On Monday, November 29, 2021, the Committee on Payments and Market Infrastructures (“CPMI”) of the Bank for International Settlements (“BIS”), together with the International Organization of Securities Commissions (“IOSCO”), issued a joint Report on clearing facilities operating around the world, and requesting, by January 24, 2022, comments particularly focusing on client access and “portability.” “Portability” is the technical term for the relative ability to move a client’s clearing operation to another clearing agency in the event of a default or other inability of a clearing agency to function. The joint Report arose due, in part, to the difficulties the capital markets experienced in dealing with the disruptions caused by Covid 19 and the related shutdowns of most of the world’s economies.
BIS and IOSCO Call for Reforms
Interestingly, the joint Report was followed by a statement on December 6, 2021, from BIS, as reported by Reuters, emphasizing the need for enhanced “buffers” of capital to absorb losses resulting from “blockages” in the capital markets involving hedge funds, mutual funds, money market funds, pension funds, and insurance companies. I have discussed some of the risks posed by Money Market Funds in a February 23, 2021 Blog “‘Bucking the Break’: SEC Requests Comments on MMF Reforms.”
BIS is a Swiss corporation owned, now, by the Central Banks of 63 countries. It is headquartered in Basel and dates from 1930, when it was created to handle reparation payments from Germany as a consequence of WWI. It now functions as the central bankers’ central bank, for instance housing the Basel Committee on Bank Supervision, which organized and promulgated the three rounds of banking reforms known as the Basel Accords. One of the “lessons” of the Basel Accords is that international banking efforts to craft new regulatory requirements do not always go smoothly. For a further discussion of aspects of the Basel Accords see my March 23, 2021 Blog “Swiss Miss: The Fed, Basel III and SLR.” The CPMI is a BIS Committee dedicated to evaluating and suggesting improvements to payment systems.
IOSCO is a “trade organization” of securities regulators, founded in 1983 to include securities regulators in North and South America. In 1984 European regulators joined. It was incorporated in Quebec in 1987, but now is headquartered in Madrid with some 230 members, associates, and affiliates. IOSCO is concerned with the ability of market participants to trade securities, especially repurchase agreements and similar liquidity enhancing assets, in organized and transparent ways where the risks of defaults or other trading disruption are reduced to a minimum.
It has become obvious to both observers of, and participants in, the capital markets that clearing agencies are critical players. As the joint Report, “[Central Counter parties] have become increasingly critical components in the financial system.” Still, the vast majority of firms “must rely on having their trades cleared by an intermediary,” which the joint Report terms a “client clearing service provider,” i.e., a clearing agency. Clearing agencies are key to the efficient operation of the capital markets, as I have previously observed on a number of occasions: viz. April 29, 2021, “Tightening the Reins: SEC Approves Proposed Rule Change to Clearing Agency Investment“; May 27, 2021, “‘Margin, I Have to Have More Margin’: The National Securities Clearing Corporation Proposes to Increase the Minimum Required Fund Deposit“; and June 8, 2021, “Fixing FICC: Agency Proposes Rule Changes to Encourage More Repo Clearing.”
The joint Report by BIS and IOSCO calls attention to the current level of concentration (citing “a relatively small number of bank-affiliated clearing firms”) and the related risks BOTH for client access (especially smaller client firms) and for orderly operations in the event that a clearing firm should default or otherwise be unable to function efficiently. The joint Report considers new models of clearing firms, such as clearing firms sponsored by a single client or a group of clients. It also discusses portability, i.e., the ability to move clearing activities to substitute agencies.
The Joint Report
The joint Report strongly endorses advance planning (called a “game plan” in the Report) to identify a substitute clearing firm, including identifying the steps needed to relocate clearing operations to another entity and dealing with whether client consent is needed for porting, or whether that can be obtained ahead of time as part of the existing clearing agreement. The Report also urges analyzing account structures to determine what aspects facilitate portability, especially if client positions are margined.
The joint Report, as noted above, seeks comments by January 24, 2022, with those comments to focus on the following:
- Access, including the design of and barriers to direct and sponsored clearing models.
- Risks in not porting.
- Communication, coordination, and harmonization practices.
- Issues involved in developing a porting protocol.
The CPMI and BIS are trying to get a better “handle” (if not a Stillson wrench) on the plumbing involved in clearing transactions, before the next blockage occurs. Careful thought should be given to responding to the joint Report; one would not want either “flooding” to occur from a failure to innovate, or wrestling with the ambiguities in rerunning the “pipes” (as happened with the Basel Accords) if this current effort should lead to regulatory changes that do not work.
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