working group #2 - report credit & liquidity risk

Working Group #2 - Report

Credit & Liquidity Risk

Working Group #2Principle #4

PFMI # 4 Risk: Credit1.What constitutes "compliance" with the Principle? Describe (in specific terms) the state characteristics of a CSD that fully meets the requirements of the Principle.•FMI type: multi or single jurisdiction•Identifying all of the potential sources of credit risk for the particular FMI that you areoIn-coming: Participants, issuers, investment banks, billing, quality of investmentsoOut-going: You may impose credit risk on your participant by not completing your activities (e.g., corporate actions)•Establish a robust framework to measure, monitor, manage, audit and reporting credit exposuresoDefined limits of credit risk tolerances at a BofD level with statute, policy and procedure governanceAccountability, frequency of review, what are the key performance indicatorsoAppropriate oversight at management committee and BofD levels (escalation alerts of limit threshold limits breaches)oMeasurement frequency → ideally real-timeoValidated timely pricing sources/models•Sufficient financial resources to cover current and potential future exposure (PFE)oSecurities Settlement Service (SSS): Fully at a high confidence levelCollateral and other equivalent financial resourcesoCentral Counterparty (CCP): Fully at a high confidence levelMargin and other prefunded financial resourcesShould consider wide range of stress scenarios (multi/single jurisdiction)•Frequency of stress testsoDaily monthly comprehensive analysisoRegular assessment of stress scenarios and resultsoEnsure appropriate parameters/indices are being stressed •Periodic validation of risk model and business changes which may introduce new risks


PFMI #4 Risk: Credit1. What constitutes "compliance" with the Principle? Describe (in specific terms) the state characteristics of a CSD that fully meets the requirements of the Principle.

PFMI # 4 Risk: Credit

2. In relation to the Key Considerations for the Principle, what metrics/data should a CSD compile in order to demonstrate compliance? How might this data be sourced?•The metric is the ability to evidence the governance framework e.g., the policy, the required monitoring of compliance, the validation of the model, the credit risk limits, etc.•Tolerances set at the BofD level

o Need a reporting framework which has transparency/alerts to the BofD – evidenced o Frequency of compliance reporting to Senior Management and the BofD – evidenced o Credit risk escalation levels with alerts escalation levels – evidenced

•Parameter validationoPrice sources/models•Adequacy of financial resourcesoMeet thresholds fully with a high degree of confidenceoUnderstand 1% scenarios and discuss them at the highest levels•Stress testingoAdequacy of stress scenarios give evolving market conditionsDoes the existing set of scenarios include potential market eventsDoes your organization know what can take you out and develop warning signals to give you heads-upsDoes the existing set of scenarios fully address the evolving portfolio of exposuresNew instrument classes•Back testingoModel performs within acceptable tolerances


PFMI #4 Risk: Credit

2. In relation to the Key Considerations for the Principle, what metrics/data should a CSD compile in order to demonstrate compliance? How might this data be sourced?



3. What “result levels" with respect to these metrics/data should a CSD achieve in obtaining "compliance"? Why?



4. What, if any, provisions should you (as an FMI) be making to ensure continued adherence to the principle (s), for example in times of market or operational distress?•Do not get a false sense of comfortoLook for the unexpectedoAssess risks from different perspectives•CCP: What is a sufficient prefunded resource in addition to margin?oAt what confidence level?•Provision for evolving market conditions is setting-up stress tests•Provision for pricing when price feeds/or models are not indicative of prevailing/prospective market prices and other price parameters •Continuing appropriateness of risk model should be assessed annually



4. What, if any, provisions should you (as an FMI) be making to ensure continued adherence to the principle(s), for example in times of market or operational distress?



PFMI # 5 Risk: Collateral1. What constitutes "compliance" with the Principle? Describe (in specific terms) the state characteristics of

a CSD that fully meets the requirements of the Principle.• Collateral more valuable than positions it covers• Demonstrated ability to price instruments and an independent dispute settlement mechanism• Low credit risk• High liquidity• Low price volatility• Low market risko Mitigate cross-border risks (e.g., market risk includes foreign exchange risk)• Low concentration risk• Mitigate high concentration of highly correlated “wrong-way” risk collateral• Frequent marking-to-marketo Daily minimumo Pricing discretion to reflect prospective market liquidation prices• Frequent testing of haircuts• Stable haircuts which mitigate pro-cyclicality• Collateral eligibility should be highly correlated to that collateral eligible to backstop your lines of credit• Category credit rings and waterfall mechanisms and how collateral covers the corresponding riskso Balancing the risk mitigation goals and the participant’s collateral costs• Custody access of collateral & legal contract enforceability


PFMI #5 Risk: Collateral1. What constitutes "compliance" with the Principle? Describe (in specific terms) the state

characteristics of a CSD that fully meets the requirements of the Principle.

PFMI # 5 Risk: Collateral2. In relation to the Key Considerations for the Principle, what metrics/data should a CSD compile in order to demonstrate compliance? How might this data be sourced?•A well develop category credit ring structure and waterfall mechanismoMetrics which are well defined and capable of being evidenced•Market depth of collateral eligible assetsoPercentage of outstanding open interest limitsoHaircuts may be adjusted to increase as posted collateral approaches percentage thresholds •Credit risk metrics•Stable haircutsoMitigate risk and manage pro-cyclical risk•Correlations of collateral eligible assets and participants•Validation of pricing sources•Ensure rights to collateral are legally enforceable across borders


PFMI #5 Risk: Collateral2. In relation to the Key Considerations for the Principle, what metrics/data should a CSD compile in order to demonstrate compliance? How might this data be sourced?


PFMI # 5 Risk: Collateral3. What “result levels" with respect to these metrics/data should a CSD achieve in obtaining "compliance"? Why?•Governance framework with appropriate monitoring, reporting and escalation mechanisms•Establish thresholds which satisfy risk controls•The legal and operational framework for rehypotication/reuse should be well managed and coordinated•Understand the sources of recourse for liquidity in support of collateral short falls•Periodic reviews/scans of the collateral management framework


PFMI #5 Risk: Collateral 3. What “result levels" with respect to these metrics/data should a CSD achieve in obtaining "compliance"? Why?


PFMI # 5 Risk: Collateral4. What, if any, provisions should you (as an FMI) be making to ensure continued adherence to the principle(s), for example in times of market or operational distress?

Working Group #2Principle # 5

PFMI #5 Risk: Collateral




PFMI # 6 Risk: Margin

1. What constitutes "compliance" with the Principle? Describe (in specific terms) the state characteristics of a CCP that fully meets the requirements of the Principle.

• Margin calculation should consider the relevant risk parameters of the underlying portfolio• Daily mark-to-market (variation margin)o Should allow for more frequent calls for variation margin• Should consider current and PFEo Risk adjusted margin modelso PFE at a 99% CLo PFE should account for close-out period• Should permit cross-margining when risks parameters can be demonstrated to be highly correlated• Methodology should mitigate wrong-way risk and pro-cyclicality• Methodology should be well documented and easy to replicate by participants• Margin calls should have strict timelines associated with themo FMI should have the ability to impose fees when a participant’s margin is late• Reliable price sources/models• Regular model validation


PFMI #6 Risk: Margin

1. What constitutes "compliance" with the Principle? Describe (in specific terms) the state characteristics of a CCP that fully meets the requirements of the Principle.


2. In relation to the Key Considerations for the Principle, what metrics/data should a CSD compile in order to demonstrate compliance? How might this data be sourced?•The processes and controls should be easy to evidence•Transparent reporting and escalation of thresholds limits•Back testing of market risk•Validation of pricing sources/models•Periodic reviews of appropriateness of liquidity/close-out assumptions•Periodic reviews of wrong-way risk/pro-cyclical mitigants



4. What, if any, provisions should you (as an FMI) be making to ensure continued adherence to the principle (s), for example in times of market or operational distress?



PFMI # 7 Risk: Liquidity

1. What constitutes "compliance" with the Principle? Describe (in specific terms) the state characteristics of a SSS & CCP that fully meets the requirements of the Principle.

• A governance framework to measure, monitor and manage liquidity risko BofD approved tolerances, thresholds and reporting mechanismso Sufficiency tests should be approved by the BofD • Mechanisms should be in place too Measure the liquidity risk and must have adequate resources to ensure that they are

sufficient to manage the default of multiple of the single largest participanto Understand current and future liquidity needs• Demonstrate that liquidity resources are available and collateral is in place as required

in support of them• Central bank to act as the ultimate banker in the event of a default o Providing liquidity subject to collateral


PFMI #7 Risk: Liquidity

1. What constitutes "compliance" with the Principle? Describe (in specific terms) the state characteristics of a SSS & CCP that fully meets the requirements of the Principle.

Mary Ann Callahan – DTCC ([email protected])Joseph Campos – CDS ([email protected])Dale Connock – Strate ([email protected])Gianinna Estrella – Cevaldom ([email protected])Roberto Oyos – Cavali ([email protected])Jorge Pelayo – Indeval ([email protected])

Working Group #2Members

working group #2 - report credit & liquidity risk

Documents

credit risk limits

realtime o

unexpected o

results o

reporting credit exposures

bofd level o

working group

testing o model