment is
netted against
other payments
submitted to thesystem. Final
settlement takes
place at adesignated time.

Time

Securities settlement systems
An SSS enables securities to be transferred and settled by book entry according to a set ofpredetermined multilateral rules. 192 An SSS typically allows transfers of securities either freeof payment or against payment. When transfer is against payment, the SSS should provide
delivery versus payment (DvP). DvP is settlement mechanism that links a securities transfer
and a funds transfer in such a way as to ensure that delivery occurs if and only if thecorresponding funds transfer occurs. 193 An SSS may be part of a formal organisational
structure that includes other FMIs, or it may operate as a completely independent entity with192

It should be noted that the definition of an SSS in this report is narrower than the one used in the RSSS, which
defined an SSS broadly to include the full set of institutional arrangements for confirmation, clearance, andsettlement of securities trades, and safekeeping of securities across a securities market.

193

An analogous settlement mechanism of delivery versus delivery (DvD) also exists. A DvD settlement
mechanism is a securities settlement mechanism which links two or more securities transfers in such a way as
to ensure that delivery of one security occurs if and only if the corresponding delivery(ies) of the othersecurity(ies) occur(s).

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its own governance structure and operating rules. An independent SSS may also provide
additional securities clearing and settlement services, such as the confirmation of trades andsettlement obligations. An SSS may operate independently of, or as part of, a CSD. Further,
an SSS can provide a guarantee of finality or settlement from the system itself or its
participants for each transaction accepted by the system, or offer no form of guarantee at all
and simply provide the technical operations of an SSS.
Institutional designs
An SSS can use a number of DvP settlement mechanisms to settle obligations. Thesemechanisms may involve either the simultaneous settlement of securities and funds or thesequential settlement of securities and funds. In addition, settlement may occur on an
obligation-by-obligation (that is, gross) or on a net basis. There are three common models forachieving DvP. 194 The first, DvP model 1, is a system that settles transfers for both securities
and funds on a gross basis, with final (irrevocable and unconditional) transfer of securities
from the seller to the buyer (delivery) occurring at the same time as final transfer of funds
from the buyer to the seller (payment). The second, DvP model 2, is a system that settles
securities transfer obligations on a gross basis, with final transfer of securities from the seller
to the buyer occurring throughout the processing cycle, but settles funds transfer obligations
on a net basis, with final transfer of funds from the buyer to the seller occurring at the end of
the processing cycle. Lastly, the third, DvP model 3, is a system that settles transfer
obligations for both securities and funds on a net basis, with final transfers of both securities
and funds occurring at the end of the processing cycle.
Model 1: Gross, simultaneous settlements of securities and funds transfers
The essential characteristic of a DvP model 1 system is the simultaneous settlement of
individual securities transfers and associated funds transfers. The system typically maintains
both securities and funds accounts for participants and makes all transfers by book entry. 195
An “against payment” transfer is settled by debiting the seller’s securities account, crediting
the buyer’s securities account, debiting the buyer’s funds account, and crediting the seller’s
funds account. 196 All transfers are final at the instant the debits and credits are posted to thesecurities and funds accounts. Overdrafts (negative balances) on securities accounts areprohibited, but the settlement agent typically provides intraday credit on funds accounts tofacilitate settlement, subject to the SSS’s operating rules and risk-management controls. An
advantage of model 1 is that transactions become final on an obligation-by-obligation basis
during the course of the settlement day, thus reducing credit and liquidity exposures among
participants or between a participant and the SSS. A disadvantage of model 1, however, isthat it requires participants to cover the principal value of the funds leg of each obligation,
thus requiring a potentially large amount of liquidity from participants. To help mitigate thisdisadvantage, some systems have adopted mechanisms for both securities and funds similar
to the liquidity-saving mechanisms used by payment systems.

194

See CPSS, Delivery versus payment in securities settlement systems, September 1992.

195

If funds accounts are held by another entity, a communications link must be established between the operatorof the securities transfer system and the entity handling participants’ funds to provide the securities transfer
system with real-time information on the completion of funds transfers.

196

The system may also allow participants to make “free of payment”, that is, transfers of securities without acorresponding transfer of funds, or “free of transfers”, that is, transfers of funds without a correspondingtransfer of securities.

CPSS-IOSCO – Principles for financial market infrastructures – April 2012153

Model 2: Gross settlements of securities transfers followed by net settlement of funds
transfers
The essential characteristic of a DvP model 2 system is that securities transfers are settled
on a obligation-by-obligation (gross) basis throughout the processing cycle, while funds
transfers are settled on a net basis, typically at the end of the processing cycle. The system
maintains securities accounts for participants. Funds accounts may be maintained by aseparate entity, such as a commercial bank or a central bank. Securities are transferred bybook entry. These securities transfers are usually provisional until the corresponding funds
settlement becomes final. The corresponding funds transfers are irrevocable but not final.
During the processing cycle (or perhaps at the end of the settlement day) the system
calculates net balances of funds debits and credits. The net balances are settled at the endof the processing cycle when the net debit positions and net credit positions are posted to thebooks of the commercial bank or central bank that maintains the funds accounts. Settlementof funds transfers may occur once a day or several times a day. Like model 1 systems,
model 2 systems prohibit participants from overdrawing securities accounts but, in somecases, intraday credit is allowed for funds, subject to SSS or participant established limits or
risk-management controls. A securities transfer may be rejected if there are insufficient
securities available in the seller’s account or the seller fails any other risk-management test.
By netting the funds values among participants, a model 2 system requires significantly lessliquidity for settlement, as compared to a model 1 system. A disadvantage to model 2,
however, is the amount of risk created by the delay in settlement finality, which is only
achieved at the end of the settlement day (or at designated times during the day).
Model 3: Simultaneous net settlement of securities and funds transfers
The essential characteristic of a DvP model 3 system is the simultaneous net settlement ofboth securities and funds transfer obligations. Settlement may occur once a day or at several
times during the day. The system maintains securities accounts for participants. Funds
accounts may be maintained by the SSS or a separate entity, such as a commercial bank ora central bank. Securities are transferred by book entry. During a processing cycle (or at theend of the settlement day), net balances of debits and credits to securities and funds
accounts are calculated. However, book-entry transfers of securities do not occur until theend of the processing cycle. In the interim, all securities and funds transfers are provisional.
At the end of the processing cycle (and possibly also at points during the processing cycle)
the system checks whether those participants in a net debit position in securities and funds
have sufficient balances to cover their net debits. 197 If a participant has insufficient balances,it may be notified and given an opportunity to obtain the necessary securities or funds. Finaltransfers of the net securities balances and net funds balances are executed if and only if allparticipants with net debit positions have sufficient balances of securities and funds. A
disadvantage to model 3, however, is the potentially large liquidity exposures created if aparticipant fails to settle its net funds debit position. In this scenario, some or all of thedefaulting participant’s transfers may have to be unwound.
Settlement process
The process of clearing and settling a securities trade includes three key steps: theconfirmation of the settlement obligations; clearance (the calculation of the obligations of thecounterparties resulting from the confirmation process); and settlement (the final transfer of
securities in exchange for final transfer of funds in order to settle the obligations). An SSS, as

197

In some systems a transfer would not be processed if it would result in a net debit position in a security larger
than the participant’s balance in that security. In other systems, however, an inadequate securities balancemight not become evident until later in the processing cycle or at the end of the processing cycle.

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strictly defined in this report, is involved in the settlement step of the clearing and settlement
process, but many SSSs may be organised to provide additional securities clearing andsettlement services, such as trade confirmation, settlement obligation validation, andsecurities safekeeping and custody.
Confirmation of settlement obligations
Once a trade is executed, the first step in the clearing and settlement process is to ensurethat the counterparties to the trade (the buyer and the seller) agree on the terms, including
the securities involved, the amounts to be exchanged, and the settlement date. This processof trade confirmation can take place in a variety of ways and the trading mechanism itself
often determines how it occurs. For example, an electronic trading system may automatically
produce a confirmed trade between the two counterparties. Other trades may be confirmedby exchanges, CCPs, or other organizations based on data submitted to them by theparticipants. In over-the-counter (OTC) markets, participants typically confirm the tradebilaterally.
Clearance
After trades have been confirmed, the next step in the process is clearance, which is thecomputation of the counterparties’ obligations to make deliveries or payments on thesettlement date. Clearance typically occurs in one of two ways, either on a gross basis, inwhich systems compute obligations for every trade individually, or a net basis. In somemarkets, a CCP interposes itself between the counterparties to a securities trade, taking oneach party’s obligation in relation to the other. A CCP typically reduces credit and liquidity
risks for the trade counterparties by netting the underlying trade obligations. Netting
arrangements are increasingly common in securities markets with high volumes of trades
because properly designed netting algorithms produce significant reductions in gross
exposures in such markets. Trade or obligation netting arrangements should be
distinguished from settlement or payment netting arrangements, in which underlying
obligations are not extinguished but funds or securities transfers are settled on a net basis.
Settlement
Settlement of a trade involves the final transfer of the securities from the seller to the buyer(delivery) and the final transfer of funds from the buyer to the seller (payment). The
processing of transfers by an SSS (and perhaps a payment system) often involves several
stages before the transfers are final and the settlement process is complete. The obligation isdischarged when the transfer becomes final, that is, an irrevocable and unconditionaltransfer.
Central counterpartiesA CCP interposes itself between counterparties to contracts traded in one or more financial
markets, becoming the buyer to every seller and the seller to every buyer and thereby
ensuring the performance of open contracts. A CCP becomes a counterparty to trades withmarket participants through novation, open-offer, or an analogous legally binding
arrangement. A CCP has the potential to reduce its participants’ risks significantly bymultilaterally netting trades and imposing more-effective risk controls on all participants. A
CCP’s typical risk controls include requiring participants to provide collateral (usually in theform of margin) to cover current and potential future exposures, collecting and paying markto-market losses and gains frequently to reduce current exposure, and requiring participants
to share residual risk in the event that one or more participant defaults. A CCP’s riskreduction mechanisms can also reduce systemic risk in the markets it serves depending on
the effectiveness of the CCP’s risk controls and the adequacy of its financial resources.

CPSS-IOSCO – Principles for financial market infrastructures – April 2012155

Organisational structures
A CCP may be privately or publicly owned and operate on an at-cost or for-profit basis. A
CCP may serve one or more markets where trades are conducted on an exchange, over-thecounter, or both and, potentially, operate across multiple jurisdictions. A CCP may bevertically or horizontally integrated. 198 Vertical integration in clearing is characterised by theformation of an integrated group, typically bringing trade and post-trade infrastructure
providers under common ownership with other parts of the value chain. Horizontal integration
occurs when a CCP expands clearing to more than one type of product or the products
traded at more than one trading venue. 199
Institutional designs
Institutional designs vary from one CCP to another. These differences may reflect risk
characteristics of the instruments that the CCP clears, the characteristics of the participants
for which the CCP clears, other external factors, and the design of the CCP’s riskmanagement framework.
Factors affecting institutional design
A number of factors affect the institutional design of a CCP, including its risk-management
framework. Among these are the risk characteristics of the instruments that a CCP clears.
For example, some instruments may be complex or have high market volatility, jump-todefault risk, or other hard-to-model sources of risk. Another important factor is the inherent
liquidity of the market being served. A less liquid market will lead to, among other things,
longer close-out times, increased difficulty in marking-to-market, and increased model risk.
Other attributes affecting institutional design are the magnitude of the duration of the
exposure between the CCP and its counterparties. Contracts cleared by a CCP can vary inlength from as short as one day (such as in some securities markets) to upwards of several
decades (such as in the credit-default swap market). Additionally, some contracts arecharacterised by trading practices that feature long periods between trade date and final
settlement (such as in the futures market).
Further, the design of a CCP may be influenced by the characteristics of the market
participants for which the CCP clears. In some markets, a CCP may permit a diverse set ofmarket participants to access its services. These participants can range from large banks tosmall non-bank dealers, and possibly buy-side firms. The range market participants may
affect the CCP’s risk-management framework, including the amount of financial resources,
eligible collateral, and loss-sharing arrangements. Further, the design of a CCP is further
influenced by other external requirements, such as regulatory requirements, required levelsof funding, and capital costs. A careful analysis of these, and the individual risk appetite of
the CCP, will influence decisions towards one design over another. As such, legal andinstitutional arrangements will also influence the institutional design of a CCP. For example,
the laws governing novation, open offer, and similar legal devices may vary by jurisdiction.
Form of guarantee
An important element of any CCP design is the legal mechanism for the CCP to become thecounterparty to its participants’ trades. In most cases, this is either novation or open offer. In
novation, the original contract between the buyer and seller is discharged and two new

198

See also CPSS, Market structure developments in the clearing industry: implications for financial stability,
September 2010.

199

It should be noted that, in some jurisdictions, a CCP may be classified as either vertically or horizontally
integrated; the two are not mutually exclusive.

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contracts are created, one between the CCP and the buyer and the other between the CCP
and the seller. The CCP thereby assumes the original parties’ contractual obligations to eachother. In an open-offer system, a CCP extends an open offer to act as a counterparty to its
participants and is automatically and immediately interposed in a transaction at the moment
the buyer and seller agree on the terms, either at the exchange or at the point of agreement
over-the-counter. In an open offer system, if all pre-agreed conditions are met, the buyer andseller never have a contractual relationship. In jurisdictions that support them, both novationand open offer give market participants legal certainty that a CCP is obligated to effectsettlement. Other legal mechanisms that allow a CCP to guarantee obligations and perform
netting also exist such as explicit and legally binding, settlement guarantees.
Approaches to loss allocation
In the event of a participant default, a CCP will need access to financial resources to perform
on its obligations and may need to initiate its loss-allocation procedures. In developing its
loss-allocation procedures, a CCP may combine a defaulter-pay approach and a survivorpay approach.
Defaulter-pay approach. In employing a defaulter-pay approach, a CCP seeks to cover alarge proportion of its losses with the defaulting participant’s financial resources. A CCP
seeking to emphasize the use of the defaulter-pay approach would have higher levels offinancial resources provided by the defaulter in the default waterfall, thereby making it lesslikely that losses will need to be allocated to non-defaulting participants through pooling-ofresources arrangements, such as a default fund. In these arrangements, the initial margin
provided by non-defaulting participants cannot be used to cover losses. Defaulter-pay
approaches typically decrease moral hazard because each participant is responsible for asignificant proportion of its own potential losses. The use of defaulter-pay approach has
historically been more prevalent in derivatives markets.
Survivor-pay approach. In employing a survivor-pay approach, a CCP would cover a residual
portion of its losses with non-defaulting participants’ resources through a pooling-ofresources arrangement, such as a default fund. The pooling of resources effectively acts as
an insurance arrangement supported by all of the participants. Non-defaulting participants of
the CCP will typically bear the risk of losses not covered by the defaulter’s resources. There
are a number of ways to allocate such losses among non-defaulting participants at different
CCPs and in different jurisdictions. When applying this approach, the CCP should be
attentive to the contagion risks created by interdependencies among participants.

CPSS-IOSCO – Principles for financial market infrastructures – April 2012

157

PSs

CSDs

SSSs

CCPs

TRs

Annex E:
Matrix of applicability of key considerations to specific types of FMIs

Principle 1: Legal basis

●

●

●

●

●

1. The legal basis should provide a high degree of certainty for eachmaterial aspect of an FMI’s activities in all relevant jurisdictions.

●

●

●

●

●

2. An FMI should have rules, procedures, and contracts that are clear,understandable, and consistent with relevant laws and regulations.

●

●

●

●

●

3. An FMI should be able to articulate the legal basis for its activities torelevant authorities, participants, and, where relevant, participants’customers, in a clear and understandable way.

●

●

●

●

●

4. An FMI should have rules, procedures, and contracts that are
enforceable in all relevant jurisdictions. There should be a high degreeof certainty that actions taken by the FMI under such rules andprocedures will not be voided, reversed, or subject to stays.

●

●

●

●

●

5. An FMI conducting business in multiple jurisdictions should identify
and mitigate the risks arising from any potential conflict of laws acrossjurisdictions.

●

●

●

●

●

Principle 2: Governance

●

●

●

●

●

1. An FMI should have objectives that place a high priority on the safety
and efficiency of the FMI and explicitly support financial stability andother relevant public interest considerations.

●

●

●

●

●

2. An FMI should have documented governance arrangements thatprovide clear and direct lines of responsibility and accountability.
These arrangements should be disclosed to owners, relevant
authorities, participants, and, at a more general level, the public.

●

●

●

●

●

3. The roles and responsibilities of an FMI’s board of directors (orequivalent) should be clearly specified, and there should be
documented procedures for its functioning, including procedures to
identify, address, and manage member conflicts of interest. The board
should review both its overall performance and the performance of its
individual board members regularly.

●

●

●

●

●

4. The board should contain suitable members with the appropriate skills
and incentives to fulfil its multiple roles. This typically requires theinclusion of non-executive board member(s).

●

●

●

●

●

5. The roles and responsibilities of management should be clearlyspecified. An FMI’s management should have the appropriate
experience, a mix of skills, and the integrity necessary to discharge
their responsibilities for the operation and risk management of the
FMI.

●

●

●

●

●

6. The board should establish a clear, documented risk-management
framework that includes the FMI’s risk-tolerance policy, assigns
responsibilities and accountability for risk decisions, and addresses
decision making in crises and emergencies. Governancearrangements should ensure that the risk-management and internal
control functions have sufficient authority, independence, resources,
and access to the board.

●

●

●

●

●

7. The board should ensure that the FMI’s design, rules, overall strategy,
and major decisions reflect appropriately the legitimate interests of its
direct and indirect participants and other relevant stakeholders. Major
decisions should be clearly disclosed to relevant stakeholders and,
where there is a broad market impact, the public.

●

●

●

●

●

Key considerations

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CPSS-IOSCO – Principles for financial market infrastructures – April 2012

PSs

CSDs

SSSs

CCPs

TRs

Principle 3: Framework for the comprehensive management of risks

●

●

●

●

●

1. An FMI should have risk-management policies, procedures, andsystems that enable it to identify, measure, monitor, and manage therange of risks that arise in or are borne by the FMI. Risk-management
frameworks should be subject to periodic review.

●

●

●

●

●

2. An FMI should provide incentives to participants and, where relevant,their customers to manage and contain the risks they pose to the FMI.

●

●

●

●

●

3. An FMI should regularly review the material risks it bears from andposes to other entities (such as other FMIs, settlement banks, liquidity
providers, and service providers) as a result of interdependencies anddevelop appropriate risk-management tools to address these risks.

●

●

●

●

●

4. An FMI should identify scenarios that may potentially prevent it frombeing able to provide its critical operations and services as a going
concern and assess the effectiveness of a full range of options forrecovery or orderly wind-down. An FMI should prepare appropriate
plans for its recovery or orderly wind-down based on the results of thatassessment. Where applicable, an FMI should also provide relevant
authorities with the information needed for purposes of resolution
planning.

●

●

●

●

●

Principle 4: Credit risk

●

●

●

1. An FMI should establish a robust framework to manage its credit
exposures to its participants and the credit risks arising from its
payment, clearing, and settlement processes. Credit exposure mayarise from current exposures, potential future exposures, or both.

●

●

●

2. An FMI should identify sources of credit risk, routinely measure andmonitor credit exposures, and use appropriate risk-management tools
to control these risks.

●

●

●

3. A payment system or SSS should cover its current and, where they
exist, potential future exposures to each participant fully with a highdegree of confidence using collateral and other equivalent financial
resources (see Principle 5 on collateral). In the case of a DNS
payment system or DNS SSS in which there is no settlement
guarantee but where its participants face credit exposures arising fromits payment, clearing, and settlement processes, such an FMI should
maintain, at a minimum, sufficient resources to cover the exposures of
the two participants and their affiliates that would create the largest
aggregate credit exposure in the system.

●●

Key considerations (cont)4. A CCP should cover its current and potential future exposures to eachparticipant fully with a high degree of confidence using margin andother prefunded financial resources (see Principle 5 on collateral andPrinciple 6 on margin). In addition, a CCP that is involved in activities
with a more-complex risk profile or that is systemically important in
multiple jurisdictions should maintain additional financial resources tocover a wide range of potential stress scenarios that should include,
but not be limited to, the default of the two participants and theiraffiliates that would potentially cause the largest aggregate credit
exposure for the CCP in extreme but plausible market conditions. Allother CCPs should maintain additional financial resources sufficient tocover a wide range of potential stress scenarios that should include,
but not be limited to, the default of the participant and its affiliates thatwould potentially cause the largest aggregate credit exposure for the
CCP in extreme but plausible market conditions. In all cases, a CCP
should document its supporting rationale for, and should haveappropriate governance arrangements relating to, the amount of total
financial resources it maintains.

CPSS-IOSCO – Principles for financial market infrastructures – April 2012●159

5. A CCP should determine the amount and regularly test the sufficiency
of its total financial resources available in the event of a default or
multiple defaults in extreme but plausible market conditions throughrigorous stress testing. A CCP should have clear procedures to report
the results of its stress tests to appropriate decision makers at the
CCP and to use these results to evaluate the adequacy of and adjust
its total financial resources. Stress tests should be performed dailyusing standard and predetermined parameters and assumptions. On
at least a monthly basis, a CCP should perform a comprehensive andthorough analysis of stress testing scenarios, models, and underlying
parameters and assumptions used to ensure they are appropriate fordetermining the CCP’s required level of default protection in light ofcurrent and evolving market conditions. A CCP should perform thisanalysis of stress testing more frequently when the products cleared or
markets served display high volatility, become less liquid, or when thesize or concentration of positions held by a CCP’s participants
increases significantly. A full validation of a CCP’s risk-management
model should be performed at least annually.

●

6. In conducting stress testing, a CCP should consider the effect of awide range of relevant stress scenarios in terms of both defaulters’
positions and possible price changes in liquidation periods. Scenarios
should include relevant peak historic price volatilities, shifts in othermarket factors such as price determinants and yield curves, multiple
defaults over various time horizons, simultaneous pressures in funding
and asset markets, and a spectrum of forward-looking stress scenarios
in a variety of extreme but plausible market conditions.

●7. An FMI should establish explicit rules and procedures that address
fully any credit losses it may face as a result of any individual or
combined default among its participants with respect to any of their
obligations to the FMI. These rules and procedures should address
how potentially uncovered credit losses would be allocated, including
the repayment of any funds an FMI may borrow from liquidity
providers. These rules and procedures should also indicate the FMI’s
process to replenish any financial resources that the FMI may employ
during a stress event, so that the FMI can continue to operate in a safe
and sound manner.

●

●

●

Principle 5: Collateral

●

●

●

1. An FMI should generally limit the assets it (routinely) accepts as
collateral to those with low credit, liquidity, and market risks.

●

●

●

2. An FMI should establish prudent valuation practices and develop
haircuts that are regularly tested and take into account stressedmarket conditions.

●

●

●

3. In order to reduce the need for procyclical adjustments, an FMI should
establish stable and conservative haircuts that are calibrated toinclude periods of stressed market conditions, to the extent practicableand prudent.

●

●

●

4. An FMI should avoid concentrated holdings of certain assets where
this would significantly impair the ability to liquidate such assets
quickly without significant adverse price effects.

●

●

●

5. An FMI that accepts cross-border collateral should mitigate the risks
associated with its use and ensure that the collateral can be used in atimely manner.

●

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●

6. An FMI should use a collateral management system that is welldesigned and operationally flexible.

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Key considerations (cont)

CPSS-IOSCO – Principles for financial market infrastructures – April 2012

Principle 6: Margin●

1. A CCP should have a margin system that establishes margin levels
commensurate with the risks and particular attributes of each product,
portfolio, and market it serves.

●

2. A CCP should have a reliable source of timely price data for its marginsystem. A CCP should also have procedures and sound valuation
models for addressing circumstances in which pricing data are notreadily available or reliable.

●

3. A CCP should adopt initial margin models and parameters that arerisk-based and generate margin requirements sufficient to cover its
potential future exposure to participants in the interval between thelast margin collection and the close out of positions following aparticipant default. Initial margin should meet an established singletailed confidence level of at least 99 percent with respect to theestimated distribution of future exposure. For a CCP that calculates
margin at the portfolio level, this requirement applies to eachportfolio’s distribution of future exposure. For a CCP that calculates
margin at more-granular levels, such as at the subportfolio level or by
product, the requirement must be met for the corresponding
distributions of future exposure. The model should (a) use aconservative estimate of the time horizons for the effective hedging or
close out of the particular types of products cleared by the CCP(including in stressed market conditions), (b) have an appropriate
method for measuring credit exposure that accounts for relevant
product risk factors and portfolio effects across products, and (c) tothe extent practicable and prudent, limit the need for destabilising,procyclical changes.

●

4. A CCP should mark participant positions to market and collectvariation margin at least daily to limit the build-up of current
exposures. A CCP should have the authority and operational capacity
to make intraday margin calls and payments, both scheduled andunscheduled, to participants.

●

5. In calculating margin requirements, a CCP may allow offsets or
reductions in required margin across products that it clears or between
products that it and another CCP clear, if the risk of one product issignificantly and reliably correlated with the risk of the other product.
Where two or more CCPs are authorised to offer cross-margining,they must have appropriate safeguards and harmonised overall riskmanagement systems.

●

6. A CCP should analyse and monitor its model performance and overallmargin coverage by conducting rigorous daily backtesting and at least
monthly, and more-frequent where appropriate, sensitivity analysis. A
CCP should regularly conduct an assessment of the theoretical andempirical properties of its margin model for all products it clears. In
conducting sensitivity analysis of the model’s coverage, a CCP shouldtake into account a wide range of parameters and assumptions thatreflect possible market conditions, including the most-volatile periods
that have been experienced by the markets it serves and extremechanges in the correlations between prices.

●

7. A CCP should regularly review and validate its margin system.

●

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Key considerations (cont)

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CCPs

●

●

1. An FMI should have a robust framework to manage its liquidity risks
from its participants, settlement banks, nostro agents, custodianbanks, liquidity providers, and other entities.

●

●

●

2. An FMI should have effective operational and analytical tools to
identify, measure, and monitor its settlement and funding flows on an
ongoing and timely basis, including its use of intraday liquidity.

●

●

●

3. A payment system or SSS, including one employing a DNS
mechanism, should maintain sufficient liquid resources in all relevant
currencies to effect same-day settlement, and where appropriate
intraday or multiday settlement, of payment obligations with a highdegree of confidence under a wide range of potential stress scenariosthat should include, but not be limited to, the default of the participant
and its affiliates that would generate the largest aggregate payment
obligation in extreme but plausible market conditions.

●

●

●

4. A CCP should maintain sufficient liquid resources in all relevant
currencies to settle securities-related payments, make required
variation margin payments, and meet other payment obligations ontime with a high degree of confidence under a wide range of potential
stress scenarios that should include, but not be limited to, the defaultof the participant and its affiliates that would generate the largest
aggregate payment obligation to the CCP in extreme but plausible
market conditions. In addition, a CCP that is involved in activities witha more-complex risk profile or that is systemically important in multiple
jurisdictions should consider maintaining additional liquidity resources
sufficient to cover a wider range of potential stress scenarios thatshould include, but not be limited to, the default of the two participants
and their affiliates that would generate the largest aggregate payment
obligation to the CCP in extreme but plausible market conditions.
5. For the purpose of meeting its minimum liquid resource requirement,
an FMI’s qualifying liquid resources in each currency include cash at
the central bank of issue and at creditworthy commercial banks,
committed lines of credit, committed foreign exchange swaps, andcommitted repos, as well as highly marketable collateral held incustody and investments that are readily available and convertible into
cash with prearranged and highly reliable funding arrangements, evenin extreme but plausible market conditions. If an FMI has access toroutine credit at the central bank of issue, the FMI may count suchaccess as part of the minimum requirement to the extent it has
collateral that is eligible for pledging to (or for conducting otherappropriate forms of transactions with) the relevant central bank. Allsuch resources should be available when needed.

●

●

●

6. An FMI may supplement its qualifying liquid resources with otherforms of liquid resources. If the FMI does so, then these liquid
resources should be in the form of assets that are likely to be saleable
or acceptable as collateral for lines of credit, swaps, or repos on an ad
hoc basis following a default, even if this cannot be reliably
prearranged or guaranteed in extreme market conditions. Even if an
FMI does not have access to routine central bank credit, it should stilltake account of what collateral is typically accepted by the relevant
central bank, as such assets may be more likely to be liquid instressed circumstances. An FMI should not assume the availability ofemergency central bank credit as a part of its liquidity plan.

●

●

●

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Principle 7: Liquidity risk

Key considerations (cont)

CPSS-IOSCO – Principles for financial market infrastructures – April 2012

CCPs
●

8. An FMI with access to central bank accounts, payment services, or
securities services should use these services, where practical, toenhance its management of liquidity risk.

●

●

●

9. An FMI should determine the amount and regularly test the sufficiency
of its liquid resources through rigorous stress testing. An FMI shouldhave clear procedures to report the results of its stress tests toappropriate decision makers at the FMI and to use these results toevaluate the adequacy of and adjust its liquidity risk-management
framework. In conducting stress testing, an FMI should consider awide range of relevant scenarios. Scenarios should include relevant
peak historic price volatilities, shifts in other market factors such as
price determinants and yield curves, multiple defaults over various
time horizons, simultaneous pressures in funding and asset markets,and a spectrum of forward-looking stress scenarios in a variety of
extreme but plausible market conditions. Scenarios should also take
into account the design and operation of the FMI, include all entities
that might pose material liquidity risks to the FMI (such as settlementbanks, nostro agents, custodian banks, liquidity providers, and linked
FMIs), and where appropriate, cover a multiday period. In all cases,
an FMI should document its supporting rationale for, and should haveappropriate governance arrangements relating to, the amount andform of total liquid resources it maintains.

●

●

●

10. An FMI should establish explicit rules and procedures that enable the
FMI to effect same-day and, where appropriate, intraday and multiday
settlement of payment obligations on time following any individual or
combined default among its participants. These rules and proceduresshould address unforeseen and potentially uncovered liquidity
shortfalls and should aim to avoid unwinding, revoking, or delaying thesame-day settlement of payment obligations. These rules andprocedures should also indicate the FMI’s process to replenish any
liquidity resources it may employ during a stress event, so that it cancontinue to operate in a safe and sound manner.

●

●

●

Principle 8: Settlement finality

●

●

●

1. An FMI’s rules and procedures should clearly define the point at which
settlement is final.

●

●

●

2. An FMI should complete final settlement no later than the end of thevalue date, and preferably intraday or in real time, to reduce
settlement risk. An LVPS or SSS should consider adopting RTGS or
multiple-batch processing during the settlement day.

●

●

●

3. An FMI should clearly define the point after which unsettled payments,
transfer instructions, or other obligations may not be revoked by aparticipant.

●

●

●

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CSDs

●

PSs

7. An FMI should obtain a high degree of confidence, through rigorous
due diligence, that each provider of its minimum required qualifying
liquid resources, whether a participant of the FMI or an external party,
has sufficient information to understand and to manage its associatedliquidity risks, and that it has the capacity to perform as required under
its commitment. Where relevant to assessing a liquidity provider’sperformance reliability with respect to a particular currency, a liquidity
provider’s potential access to credit from the central bank of issue may
be taken into account. An FMI should regularly test its procedures foraccessing its liquid resources at a liquidity provider.

Key considerations (cont)

163

CCPs

●

●

1. An FMI should conduct its money settlements in central bank money,
where practical and available, to avoid credit and liquidity risks.

●

●

●

2. If central bank money is not used, an FMI should conduct its money
settlements using a settlement asset with little or no credit or liquidity
risk.

●

●

●

3. If an FMI settles in commercial bank money, it should monitor,
manage, and limit its credit and liquidity risks arising from thecommercial settlement banks. In particular, an FMI should establish
and monitor adherence to strict criteria for its settlement banks thattake account of, among other things, their regulation and supervision,creditworthiness, capitalisation, access to liquidity, and operationalreliability. An FMI should also monitor and manage the concentrationof credit and liquidity exposures to its commercial settlement banks.

●

●

●

4. If an FMI conducts money settlements on its own books, it should
minimise and strictly control its credit and liquidity risks.

●

●

●

5. An FMI’s legal agreements with any settlement banks should stateclearly when transfers on the books of individual settlement banks are
expected to occur, that transfers are to be final when effected, andthat funds received should be transferable as soon as possible, at aminimum by the end of the day and ideally intraday, in order to enable
the FMI and its participants to manage credit and liquidity risks.

●

●

●

Principle 10: Physical deliveries

●

●

●

1. An FMI’s rules should clearly state its obligations with respect to thedelivery of physical instruments or commodities.

●

●

●

2. An FMI should identify, monitor, and manage the risks and costs
associated with the storage and delivery of physical instruments orcommodities.

●

●

●

Principle 11: Central securities depositories●

1. A CSD should have appropriate rules, procedures, and controls,
including robust accounting practices, to safeguard the rights of
securities issuers and holders, prevent the unauthorised creation ordeletion of securities, and conduct periodic and at least daily
reconciliation of securities issues it maintains.

●

2. A CSD should prohibit overdrafts and debit balances in securities
accounts.

●

3. A CSD should maintain securities in an immobilised or dematerialised
form for their transfer by book entry. Where appropriate, a CSD should
provide incentives to immobilise or dematerialise securities.

●

4. A CSD should protect assets against custody risk through appropriate
rules and procedures consistent with its legal framework.

●

5. A CSD should employ a robust system that ensures segregation
between the CSD’s own assets and the securities of its participants
and segregation among the securities of participants. Where
supported by the legal framework, the CSD should also support
operationally the segregation of securities belonging to a participant’s
customers on the participant’s books and facilitate the transfer ofcustomer holdings.

●

6. A CSD should identify, measure, monitor, and manage its risks fromother activities that it may perform; additional tools may be necessary
in order to address these risks.

●

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Principle 9: Money settlements

Key considerations (cont)

CPSS-IOSCO – Principles for financial market infrastructures – April 2012

SSSs

CCPs

Principle 12: Exchange-of-value settlement systems

●

●

●

1. An FMI that is an exchange-of-value settlement system should
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, regardless of whether the FMI settles on agross or net basis and when finality occurs.

●

●

●

Principle 13: Participant-default rules and procedures

●

●

●

●

1. An FMI should have default rules and procedures that enable the FMI
to continue to meet its obligations in the event of a participant default
and that address the replenishment of resources following a default.

●

●

●

●

2. An FMI should be well prepared to implement its default rules andprocedures, including any appropriate discretionary procedures
provided for in its rules.

●

●

●

●

3. An FMI should publicly disclose key aspects of its default rules andprocedures.

●

●

●

●

4. An FMI should involve its participants and other stakeholders in thetesting and review of the FMI’s default procedures, including any
close-out procedures. Such testing and review should be conducted atleast annually or following material changes to the rules andprocedures to ensure that they are practical and effective.

●

●

●

●

Principle 14: Segregation and portability●

1. A CCP should, at a minimum, have segregation and portability
arrangements that effectively protect a participant’s customers’
positions and related collateral from the default or insolvency of thatparticipant. If the CCP additionally offers protection of such customer
positions and collateral against the concurrent default of theparticipant and a fellow customer, the CCP should take steps toensure that such protection is effective.

●

2. A CCP should employ an account structure that enables it readily toidentify positions of a participant’s customers and to segregate related
collateral. A CCP should maintain customer positions and collateral inindividual customer accounts or in omnibus customer accounts.

●

3. A CCP should structure its portability arrangements in a way thatmakes it highly likely that the positions and collateral of a defaulting
participant’s customers will be transferred to one or more otherparticipants.

●

4. A CCP should disclose its rules, policies, and procedures relating to
the segregation and portability of a participant’s customers’ positions
and related collateral. In particular, the CCP should disclose whether
customer collateral is protected on an individual or omnibus basis. In
addition, a CCP should disclose any constraints, such as legal or
operational constraints, that may impair its ability to segregate or porta participant’s customers’ positions and related collateral.

●

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CSDs

Key considerations (cont)Principle 15: General business risk

●

●

●

●

●

1. An FMI should have robust management and control systems toidentify, monitor, and manage general business risks, including losses
from poor execution of business strategy, negative cash flows, or
unexpected and excessively large operating expenses.

●

●

●

●

●

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TRs

2. An FMI should hold liquid net assets funded by equity (such ascommon stock, disclosed reserves, or other retained earnings) so thatit can continue operations and services as a going concern if it incurs
general business losses. The amount of liquid net assets funded byequity an FMI should hold should be determined by its generalbusiness risk profile and the length of time required to achieve arecovery or orderly wind-down, as appropriate, of its critical operations
and services if such action is taken.

●

●

●

●

●

3. An FMI should maintain a viable recovery or orderly wind-down planand should hold sufficient liquid net assets funded by equity to
implement this plan. At a minimum, an FMI should hold liquid net
assets funded by equity equal to at least six months of current
operating expenses. These assets are in addition to resources held tocover participant defaults or other risks covered under the financial
resources principles. However, equity held under international riskbased capital standards can be included where relevant andappropriate to avoid duplicate capital requirements.

●

●

●

●

●

4. Assets held to cover general business risk should be of high quality
and sufficiently liquid in order to allow the FMI to meet its current andprojected operating expenses under a range of scenarios, including inadverse market conditions.

●

●

●

●

●

5. An FMI should maintain a viable plan for raising additional equity
should its equity fall close to or below the amount needed. This planshould be approved by the board of directors and updated regularly.

●

●

●

●

●

Principle 16: Custody and investment risks

●

●

●

●

1. An FMI should hold its own and its participants’ assets at supervised
and regulated entities that have robust accounting practices,safekeeping procedures, and internal controls that fully protect theseassets.

●

●

●

●

2. An FMI should have prompt access to its assets and the assets
provided by participants, when required.

●

●

●

●

3. An FMI should evaluate and understand its exposures to its custodianbanks, taking into account the full scope of its relationships with each.

●

●

●

●

4. An FMI’s investment strategy should be consistent with its overall riskmanagement strategy and fully disclosed to its participants, andinvestments should be secured by, or be claims on, high-quality
obligors. These investments should allow for quick liquidation withlittle, if any, adverse price effect.

●

●

●

●

Principle 17: Operational risk

●

●

●

●

●

1. An FMI should establish a robust operational risk-management
framework with appropriate systems, policies, procedures, andcontrols to identify, monitor, and manage operational risks.

●

●

●

●

●

2. An FMI’s board of directors should clearly define the roles andresponsibilities for addressing operational risk and should endorse the
FMI’s operational risk-management framework. Systems, operational
policies, procedures, and controls should be reviewed, audited, andtested periodically and after significant changes.

●

●

●

●

●

3. An FMI should have clearly defined operational reliability objectives
and should have policies in place that are designed to achieve thoseobjectives.

●

●

●

●

●

4. An FMI should ensure that it has scalable capacity adequate to handle
increasing stress volumes and to achieve its service-level objectives.

●

●

●

●

●

5. An FMI should have comprehensive physical and information security
policies that address all potential vulnerabilities and threats.

●

●

●

●

●

Key considerations (cont)166

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6. An FMI should have a business continuity plan that addresses events
posing a significant risk of disrupting operations, including events that
could cause a wide-scale or major disruption. The plan shouldincorporate the use of a secondary site and should be designed toensure that critical information technology (IT) systems can resume
operations within two hours following disruptive events. The planshould be designed to enable the FMI to complete settlement by theend of the day of the disruption, even in case of extreme
circumstances. The FMI should regularly test these arrangements.

●

●

●

●

●

7. An FMI should identify, monitor, and manage the risks that key
participants, other FMIs, and service and utility providers might poseto its operations. In addition, an FMI should identify, monitor, andmanage the risks its operations might pose to other FMIs.

●

●

●

●

●

Principle 18: Access and participation requirements

●

●

●

●

●

1. An FMI should allow for fair and open access to its services, including
by direct and, where relevant, indirect participants and other FMIs,
based on reasonable risk-related participation requirements.

●

●

●

●

●

2. An FMI’s participation requirements should be justified in terms of thesafety and efficiency of the FMI and the markets it serves, be tailored
to and commensurate with the FMI’s specific risks, and be publicly
disclosed. Subject to maintaining acceptable risk control standards, an
FMI should endeavour to set requirements that have the leastrestrictive impact on access that circumstances permit.

●

●

●

●

●

3. An FMI should monitor compliance with its participation requirements
on an ongoing basis and have clearly defined and publicly disclosed
procedures for facilitating the suspension and orderly exit of aparticipant that breaches, or no longer meets, the participation
requirements.

●

●

●

●

●

Principle 19: Tiered participation arrangements

●

●

●

●

●

1. An FMI should ensure that its rules, procedures, and agreementsallow it to gather basic information about indirect participation in order
to identify, monitor, and manage any material risks to the FMI arisingfrom such tiered participation arrangements.

●

●

●

●

●

2. An FMI should identify material dependencies between direct andindirect participants that might affect the FMI.

●

●

●

●

●

3. An FMI should identify indirect participants responsible for a significant
proportion of transactions processed by the FMI and indirect
participants whose transaction volumes or values are large relative tothe capacity of the direct participants through which they access the
FMI in order to manage the risks arising from these transactions.

●

●

●

●

●

4. An FMI should regularly review risks arising from tiered participation
arrangements and should take mitigating action when appropriate.

●

●

●

●

●

Principle 20: FMI links

●

●

●

●

1. Before entering into a link arrangement and on an ongoing basis once
the link is established, an FMI should identify, monitor, and manage all
potential sources of risk arising from the link arrangement. Link
arrangements should be designed such that each FMI is able toobserve the other principles in this report.

●

●

●

●

2. A link should have a well-founded legal basis, in all relevant
jurisdictions, that supports its design and provides adequate protection
to the FMIs involved in the link.

●

●

●

●

Key considerations (cont)

CPSS-IOSCO – Principles for financial market infrastructures – April 2012167

4. Provisional transfers of securities between linked CSDs should beprohibited or, at a minimum, the retransfer of provisionally transferred
securities should be prohibited prior to the transfer becoming final.

●●

5. An investor CSD should only establish a link with an issuer CSD if thearrangement provides a high level of protection for the rights of theinvestor CSD’s participants.

●●

6. An investor CSD that uses an intermediary to operate a link with anissuer CSD should measure, monitor, and manage the additional risks(including custody, credit, legal, and operational risks) arising from theuse of the intermediary.

●●

7. Before entering into a link with another CCP, a CCP should identify
and manage the potential spill-over effects from the default of thelinked CCP. If a link has three or more CCPs, each CCP should
identify, assess, and manage the risks of the collective linkarrangement.

●

8. Each CCP in a CCP link arrangement should be able to cover, at least
on a daily basis, its current and potential future exposures to thelinked CCP and its participants, if any, fully with a high degree ofconfidence without reducing the CCP’s ability to fulfil its obligations to
its own participants at any time.

●

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●

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●

PSs

3. Linked CSDs should measure, monitor, and manage the credit andliquidity risks arising from each other. Any credit extensions between
CSDs should be covered fully with high-quality collateral and be
subject to limits.

Key considerations (cont)●9. A TR should carefully assess the additional operational risks related toits links to ensure the scalability and reliability of IT and relatedresources.
Principle 21: Efficiency and effectiveness

●

●

●

●

●

1. An FMI should be designed to meet the needs of its participants andthe markets it serves, in particular, with regard to choice of a clearing
and settlement arrangement; operating structure; scope of products
cleared, settled, or recorded; and use of technology and procedures.

●

●

●

●

●

2. An FMI should have clearly defined goals and objectives that aremeasurable and achievable, such as in the areas of minimum service
levels, risk-management expectations, and business priorities.

●

●

●

●

●

3. An FMI should have established mechanisms for the regular review of
its efficiency and effectiveness.

●

●

●

●

●

Principle 22: Communication procedures and standards

●

●

●

●

●

1. An FMI should use, or at a minimum accommodate, internationallyaccepted communication procedures and standards.

●

●

●

●

●

Principle 23: Disclosure of rules, key procedures, and market data

●

●

●

●

●

1. An FMI should adopt clear and comprehensive rules and proceduresthat are fully disclosed to participants. Relevant rules and key
procedures should also be publicly disclosed.

●

●

●

●

●

2. An FMI should disclose clear descriptions of the system’s design andoperations, as well as the FMI’s and participants’ rights andobligations, so that participants can assess the risks they would incurby participating in the FMI.

●

●

●

●

●

3. An FMI should provide all necessary and appropriate documentationand training to facilitate participants’ understanding of the FMI’s rules
and procedures and the risks they face from participating in the FMI.

●

●

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●

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4. An FMI should publicly disclose its fees at the level of individual
services it offers as well as its policies on any available discounts. The
FMI should provide clear descriptions of priced services forcomparability purposes.

●

●

●

●

●

5. An FMI should complete regularly and disclose publicly responses to
the CPSS-IOSCO Disclosure framework for financial market
infrastructures. An FMI also should, at a minimum, disclose basic
data on transaction volumes and values.

●

●

●

●

●

Key considerations (cont)Principle 24: Disclosure of market data by trade repositories●

1. A TR should provide data in line with regulatory and industry
expectations to relevant authorities and the public, respectively, that iscomprehensive and at a level of detail sufficient to enhance market
transparency and support other public policy objectives.

●

2. A TR should have effective processes and procedures to provide data
to relevant authorities in a timely and appropriate manner to enable
them to meet their respective regulatory mandates and legal
responsibilities.

●

3. A TR should have robust information systems that provide accurate
current and historical data. Data should be provided in a timely
manner and in a format that permits it to be easily analysed.

●

CPSS-IOSCO – Principles for financial market infrastructures – April 2012169

Annex F:
Oversight expectations applicable to critical service providers

The operational reliability of an FMI may be dependent on the continuous and adequate
functioning of service providers that are critical to an FMI’s operations, such as information
technology and messaging providers. A regulator, supervisor, or overseer of an FMI may
want to establish expectations for an FMI’s critical service providers in order to support the
FMI’s overall safety and efficiency. The expectations should help ensure the operations of a
critical service provider are held to the same standards as if the FMI provided the service.
The expectations outlined below are specifically targeted at critical service providers andcover risk identification and management, robust information security management, reliability
and resilience, effective technology planning, and strong communications with users. These
expectations are written at a broad level, allowing critical service providers flexibility indemonstrating that they meet the expectations.
1.

Risk identification and management

A critical service provider is expected to identify and manage relevant operational andfinancial risks to its critical services and ensure that its risk-management processes
are effective.
A critical service provider should have effective processes and systems for identifying anddocumenting risks, implementing controls to manage risks, and making decisions to accept
certain risks. A critical service provider may face risks related to information security,
reliability and resilience, and technology planning, as well as legal and regulatory
requirements pertaining to its corporate organisation and conduct, relationships withcustomers, strategic decisions that affect its ability to operate as a going concern, anddependencies on third parties. A critical service provider should reassess its risks, as well as
the adequacy of its risk-management framework in addressing the identified risks, on an
ongoing basis.
The identification and management of risks should be overseen by the critical service
provider’s board of directors (board) and assessed by an independent, internal audit functionthat can communicate clearly its assessments to relevant board members. The board is
expected to ensure an independent and professional internal audit function. The internal
audit function should be reviewed to ensure it adheres to the principles of a professionalorganisation that governs audit practice and behaviour (such as the Institute of Internal
Auditors) and is able to independently assess inherent risks as well as the design andeffectiveness of risk-management processes and internal controls. The internal audit function
should also ensure that its assessments are communicated clearly to relevant board
members.
2.

Information security

A critical service provider is expected to implement and maintain appropriate policies
and procedures, and devote sufficient resources to ensure the confidentiality andintegrity of information and the availability of its critical services in order to fulfil theterms of its relationship with an FMI.
A critical service provider should have a robust information security framework that appropriately
manages its information security risks. The framework should include sound policies andprocedures to protect information from unauthorised disclosure, ensure data integrity, andguarantee the availability of its services. In addition, a critical service provider should havepolicies and procedures for monitoring its compliance with its information security framework.

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This framework should also include capacity planning policies and change-management
practices. For example, a critical service provider that plans to change its operations should
assess the implications of such a change on its information security arrangements.
3.

Reliability and resilience

A critical service provider is expected to implement appropriate policies andprocedures, and devote sufficient resources to ensure that its critical services areavailable, reliable, and resilient. Its business continuity management and disasterrecovery plans should therefore support the timely resumption of its critical services
in the event of an outage so that the service provided fulfils the terms of its agreementwith an FMI.
A critical service provider should ensure that it provides reliable and resilient operations tousers, whether these operations are provided to an FMI directly or to both an FMI and its
participants. A critical service provider should have robust operations that meet or exceed theneeds of the FMI. Any operational incidents should be recorded and reported to the FMI and
the FMI’s regulator, supervisor, or overseer. Incidents should be analysed promptly by thecritical service provider in order to prevent recurrences that could have greater implications. In
addition, a critical service provider should have robust business continuity and disasterrecovery objectives and plans. These plans should include routine business continuity testing
and a review of these test results to assess the risk of a major operational disruption.
4.

Technology planning

The critical provider is expected to have in place robust methods to plan for the entire
lifecycle of the use of technologies and the selection of technological standards.
A critical service provider should have effective technology planning that minimises overall
operational risk and enhances operational performance. Planning entails a comprehensive
information technology strategy that considers the entire lifecycle for the use of technologies
and a process for selecting standards when deploying and managing a service. Proposedchanges to a critical service provider’s technology should entail a thorough andcomprehensive consultation with the FMI and, where relevant, its participants. A criticalservice provider should regularly review its technology plans, including assessments of its
technologies and the processes it uses for implementing change.
5.

Communication with users

A critical service provider is expected to be transparent to its users and provide themsufficient information to enable users to understand clearly their roles andresponsibilities in managing risks related to their use of a critical service provider.
A critical service provider should have effective customer communication procedures andprocesses. In particular, a critical service provider should provide the FMI and, whereappropriate, its participants with sufficient information so that users clearly understand theirroles and responsibilities, enabling them to manage adequately their risks related to their useof the services provided. Useful information for users typically includes, but is not limited to,
information concerning the critical service provider’s management processes, controls, andindependent reviews of the effectiveness of these processes and controls. As a part of its
communication procedures and processes, a critical service provider should havemechanisms to consult with users and the broader market on any technical changes to its
operations that may affect its risk profile, including incidences of absent or non-performing
risk controls of services. In addition, a critical service provider should have a crisis
communication plan to handle operational disruptions to its services.

CPSS-IOSCO – Principles for financial market infrastructures – April 2012171

Annex G:
Bibliography

BCBS, The application of Basel II to trading activities and the treatment of double default
effects, April 2005.
BCBS, International convergence of capital measurement and capital standards, June 2006.
BCBS, Principles for sound stress testing practices and supervision, May 2009.
BCBS, Sound practices for backtesting counterparty credit risk models - consultative
document, April 2010. CGFS, Implications of repo markets for central banks, 1999.
CGFS, The macrofinancial implications of alternative configurations for access to central
counterparties in OTC derivatives markets, November 2011.
CGFS, The role of margin requirements and haircuts in procyclicality, March 2010.
CPSS, Central bank oversight of payment and settlement systems, May 2005.
CPSS, Core principles for systemically important payment systems, January 2001.
CPSS, Delivery versus payment in securities settlement systems, September 1992.
CPSS, A glossary of terms used in payments and settlement systems, March 2003.
CPSS, The interdependencies of payment and settlement systems, June 2008.
CPSS, Market structure developments in the clearing industry: implications for financial
stability, September 2010.
CPSS, New developments in large value payment systems, May 2005.
CPSS, Report of the Committee on Interbank Netting Schemes of the central banks of theGroup of Ten countries, November 1990.
CPSS, Strengthening repo clearing and settlement arrangements, September 2010.
CPSS-IOSCO, Assessment methodology for 'Recommendations for securities settlement
systems', November 2002.
CPSS-IOSCO, Considerations for trade repositories in OTC derivatives, May 2010.
CPSS-IOSCO, Guidance on the application of 2004 CPSS-IOSCO recommendations forcentral counterparties to OTC derivatives CCPs, May 2010.
CPSS-IOSCO, Recommendations for central counterparties, November 2004.
CPSS-IOSCO, Recommendations for securities settlement systems, November 2001.
CPSS-IOSCO, Report on OTC derivatives data reporting and aggregation requirements,
January 2012.
CPSS-IOSCO, Securities lending transactions: market development and implications, 1999.
European Central Bank and Eurosystem, Glossary of terms related to payment, clearing, andsettlement systems, December 2009.
Financial Stability Forum, FSF principles for sound compensation practices, April 2009.
FSB, Key attributes of effective resolution regimes for financial institutions, October 2011.
FSB, Implementing OTC derivatives market reforms, October 2010.
IOSCO, Client asset protection, 1996.

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IOSCO, Multilateral memorandum of understanding for cooperation concerning consultationand cooperation and the exchange of information, May 2002.
IOSCO, Objectives and principles of securities regulation, October 2003.
IOSCO, Principles regarding cross-border supervisory cooperation, May 2010.

CPSS-IOSCO – Principles for financial market infrastructures – April 2012173

Annex H:
Glossary

For general definitions of terms not found in this glossary, please see CPSS, A glossary ofterms used in payments and settlement systems, March 2003, and European Central Bankand Eurosystem, Glossary of terms related to payment, clearing, and settlement systems,
December 2009.

Term

Definition

affiliates

A company that controls, or is controlled by, or is under common
control with the participant. Control of a company is defined as (a)ownership, control, or holding with power to vote 20 percent or more ofa class of voting securities of the company; or (b) consolidation of thecompany for financial reporting purposes.

backtesting

An ex-post comparison of observed outcomes with expected outcomes
derived from the use of margin models.

batch settlement

The settlement of groups of payments, transfer instructions, or otherobligations together at one or more discrete, often pre-specified times
during the processing day.

beneficial owner

A person or entity that is entitled to receive some or all of the rights
deriving from ownership of a security or financial instrument (forexample, income, voting rights, and power to transfer).

book-entry

The transfer of securities and other financial assets which does not
involve the physical movement of paper documents or certificates (forexample, the electronic transfer of securities).

business
continuity

A state of uninterrupted business operations. This term also refers to
all of the organisational, technical, and staffing measures used toensure the continuation of operations following a disruption to aservice, including in the event of a wide-scale or major disruption.

central bankmoney

A liability of a central bank, in this case in the form of deposits held at
the central bank, which can be used for settlement purposes.

centralcounterparty

An entity that interposes itself between counterparties to contracts
traded in one or more financial markets, becoming the buyer to every
seller and the seller to every buyer and thereby ensuring theperformance of open contracts.

central securities
depository

An entity that provides securities accounts, central safekeeping
services, and asset services, which may include the administration of
corporate actions and redemptions, and plays an important role inhelping to ensure the integrity of securities issues (that is, ensure that
securities are not accidentally or fraudulently created or destroyed or
their details changed).

choice of law

A contractual provision by which parties choose the law that will govern
their contract or relationship. Choice of law may also refer to thequestion of what law should govern in the case of a conflict of laws.

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Term

Definition

clearing

The process of transmitting, reconciling, and, in some cases,
confirming transactions prior to settlement, potentially including thenetting of transactions and the establishment of final positions forsettlement. Sometimes this term is also used (imprecisely) to coversettlement. For the clearing of futures and options, this term also refers
to the daily balancing of profits and losses and the daily calculation ofcollateral requirements.

clearing fundA prefunded default arrangement that is composed of assets
contributed by a CCP’s participants that may be used by the CCP in
certain circumstances to cover losses or liquidity pressures resulting
from participant defaults.

collateral

An asset or third-party commitment that is used by a collateral provider
to secure an obligation vis-à-vis a collateral taker.

commercial bankmoney

A liability of a commercial bank, in the form of deposits held at thecommercial bank, which can be used for settlement purposes.

confirmation

A process whereby the terms of a trade are verified either by directly
involved market participants or by a central entity.

conflict of laws

An inconsistency or difference in the laws of jurisdictions that have apotential interest in a transaction.

counterparty

A party to a trade.

credit risk

The risk that a counterparty, whether a participant or other entity, will
be unable to meet fully its financial obligations when due, or at any
time in the future.

cross-margining
agreement

An agreement among CCPs to consider positions and supporting
collateral at their respective organisations as a common portfolio forparticipants that are members of two or more of the organisations.

current exposure

The loss that an FMI (or in some cases, its participants) would face
immediately if a participant were to default. Current exposure istechnically defined as the larger of zero or the market value (orreplacement cost) of a transaction or portfolio of transactions within a
netting set with a counterparty that would be lost upon the default of
the counterparty.

custody risk

The risk of loss on assets held in custody in the event of a custodian’s(or subcustodian’s) insolvency, negligence, fraud, poor administration,or inadequate recordkeeping.

default

An event stipulated in an agreement as constituting a default.
Generally, such events relate to a failure to complete a transfer offunds or securities in accordance with the terms and rules of thesystem in question.

deferred net
settlement

A net settlement mechanism which settles on a net basis at the end ofa predefined settlement cycle.

delivery versus
deliveryA securities settlement mechanism that links two securities transfers insuch a way as to ensure that delivery of one security occurs if and only
if the corresponding delivery of the other security occurs.

CPSS-IOSCO – Principles for financial market infrastructures – April 2012

175

Term

Definitiondelivery versus
payment

A securities settlement mechanism that links a securities transfer and afunds transfer in such a way as to ensure that delivery occurs if andonly if the corresponding payment occurs.

dematerialisation

The elimination of physical certificates or documents of title that
represent ownership of securities so that securities exist only as
accounting records.

derivative

A financial contract whose value depends on the value of one or more
underlying reference assets, rates or indices, on a measure of
economic value or on factual events.

fellow-customerrisk

The risk that another customer of the same participant will default andcreate a loss that exceeds both the amount of available collateralsupporting the defaulting customer’s positions and the available
resources of the participant.

final settlement

The irrevocable and unconditional transfer of an asset or financial
instrument, or the discharge of an obligation by the FMI or its
participants in accordance with the terms of the underlying contract.
Final settlement is a legally defined moment.

financial market
infrastructure

A multilateral system among participating institutions, including theoperator of the system, used for the purposes of clearing, settling, orrecording payments, securities, derivatives, or other financialtransactions.

general businessrisk

Any potential impairment of the FMI’s financial position (as a businessconcern) as a consequence of a decline in its revenues or an increase
in its expenses, such that expenses exceed revenues and result in aloss that must be charged against capital.

governance

The set of relationships between an FMI’s owners, board of directors(or equivalent), management, and other relevant parties, including
participants, authorities, and other stakeholders (such as participants’customers, other interdependent FMIs, and the broader market).

haircut

A risk control measure applied to underlying assets whereby the valueof those underlying assets is calculated as the market value of theassets reduced by a certain percentage (the “haircut”). Haircuts areapplied by a collateral taker in order to protect itself from losses
resulting from declines in the market value of a security in the eventthat it needs to liquidate that collateral.

immobilisation

The act of concentrating the location of securities in a depository andtransferring ownership by book entry.

initial margin

Collateral that is collected to cover potential changes in the value ofeach participant’s position (that is, potential future exposure) over theappropriate close-out period in the event the participant defaults.

investment risk

The risk of loss faced by an FMI when it invests its own or its
participants’ resources, such as collateral.

investor CSD

A term used in the context of CSD links. An investor CSD – or a third
party acting on behalf of the investor CSD – opens an account inanother CSD (the issuer CSD) so as to enable the cross-systemsettlement of securities transactions.

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Term

Definition

issuer CSD

A CSD in which securities are issued (or immobilised). The issuer CSD
opens accounts allowing investors (in a direct holding system) andintermediaries (including investor CSDs) to hold these securities.

large-value
payment system

A funds transfer system that typically handles large-value and highpriority payments.

legal risk

The risk of the unexpected application of a law or regulation, usually
resulting in a loss.

liquidity risk

The risk that a counterparty, whether a participant or other entity, will
have insufficient funds to meet its financial obligations as and when
expected, although it may be able to do so in the future.

mark to market

The practice of revaluing securities and financial instruments using
current market prices.

netting

The offsetting of obligations between or among participants in the
netting arrangement, thereby reducing the number and value of
payments or deliveries needed to settle a set of transactions.

novation

A process through which the original obligation between a buyer and aseller is discharged through the substitution of the CCP as seller to thebuyer and buyer to the seller, creating two new contracts.

omnibusaccount

An account structure where securities or collateral belonging to someor all customers of a particular participant is commingled and held in asingle account segregated from that of the participant.

open offer

A process through which a CCP extends an “open offer” to act ascounterparty to market participants and thereby is interposed between
participants at the time a trade is executed.

operational risk

The risk that deficiencies in information systems or internal processes,
human errors, management failures, or disruptions from external
events will result in the reduction, deterioration, or breakdown ofservices provided by an FMI.

payment system

A set of instruments, procedures, and rules for the transfer of funds
between or among participants; the system includes the participants
and the entity operating the arrangement.

payment versus
payment

A settlement mechanism that ensures that the final transfer of apayment in one currency occurs if and only if the final transfer of apayment in another currency or currencies takes place.

physical delivery

The delivery of an asset, such as an instrument or commodity, in
physical form.

portability

The operational aspects of the transfer of contractual positions, funds,
or securities from one party to another party.

potential future
exposure

Any potential credit exposure that an FMI could face at a future point intime. Potential future exposure is technically defined as the maximum
exposure estimated to occur at a future point in time at a high level ofstatistical confidence. Potential future exposure arises from potential
fluctuations in the market value of a participant’s open positions
between the time they are incurred or reset to the current market price,and the time they are liquidated or effectively hedged.

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177

Term

Definition

principal risk

The risk that a counterparty will lose the full value involved in atransaction, for example, the risk that a seller of a financial asset will
irrevocably deliver the asset, but not receive payment.

procyclicality

The changes in risk-management requirements or practices that are
positively correlated with business or credit cycle fluctuations and that
may cause or exacerbate financial instability.

real-time grosssettlement

The real-time settlement of payments, transfer instructions, or otherobligations individually on a transaction-by-transaction basis.

reconciliation

A procedure to verify that two sets of records issued by two different
entities match.

replacement cost

The unrealised gain on the unsettled contract or the cost of replacing
the original contract at market prices that may be changing rapidly
during periods of stress.

replacementcost risk

The risk of loss of unrealised gains on unsettled transactions with acounterparty. The resulting exposure is the cost of replacing theoriginal transaction at current market prices.

repurchaseagreement (repo)

A contract to sell and subsequently repurchase securities at a specified
date and price.

retail payment
system

A funds transfer system that typically handles a large volume ofrelatively low-value payments in such forms as cheques, credit
transfers, direct debits, and card payment transactions.

securities
registrar

An entity that provides the service of preparing and recording accurate,current, and complete securities registers for securities issuers.

securities
settlement
systemAn entity that enables securities to be transferred and settled by bookentry according to a set of predetermined multilateral rules. Suchsystems allow transfers of securities either free of payment or against
payment.

segregation

A method of protecting customer collateral and contractual positions byholding or accounting for them separately from those of the direct
participant (such as a carrying firm or broker).

settlement risk

The general term used to designate the risk that settlement in a funds
or securities transfer system will not take place as expected. This risk
may comprise both credit and liquidity risk.

specific wrongway risk

The risk that an exposure to a counterparty is highly likely to increase
when the creditworthiness of that counterparty is deteriorating.

stress testing

The estimation of credit and liquidity exposures that would result fromthe realisation of extreme price changes.

systemic risk

The risk that the inability of one or more participants to perform as
expected will cause other participants to be unable to meet their
obligations when due.

trade repository

An entity that maintains a centralised electronic record (database) oftransaction data.

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Term

Definition

unwindThe process used to recalculate obligations in some net settlement
systems where transfers between the accounts of participants areprovisional until all of them have finally discharged their settlement
obligations. If a particular participant fails to settle, some or all of theprovisional transfers involving that participant are deleted from thesystem and the settlement obligations of the remaining participants arerecalculated.

value date

The day on which the payment, transfer instruction, or other obligationis due and the associated funds and securities are typically available to
the receiving participant.

variation margin

Funds that are collected and paid out to reflect current exposuresresulting from actual changes in market prices.

zero-hour rule

A provision in the insolvency law of some countries whereby thetransactions conducted by an insolvent institution after midnight on thedate the institution is declared insolvent are automatically ineffective by
operation of law.

CPSS-IOSCO – Principles for financial market infrastructures – April 2012179

Annex I:
Members of the CPSS-IOSCO review of standards

This list shows the members of the Steering Group that coordinated the review. Thosemembers who were also part of the Editorial Team that implemented the review and/or who
chaired a sub-group looking at a specific review issue have an asterisk next to their name.
Steering Group co-chairs
Federal Reserve Bank of New YorkFinancial Services Agency, Japan
Securities and Exchange Commission, US

William C Dudley
Masamichi Kono (since August 2011)
Kathleen Casey (until July 2011)

Editorial Team co-chairs
European Central Bank
Securities and Exchange Commission, US

Daniela Russo*
Jeffrey Mooney*

Members
Reserve Bank of Australia

Christopher Kent (since September
2010)
Michele Bullock (until August 2010)

National Bank of Belgium

Johan Pissens*

Central Bank of Brazil

Daso Maranhão Coimbra (since October2010)
Radjalma Costa (until October 2010)

Securities and Exchange Commission of Brazil

Marcelo Queiroga Reis

Bank of Canada

Paul Chilcott (since November 2010)*
Carol Ann Northcott (until November
2010)

Autorité des marchés financiers, Québec

Claude Gatien

Ontario Securities Commission

Maxime Paré*Superintendencia de Valores y Seguros, Chile

Vicente Lazen

People's Bank of China

Pan Song

China Securities Regulatory Commission

Fan YuShen Bing*

European Central Bank

Andreas Schönenberger*
Karine Themejian*

Bank of France

Frédéric Hervo*

Autorité des marchés financiers, France

Sonia Cattarinussi (since November2011)*
Bénédicte Doumayrou (until October2011)*

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Deutsche Bundesbank

Jochen Metzger
Roland Neuschwander*

Bafin (German Financial Supervisory Authority)

Thomas Eufinger
Jan Budaeus*

Hong Kong Monetary Authority

Esmond K Y Lee

Securities and Futures Commission, Hong Kong

Rico Leung

Reserve Bank of India

G PadmanabhanBank of Italy

Paolo Marullo Reedtz*

Bank of Japan

Yutaka Soejima (since June 2011)*
Masayuki Mizuno (until June 2011)*

Financial Services Agency, Japan

Jun Mizuguchi*
Kazunari Mochizuki*
Jutaro Kaneko*
Takashi Nagaoka (until July 2011)

Bank of Korea

Jeon Beopyong

Bank of Mexico

David Margolín Schabes

Netherlands Bank

Ron Berndsen

Central Bank of the Russian Federation

Nikolay Geronin

Saudi Arabian Monetary Agency

Ali Al Homidan

Monetary Authority of Singapore

Andrew Khoo

Comisión Nacional del Mercado de Valores,
Spain

Iñigo de la Lastra

Sveriges Riksbank

Malin Alpen

Swiss National Bank

Philipp Haene

Swiss Financial Market Supervisory Authority

Andreas Bail (since January 2012)
Michael Zumbach (from July - December
2011)
Tina Müller (until June 2011)*

Bank of England

Edwin Schooling Latter (since March
2011)*
Julian Oliver (from November 2010 until
February 2011)*
Paul Chilcott (until October 2010)*

Financial Services Authority, UK

Barry King*

Board of Governors of the Federal Reserve
SystemJeffrey Marquardt*
Jennifer Lucier*Paul Wong*

Federal Reserve Bank of New York

Lawrence Sweet*

Commodity Futures Trading Commission, US

Ananda Radhakrishnan
Robert Wasserman (since March 2011)*
Sarah Josephson (until March 2011)*

Securities and Exchange Commission, US

Alison Duncan* (since October 2010)David Michehl* (until August 2010)

CPSS-IOSCO – Principles for financial market infrastructures – April 2012181

International Monetary Fund

Christine Sampic*

World Bank

Massimo Cirasino*Observers
European Commission

Patrick Pearson

European Securities and Markets Authority

Fabrizio Planta

Secretariat
Bank for International Settlements

Daniel Heller*
Robert Lindley*International Organization of Securities
Commissions

Yukako Fujioka (since February 2011)*
Werner Bijkerk (until February 2011)*

The review also benefited from contributions by Greg Chugg, Louise Carter, Darren Massey(Reserve Bank of Australia), Rogerio Antonio Lucca (Central Bank of Brazil), Suzanne
Mercure, Élaine Lanouette (Autorité des marchés financiers, Québec), Sylvia Tyroler(Deutsche Bundesbank), Ryan Ko (Securities and Futures Commission, Hong Kong),
Takeshi Mori (Bank of Japan), Lau Tze Hon, Loh Pui Hoon, Ken Nagatsuka, Janice Chua
(Monetary Authority of Singapore), Miguel Ángel Herrero Alvite (Comisión Nacional del
Mercado de Valores, Spain), David Maurer, Thomas Nellen, Robert Oleschak, Andy Sturm(Swiss National Bank), Simon Turek, Ben Mitchell (Financial Services Authority, UK), Travis
Nesmith, Mark Magro, Emily Caron, Namirembe Mukasa, Michael Koslow, Jeremy Ward,
Kristopher Natoli, Sarah Wright (Board of Governors of the Federal Reserve System),Marsha Takagi, Brian Begalle, Shari Ben-Haim, Kirsten Harlow (Federal Reserve Bank of
New York), Marta Chaffee, Joseph Kamnik, Matthew Landon, Katherine Martin, Catherine
Moore (US Securities and Exchange Commission) Maria Teresa Chimienti and Mario
Guadamillas (World Bank).
The Steering Group and Editorial Team co-chairs would also like to give special thanks to
Jeffrey Marquardt, Jennifer Lucier, Paul Wong, Mark Magro, Emily Caron, Shari Ben-Haim,
Namirembe Mukasa, and Jeremy Ward, who coordinated the drafting of this report.

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