European Union
Detailed Assessment of Implementation of the European Central Bank Observance of the CPSS-IOSCO Responsibilities of Authorities for Financial Market Infrastructure

This paper discusses key findings of the detailed assessment of implementation of the European Central Bank (ECB) Observance of the Committee on Payment and Settlement Systems/International Organization of Securities Commission (CPSS-IOSCO) responsibilities of authorities for financial market infrastructures. The oversight framework of the ECB is comprehensive. The ECB has developed a wide-ranging oversight policy, including quantitative and qualitative criteria to identify, monitor, and remedy any potential systemic risks related to financial market infrastructures. It has also developed oversight standards covering a broad range of infrastructures, service providers, and payment schemes within the euro area.

Abstract

This paper discusses key findings of the detailed assessment of implementation of the European Central Bank (ECB) Observance of the Committee on Payment and Settlement Systems/International Organization of Securities Commission (CPSS-IOSCO) responsibilities of authorities for financial market infrastructures. The oversight framework of the ECB is comprehensive. The ECB has developed a wide-ranging oversight policy, including quantitative and qualitative criteria to identify, monitor, and remedy any potential systemic risks related to financial market infrastructures. It has also developed oversight standards covering a broad range of infrastructures, service providers, and payment schemes within the euro area.

Executive Summary

The oversight framework of the European Central Bank (ECB) is comprehensive. The ECB has developed a wide-ranging oversight policy, including quantitative and qualitative criteria to identify, monitor, and remedy any potential systemic risks related to financial market infrastructures. It has also developed oversight standards covering a broad range of infrastructures, service providers, and payment schemes within the euro area (EA). Furthermore, it has extensive oversight cooperation with a wide range of authorities both at the European level and globally. Within the European Union (EU), the ECB has been a driving force to promoting stability and integrating financial infrastructures. Globally, the ECB is deeply involved in shaping the regulatory framework for financial market infrastructures (FMIs) by assuming the leadership in developing new principles. It is also involved in several global cooperative oversight arrangements covering globally critical payment systems, post-trading FMIs, and the service provider SWIFT.

The ECB should be entrusted to coordinate the Eurosystem oversight function to ensure that international principles for FMIs are consistently enforced throughout the EA. The regulation and oversight of systemically important FMIs has differed across the EA with potential contagion systemic risk affecting the stability of the EA financial system. The adoption of the PFMIs as legally binding is a step in the right direction. However, these principles are not sufficiently detailed to ensure a uniformed and harmonized implementation across the EA, since their enforcement for post trade FMIs will be conducted by national competent authorities on a decentralized basis (except for trade repositories, for which the supervisory responsibility lies with ESMA). Currently, the ECB is the lead overseer for payment systems, including TARGET2, EURO 1, STEP 2 and CLS (as concerns the settlement of euro transactions), but not for systemically important post-trade FMIs with cross-border reach. Therefore, there is merit in entrusting the ECB with responsibility to ensure that these principles are consistently enforced throughout the EA. Assuming such a role would strengthen financial stability across the EA by ensuring EA-wide policy objectives, harmonized regulation, and consistent implementation.

The ECB should rely more on its power to issue legally binding corrective action to effectively enforce its oversight responsibilities. To implement its oversight responsibilities, the ECB currently relies mainly on ‘soft’ tools and measures such as moral suasion, publication of oversight assessments, public statements, and cooperation with other authorities. These tools have worked so far, but with more demanding oversight standards this may not be effective in all circumstances in forcing the system’s operators to promptly address potential deficiencies. The ECB should rely more on legally binding corrective action to effectively enforce its responsibilities, including imposing sanctions, penalty, suspending some operations or services, etc. As it does not have an exclusive mandate over post-trade FMIs, the ECB should coordinate its corrective measures with the relevant securities regulators and banking supervisors. Furthermore, the ECB should be actively involved in any EU legislation addressed to FMIs, as it would affect the effectiveness of its oversight responsibility.

Recognize the role of the ECB/Eurosystem as central bank of issue for the regulation and oversight of all types of post-trade FMIs. The role of the ECB/Eurosystem as central bank of issue of the euro is recognized in relation to CCP regulation and oversight under EMIR. In line with the CPSS-IOSCO Responsibilities, the ECB role should also recognized as central bank of issue for the regulation and oversight of central securities depositories (CSDs), securities settlement systems (SSSs) and trade repositories (TRs).

The ECB’s oversight role is effectively structured and organized, but further clarity on the separation between its roles as service provider and overseer is warranted. The operation and oversight functions are hosted by separate Divisions within the same Directorate General and, while entrusted to two different Working Groups, treated within the same Eurosystem’s committee (in clearly separated agenda items, which may meet in different compositions and for which there are separate mailing lists and access to documents for oversight and operation). The two functions report to separate members of the ECB Executive Board. To avoid any potential or appearance of a conflict of interest, consideration could be given to providing further clarity to the public on the separation between the operation function and oversight function, aimed at enhancing transparency and accountability.

The ECB’s oversight capacity should be strengthened. The ECB oversight team has the responsibility to define the Eurosystem’s strategy and policy, develop rules and guidance, coordinate the Eurosystem works, and contribute to the works of international fora. In addition, the ECB will soon participate in several EU colleges for central counterparties (CCPs). In order to implement the new risk-based approach in a credible way and be able to contribute actively to the works of European and international fora, the ECB needs to strengthen the capacity and the skill of its staff. ECB oversight staff should be significantly increased.

Methodology used for Assessment

1. The assessment of the ECB’s observance of the Principles for Financial Market Infrastructures (PFMI) was undertaken in the context of the IMF’s Financial Sector Assessment Program (FSAP) of the EU. The assessor was Elias Kazarian of the IMF’s Monetary and Capital Markets Department (MCM).

2. This report presents only the outcome of an assessment of the ECB observance of the Responsibilities of Authorities (RA), while the assessment of TARGET2 against the principles are planned to take place at a later stage. The assessment of the responsibilities was based on a self-assessment prepared by the ECB and drew on a wide range of both public and non-public documentation. It also benefited from discussions with the ECB Directorate General Payments and Market Infrastructure senior management and staff, for which the mission would like to thank them for their full cooperation and hospitality.

3. This assessment is limited to ECB’s oversight activities, while the Eurosystem national central banks’ oversight activities are out of scope of this assessment and only covered to the extent necessary. The assessment was based on information received during the first part of 2013 and it does not take into account the evolution of EU regulation.

Overview

4. In the EA, there are two large-value payment systems: TARGET2 and EURO1. The former is a centralized real time gross settlement (RTGS) system owned and operated by the Eurosystem. The EURO1 system, owned and operated by the European Banking Association (EBA) Clearing, is an EU-wide payment system that settles its end-of-day balances in euro in TARGET2.

5. Retail clearing and settlement are organized differently in the various EA countries, reflecting their traditions and business preferences. STEP1 and STEP2 are two EA-wide retail payment systems, which were set up to complement the EURO1 system. Most retail payment systems are multilateral netting systems that settle their balances in TARGET2. At the end of 2012, there were 20 retail payment systems in the EA (the five largest retail systems hold a market share of some 85 percent in terms of number of transactions processed). Moreover, 25 national and six international card schemes operate in the EA.

6. In 2012, the EA securities and derivatives markets were served by nine officially registered CCPs. In addition to infrastructures located in the EA, euro-denominated financial instruments are cleared by CCPs located outside the EA. Important systems are LCH.Clearnet Ltd (U.K.), ICE Clear Europe (U.K.), and SIX x-clear (Switzerland).

7. There are 25 securities settlement systems (SSSs) operating in the EA, of which 23 are eligible for the delivery of securities to the Eurosystem as collateral in central bank credit operations. All EA central securities depositories (CSDs) offer settlement in central bank money, whereas the two international CSDs (ICSDs) offer settlement in commercial bank money.

Table 1.

European Union: CCP Landscape for Euro-Denominated Instruments

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8. There is one trade repository (TR) within the EA, REGIS-TR, which has been operational since December 2010. OTC derivatives contracts in euro or with EA counterparts are, as a rule, reported to DTCC Derivatives Repository Limited (DDRL U.K.).

A. The ECB’s Oversight Policy Framework

9. The ECB has a leading role in developing, in close cooperation with national central banks (NCBs), the Eurosystem oversight policies, which are defined by the Governing Council of the ECB, the highest decision making body of the Eurosystem. The Eurosystem’s oversight covers (i) large-value payment systems; (ii) retail payment systems; (iii) central securities depositories (CSDs); (iv) securities settlement systems (SSSs); (v) central counterparties (CCPs); (vi) payments instruments/schemes; (vii) correspondent banking; (viii) critical service providers; and (ix) trade repositories (TR).

10. The ECB has responsibility as lead overseer for select payment systems, including: the large-value payment systems TARGET2 and EURO 1; retail payment system, including STEP2, and CLS euro settlement; select payment card schemes in Europe, including VISA Europe, Amex and Diners; and payment instruments, including SEPA Credit Transfer and SEPA Direct Debit.

11. The ECB does not have a clear oversight responsibility for post-trade infrastructures like CSDs, SSSs, and CCPs. It is the responsibility of the Eurosystem NCBs, which is based on mandates provided by national legislation, which differs across EA jurisdictions. However, the new European Market Infrastructure Regulation (EMIR) and the prospective CSD Regulation will harmonize (at the EU level) the regulatory requirements and many implementation aspects for the FMIs to which they apply, including licensing and cooperation among authorities.

12. At an early stage of the single currency, the Governing Council of the ECB expressed keen interest in the well functioning of post-trade infrastructures. It was considered crucial for the smooth implementation of monetary policy. The fact that the Eurosystem had no explicit legal competence in the field of post-trade infrastructures was not seen as an obstacle to establishing standards, common principles, or best practices ensuring the safety and soundness of such systems within the euro area. To this end, the ECB adopted standards for the use of EU SSS involved in European System of Central Banks (ESCB) credit operations. The systems were assessed against these standards to be qualified as settlement systems for monetary policy operations. Nevertheless, the ECB is lead overseer for the future critical service provider TARGET2-Securities (T2S), which is a Eurosystem owned and operated service offering securities settlement services to central securities depositories (CSDs).

Table 2.

European Union: European Central Bank Oversight Role – Overview

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Explanatory notes: (Y) Yes; (Y*) Yes, in the future; (?*) Future involvement of ECB not yet decided.

The ECB/Eurosystem also conducts semi-annual surveys on correspondent banking in euro and has published a first report on payment cards fraud.

In the context of the European Forum for Security in Retail Payments (involving EU/EEA overseers and supervisors of payment service providers).

ESCB-CESR recommendations for SSSs and CCPs in the EU as well as joint work with ESMA on EMIR regulatory technical standards.

TARGET2 and EURO 1.

ECB has lead oversight responsibility for euro settlement by CLS, FRBNY lead overseer and supervisor of CLS Bank.

STEP2.

Links with STEP2.

For ECB/Eurosystem operations in foreign exchange denominated derivatives.

EuroCHATS (Hong Kong).

Euroclear Bank (Belgium).

13. The ECB plays a leading role in coordinating crisis management. For this purpose, a crisis-communication framework was set up, aimed at enhancing information sharing between overseers in the European System of Central Banks (ESCB). The framework goes beyond those developed for the cooperative oversight of individual systems, as system-specific frameworks might not be sufficient for certain types of crisis.

14. The ECB plays an important advisory role within the EU. Based on its statute, the ECB should be consulted in relation to proposed EU community acts and draft national legislation, as well as to submit (on its own initiative) opinions to the appropriate EU institutions and national authorities. ECB opinions and other less formal communications constitute important tools in influencing legal and regulatory developments.

B. Relevant Authorities Involved

15. The Council of the EU and the European Parliament are empowered by the Treaty of EU to adopt legal acts. These may include rules relating to credit and other financial institutions, the provision of financial services, payments, financial instruments, and market infrastructures.

16. The European Commission acts as the guardian of the EU’s treaties and it has the power to propose legislation to parliament and to the council. The Commission works in the interests of the EU as a whole. One of the principal aims is to create a single market with a level playing field and equal opportunities throughout the EU.

17. The Eurosystem, comprising the ECB and the NCBs of the euro area, is assigned oversight responsibilities by the treaty. The Governing Council of the ECB defines the Eurosystem oversight policies, standards, and rules for euro payment systems, payment instruments and post-trade FMIs. The Eurosystem jurisdiction is the EA.

18. The ECB has enforcement responsibility in relation to payment systems and instruments, and will obtain responsibilities in relation to EU CCP Colleges. In relation to trade repositories (TRs), the nature of the ECB involvement will be shaped by the Regulatory Technical Standards (RTS) for the regulation and oversight of trade repositories that are prepared by European Securities and Markets (ESMA). The Central Securities Depositories Regulation (CSDR) and the related RTS will determine the nature of possible ECB involvement in CSD/SSS regulation and oversight.

19. The NCBs have responsibility for the enforcement of Eurosystem oversight policies and standards in relation to payment systems and instruments, and will obtain responsibilities in relation to EU CCP Colleges. The central bank oversight of clearing and settlement systems in the euro area is conducted by NCBs under national law competencies (i.e., not under Eurosystem competence), alongside regulation by securities regulators and banking supervisors.

20. ESMA contributes to the supervision of financial services firms with a pan-European reach, either through direct supervision or through the active coordination of national supervisory activity. ESMA is entrusted with the definition of secondary legislation (regulatory technical standards, implementation standards, and regulatory guidelines) as set out in the council and parliament regulations concerning post-trade FMIs, as well as the enforcement of such rules in relation to post-trade FMIs.

21. The European Systemic Risk Board (ESRB) is an independent body responsible for the macro-prudential oversight of the EU financial system. It contributes to the prevention or mitigation of systemic risks to financial stability arising from developments within the financial system (e.g., in relation to CCP activities), so as to avoid periods of widespread financial distress.

C. Major Changes and Reforms

22. In the context of EU legislative reform, EMIR and the forthcoming CSDR are the two most important initiatives. Other initiatives are the revisions of the Markets in Financial Instruments Directive and of the Capital Requirements Directive.

23. In terms of changing FMI landscape, the T2S service is the most important development under way. The main aim of T2S is to bring all securities and cash accounts together on one technical platform with a view to settling nearly all securities transactions in Europe on that platform. However, T2S will not constitute a CSD or an SSS in the legal sense, as, for example, defined in the Settlement Finality Directive. It is purely an IT platform to be used by CSDs to settle their securities transactions with immediate legal validity in T2S. CSDs will maintain their legal relationships with their customers and will continue to perform their custody and notary functions.

Summary Assessment

A. Summary Assessment of Observance of the Responsibilities

24. The assessment finds the ECB observing all the responsibilities of authorities for FMIs.

Table 3.

European Union: Rating Summary

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B. Recommendations for the Authorities

25. The Governing Council should adopt the CPSS-IOSCO Principles for FMIs as Eurosystem oversight standards. It is not entirely clear when and whether the Principles for FMIs would be adopted by EA national authorities. The early adoption of the principles by the Eurosystem will allow for harmonized provisions and rules throughout the EA and timely strengthening of its oversight standards1.

26. The ECB should rely more on its power to issue legally binding corrective action to effectively enforce its oversight responsibilities. The current tools have worked so far, but with more demanding oversight standards, they may not be effective in all circumstances to address potential deficiencies or inducing prompt crucial changes to enhance a system’s soundness. In order have an effective oversight function, the ECB should rely more on legally binding corrective action to effectively enforce its responsibilities, including imposing sanctions, penalty, suspending some operations or services, etc. As it does not have an exclusive mandate over post trade FMIs, the ECB should coordinate its corrective measures with the relevant securities regulators and banking supervisors. Furthermore, the ECB should be actively involved in any EU legislation addressed to FMIs, as it would affect its oversight responsibility.

27. The ECB is in the course of moving toward a risk-based and forward-looking oversight approach by developing new and more quantitative and dynamic analytical oversight tools. It is increasingly involved in various cooperative oversight arrangements and obtain new legal responsibilities, e.g., as central bank of issue in EMIR colleges. To ensure a consistent, proactive, and credible fulfillment of its responsibilities, a timely and significant resource increase should be granted to the oversight function in the DG-P.

28. The smooth functioning of CCPs and CSDs/SSSs is of vital importance to the central bank on account of its responsibility in the fields of monetary policy, payment systems, and financial stability. EU legislation recognizes the role of central banks in relation to CCP regulation and oversight. It is, therefore, recommended that the oversight role and interest of the ECB, as a central bank of issue, be also recognized in upcoming EU legislation on CSDs and SSSs oversight and regulation. In this context, consistency should be ensured between the Eurosystem/ESCB role in CSD/SSS oversight standard setting at EU and global level. Furthermore, the ECB should be entrusted the role of oversight coordinator to ensure consistent implementation of regulation and rules throughout the EA.

29. The ECB’s oversight role is effectively structured and organized, but further clarity on the separation between its service provider and oversight roles is warranted. In particular, in order to further reduce any potential conflict of interests and to ensure the clear division of responsibility and accountability, the separation between the oversight function and the operational function at all levels of the decision making, including the senior manager level of the Directorate General Payments and Market Infrastructure (DP), Payment and Settlement System Committee (PSSC), and ECB Board, respectively, should be more clearly articulated and made transparent to external parties.

Table 4.

European Union: Prioritized List of Recommendations

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Table 5.

European Union: Detailed Assessment of Observance of Responsibilities

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1

It is noted that subsequent to the IMF assessment, the Governing Council of the ECB adopted in early June 2013 the PFMIs as Eurosystem oversight standards for all types of FMIs and published for public consultation a draft ECB Regulation on oversight requirements for systemically important payment systems.

European Union: Detailed Assessment of Implementation of the European Central Bank Observance of the CPSS-IOSCO Responsibilities of Authorities for Financial Market Infrastructure
Author: International Monetary Fund. Monetary and Capital Markets Department