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

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

  • Lessons Learnt for firms from the 2021/22 reporting period (where available); and
  • New Rules: BoE prepares firms for upcoming regulatory developments, also in light of the new general rulemaking powers under the Financial Services and Markets Bill (“FSMB”) currently before the UK Parliament with respect to central securities depositories (“CSDs“) and central counterparties (“CCPs“).

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

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

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

Operational resilience

Lessons Learnt:

  • 2022 was a year that put FMIs under significant market shocks due to the pandemic and the war in Ukraine. Nevertheless, FMIs have proven resilient to these extraordinary market conditions.
  • The suspension of nickel trading for a week by the London Metal Exchange (“LME“) due to the extreme market volatility and the build up of large derivative exposures (many of which to be cleared by LME Clear) forced the BoE to look into LME Clear’s governance and risk management framework to extract any lessons learnt.
  • The settlement system outage that Euroclear UK and International (“EUI“) suffered (the second since 2020) forced BoE to take enforcement action and to use its supervisory tools to maintain the resilience in EUI. Specifically, the BoE made use of its power under Section 166 of the Financial Services and Markets Act 2000 to require EUI to appoint a skilled person responsible for assessing whether the relevant lessons learnt from the first outage back in 2020 had been appropriately implemented and whether any additional steps to improve IT resilience need to be taken.

New Rules:

  • The BoE together with the Financial Conduct Authority (“FCA“) and Prudential Regulation Authority published a joint Discussion Paper in July 2022 to present the potential measures by way of which supervisory authorities could use the proposed new powers under the FSMB in respect of improving the resilience of services outsourced to critical third parties (“CTPs“) by firms and FMIs. These measures are build on three pillars according to the FSMB:
    • Identifying CTPs and recommending them to HMT for formal designation;
    • Setting minimum resilience standards for designated CTPs in respect of material services provided to firms and FMIs; and
    • Tools for testing the resilience of material services that CTPs provide to firms and FMIs.

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

  • The FSMB will introduce a high-level Senior Managers and Certification Regime framework for CCPs and CSDs. The BoE is expected to develop a policy in that respect in conjunction with the HMT.
  • The BoE will continue to undertake thematic and firm-specific deep dive reviews across the FMIs.
  • The BoE will ensure that FMIs comply with their obligation to implement the BoE’s latest policy requirement for operational resilience by 2025.

CCP resilience and recovery

Lessons Learnt:

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

New Rules:

  • Rules on CCP margin will primarily derive from the work of the joint BCBS-CPMI-IOSCO group which is co-chaired by the BoE. Following the publication of the final report on margining practices in September 2022, further international work is expected on liquidity preparedness and data gaps in regulatory reporting.
  • As set out in the BoE’s policy statement in relation to the discontinuation of the USD Libor benchmark at the end of Q2 2023, USD Libor referencing contracts will be removed from the clearing obligation on 24 April 2023.
  • The BoE intends to publish a framework document for CCP supervisory stress testing, which will set out the BoE’s framework for CCP supervisory stress testing and guide the design of each of the BoE’s annual stress testing exercises. This new framework will be developed on the basis of the BoE’s Discussion Paper on Supervisory Stress Testing of Central Counterparties together with the lessons learned from the first CCP stress testing exercise.
  • The BoE will also start preparing its second CCP stress testing.
  • New CCP resolution and pre-resolution rules will be introduced under the FSMB, which will largely mimic banking resolution rules in line with international standards.

Innovation in payments

New Rules:

  • Significant work has been done by CPMI-IOSCO in relation to the design of stablecoin arrangements confirming that the Principles for FMIs apply to systemically important stablecoin arrangements that transfer stablecoins. In addition, this guidance by CPMI-IOSCO addresses issues of governance, risk management, settlement finality and money settlements, as well as considerations related to the classification of a stablecoin arrangement as systemically important. The rules set out in the FSMB are consistent with the abovementioned guidance.
  • The BoE’s regulatory framework for systemic stablecoins will follow the proposed FSB’s “Global Stablecoin” (“GSC“) arrangements which in turn are expected to be finalised by July 2023. The revised framework requires GSC arrangements to provide a robust legal claim, guarantee timely redemption at par into fiat and maintain effective stabilisation mechanisms, as well as to be subject to appropriate prudential requirements.
  • The new stablecoin regime in the UK will be combined with a Special Administrative Regime for stablecoins which will be a bespoke insolvency framework for systemic payment and settlement systems.
  • New rules are likely to be introduced in respect of wholesale cash distribution network in the UK. In line with the BoE consultation on this matter, any firm recognised as systemic by HMT would be brought into the scope of the BoE’ prudential supervision. The above notwithstanding, currently it appears that no firm in the wholesale cash sector would meet the criteria for systemic recognition.
  • The BoE is working together with HMT and the FCA to develop an FMI Sandbox which should be ready for launch by the end of 2023. Participating firms will have the possibility to test and adopt new technologies that are currently not supported by the existing legislation.

Recognition and supervision of cross-border CCPs and CSDs

New Rules:

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