Change is Inevitable...

Change is Inevitable...

'Except from vending machines' (Robert C. Gallagher): the impact of new standards proposed by the CPSS-IOSCO for financial market infrastructures on payment service providers

18 July 11

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The new principles for financial market infrastructures

The Committee on Payment and Settlement Systems (CPSS) of the Bank for International Settlements1, together with the Technical Committee of the International Organization of Securities Commissions (IOSCO)2, has issued a consultative report setting out principles for financial market infrastructures: the FMI Principles. The report will replace the 'Core Principles for Systemically Important Payment Systems' (Core Principles) issued by the CPSS in 2001. The Core Principles are, in effect, the regulatory rulebook for the clearing and settlement of payments, so the new FMI Principles will be an important component of the regulatory environment for payments in Europe and in the world beyond.

The FMI Principles cover 18 issues of relevance to payment systems, their operators and their participants, as well as six more issues for other types of market infrastructure. The FMI Principles deal with subjects such as governance, risk management, settlement finality, default management, conditions of participation, efficiency and communications. Some aspects of the FMI Principles are new, while others repeat the thinking reflected in the previous version. This article comments on a selection of the FMI Principles.

Legal basis

For many years, payment systems have been required to have a well-founded legal basis for their operations. The degree of detail which fills out this basic idea has, however, grown considerably. The consequence is that payment systems may now have to obtain legal opinions on the 'soundness' of the legal basis for their activities. Additionally, payment systems may have to revise their rulebooks to 'include participant requirements, exposure limits, collateral requirements and prefunded default arrangements' to cover cases where full legal certainty is not achievable.


The Core Principles require that the governance arrangements of a system should be effective, accountable and transparent. The FMI Principles will broaden out the requirements for governance, so that they must additionally 'promote the safety and efficiency of the [system], and support the stability of the broader financial system, other relevant public interest considerations and the objectives of relevant stakeholders'. Many payment systems will have to overhaul their governance structures to comply with these new obligations.

While the result might be more open decision-making within payment systems, there is a lot of additional detail in the explanatory text of these latest principles, which may be interpreted by regulators as 'regulatory rules', e.g. dealing with composition of boards of directors, reporting lines, risk management, modelling, internal controls and audit. This new, more detailed approach is likely to lead to greater involvement of participants and other stakeholders in the management and oversight of payment systems. On the other hand, more elaborate governance processes might result in increased running costs for systems. 

Risk management

The centre-piece of the FMI Principles is a group of principles dealing with credit risk, liquidity risk and operational risk. Each of these subjects is considered in detail. The FMI Principles are addressed not only to payment systems but also to other types of infrastructure such as central securities depositaries and central counterparties. As far as participants in infrastructures are concerned, they are the organisations which may shoulder many of the credit and liquidity risks and the details set out in the new text will be of interest to them. Taking collateral is recommended as a means of managing credit risk and there is a new section entirely devoted to collateral.

One item which is potentially controversial is the extent to which a system needs to have resources available for credit and liquidity risk management. The Core Principles said, in relation to systems which rely on multilateral netting, that the system should be capable of completing daily settlements in the event that the participant with the largest single settlement obligation fails. The FMI Principles seek to upgrade this standard by: covering the failure of the two largest participants and their affiliates; applying the standard not just to netting systems but to all types of payment systems and infrastructure; and applying this to cover both credit and liquidity risk. It is not yet certain that this stricter standard will be adopted and it is one of the subjects on which the CPSS-IOSCO specifically invite feedback.

Access criteria

It is a principle of competition policy in Europe that conditions of access should be transparent and objective. This was reflected in the Core Principles and it is also repeated in the FMI Principles. These latest standards, however, take this one step further by requiring access criteria to be 'risk-based' as well as objective and publicly disclosed. Participants will be expected to meet appropriate financial and operational tests, but other criteria would have to be justified in terms of safety and efficiency as well as being objective and non-discriminatory.

Whether this new formulation could require payment systems to open up services to non-bank payment service providers ( ) is unclear. In Europe, payment systems enjoy a special protected status as 'designated systems', which enables them to fend off challenges from insolvency officers which might disrupt default management. This status could be threatened if the system were required to allow some types of to participate directly in the system.

Indirect participation

A structure adopted in many payment systems is where an inner circle of 'direct participants' provides clearing and settlement services to other banks or , sometimes called 'indirect participants'. The FMI Principles apply the rule of fair and open access to indirect participants as well as direct participants.

These latest principles also warn payment system operators that indirect participants with very high volumes of business may introduce risk into the system, for example where insolvency of a large indirect participant could mean that its direct participant is itself unable to satisfy its obligations. The FMI Principles consider that the system operator should manage the risks arising from 'tiered participation arrangements', which essentially means indirect participation in the system. In practical terms, risk management of indirect participation may mean that payment systems wish to gather information from their direct participants about the relative size of their clients' payments business. Rules requiring participants to establish volume limits for their clients may also be introduced.

Next steps

The issues discussed above show that it is not just the payment systems themselves that could be affected by the new principles.

The CPSS-IOSCO issued the FMI Principles under a consultation document in March 2011. A final version of the FMI Principles is expected to be published early next year with a view to being implemented by regulators later in 2012. The consultation closes on 29 July 2011, so there is only a short time left to make comments on the draft.

Dermot Turing is a Partner in the international financial regulatory team at Clifford Chance.

Related links:

Committee on Payment and Settlement Systems - Technical Committee of the International Organization of Securities Commissions: Principles for financial market infrastructures. Consultative report (March 2011)

Cover Note on the Consultative Report cited above

Related articles in this issue:

Get Ready for More. Basel III marks only the beginning of increased regulatory scrutiny of the payments market

A Closer Look at Innovation in Retail Payments. Central bank research in preparation: a report on first findings of working group established by the Committee on Payments and Settlement Systems

Related article in previous issue:

Moving Into New Territory. The impact of the e-money Directive on payment service providers ( Newsletter, Issue 10, April 2011)


1The Committee on Payment and Settlement Systems (CPSS) contributes to strengthening the financial market infrastructure through promoting sound and efficient payment and settlement systems. The CPSS is a standard stetting body for payment and securities settlement systems. It also serves as a forum for central banks to monitor and analyse developments in domestic payment, settlement and clearing systems as well as in cross-border and multicurrency settlement schemes.

2The member agencies currently assembled together in the International Organization of Securities Commissions have resolved, through its permanent structures: to cooperate in developing, implementing and promoting adherence to internationally recognised and consistent standards of regulation, oversight and enforcement in order to protect investors, maintain fair, efficient and transparent markets, and seek to address systemic risks; to enhance investor protection and promote investor confidence in the integrity of securities markets, through strengthened information exchange and cooperation in enforcement against misconduct and in supervision of markets and market intermediaries; and to exchange information at both global and regional levels on their respective experiences in order to assist the development of markets, strengthen market infrastructure and implement appropriate regulation.

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