Dutch response to the European Commission’s consultation on a proposal for a ‘recovery and resolution framework for financial institutions other than banks’
Ministry of Finance – The Netherlands
Introduction
The Netherlands welcomes the consultation paper, which focuses on an important aspect of financial stability: a smooth recovery and resolution framework for financial institutions other than banks. The consultation paper rightly points out the possibility that failure of non-bank financial institutions – caused by either a solvency problem or a technical malfunction – can severely impact financial stability.
General comments
· We are of the opinion that for systemically important financial institutions, an effective recovery and resolution framework should be available. Factors that play a role in determining whether a financial institution is systemically important are inter alia size, inter-connectedness with other institutions and the degree to which an entity’s critical services are substitutable. However, the determination whether an institution is indeed systemically important cannot be answered clearly at all times. It is also important to bear in mind that (implicit) guarantees provided by governments should be minimized, in order to reduce moral hazard and strengthen market discipline and competition.
· Furthermore, we urge the Commission to take into account that the recovery and resolution tools that could be used for banks, are not fully transferable to nonbank financial entities at all times. For that particular reason, we have not always been able to answer each and every question of the consultation paper in great detail. Some particular tools are just not feasible for nonbank financial institutions. In such cases, we have tried to communicate our main message about the subject in question.
· A matter that is not discussed in the consultation paper, which we find important to express is the fact that for, in principle, all recovery and resolution mechanisms and powers that will be created should be subject to independent court approval. Whether this approval has to be acquired in advance of in a later stage, will depend on the character of the measure and the circumstances. In our view, there could be scenario’s possible in which certain recovery mechanisms can be put in place would not need prior court approval, but we do think that in all cases resolution mechanisms, especially those which involve an infringement of property rights, should be subject to prior court approval.
Comments related to the various questions
Financial market infrastructures: Central counterparties and central securities depositories
1. Do you think that a framework of measures and powers for authorities to resolve CCPs and CSDs is needed at EU level or do you consider that ordinary insolvency law is sufficient?
The Netherlands is of the opinion that a framework of measures and powers for authorities to resolve CCPs and CSDs is needed. Therefore we welcome the Commission’s initiative to work towards a resolution scheme at a European level. A solution at the national level would in our view not be effective, considering the extended cross-border character of Clearing and Settlement services.
The traditional bankruptcy process does not have the preservation of financial stability as an objective. Conventional insolvency procedures can disrupt the provision of services provided by clearing- and settlement entities for an extended period of time. In practice, however, there will only be a very short period of time available in which the clearing and/or settlement of transactions can be postponed, without causing a severe disruption of the financial markets. Therefore an adequate segregation/portability regime is needed to protect investor positions in the event of a default or insolvency.
Even though we deem a recovery and resolution framework for nonbank financial institutions such as CCPs, (re-)insurance firms, payment systems and other nonbank financial entities desirable, we are of the opinion that CSDs should not be included here. A default of a CSD incorporates mainly operational risks. As a consequence, we think it would be best to discuss a possible recovery and resolution framework into the CSDR (CSD Regulation), in order to ensure an integral approach for CSDs. However, if this would imply a significant delay in the negotiation process with regard to the CSDR proposal, The Netherlands would favor to work out a Recovery and Resolution regime for CSDs in this context.
2. In your view, which scenarios/events might lead to the need to resolve respectively a CCP and a CSD? Which types of scenarios CCPs/CSDs and authorities need to be prepared for which may imply the need for recovery actions if not yet resolution?
In our view a CCP or CSD can fail because of different reasons. The main differentiation would probably be between a failure because of operational or internal causes and a failure because of extreme market circumstances.
Both scenario’s are unlikely because regulation requires FMIs to prevent a failure of the FMI to the largest extend possible. The effect of a failure then would be very difficult to analyze beforehand and would be difficult to measure, for example in terms of financial impact. However the resolution or recovery of an FMI would be operationally different between both types of failure and would probably have a different impact financially on the participants of the system.
It should be required for FMIs to develop scenarios which would cause its failure and to assess its effects. Authorities should cooperate with FMIs, market participants and other authorities to mitigate its effects.
Possible scenario’s which would require involvement of authorities would be liquidity provision in case a CCP is solvent but cannot liquidate its resources in time; imposing loss distribution schemes in the rules of FMIs to in order to absorb a possible loss; halting trading to freeze positions in order to limit damages (possibly trading should be allowed to limit damages as well).
Different scenarios need different approaches and measures.
If the CCP becomes insolvent, there are broadly two possible solutions: (i) keep the positions open or (ii) liquidate the positions. If the positions are kept open, another CCP should take them over. It could be necessary to renegotiate the terms of the contracts between the CCP and its trading platform, which could destabilize the financial markets. Standardization of contracts is therefore a second measure that should be promoted.
However, in practice portability of contracts could prove to be very difficult. To disentangle all contracts that are cleared within a CCP, as well as the various links between the Clearing Members can be impossible in the short time provided. Moreover, another CCP should be found which would be able to take over the various positions of the insolvent CCP. If this would be made possible on a voluntary basis, it could be the case that no other CCP would be willing to step in and take over. The regulator could make this obligatory, but the question is whether such an obligation would not harm the markets, especially in periods of high stress levels and high volatility. Indeed the insolvency of a CCP is more likely during stressed economic times, times in which other CCPs could already face their own difficulties without taking over other positions.
Furthermore, portability to another CCP would cause practical issues: two competing FMIs may have different participants and participant requirements; IT systems are incompatible; and there could be legal barriers when CCPs are located in different countries.
3. Do you think that existing rules which may impact CCPs/CSDs resolution (such as provisions on collateral or settlement finality) should be amended to facilitate the implementation of a resolution regime for CCPs/CSDs?
Resolution and recovery of FMIs may be impacted by the SFD or the collateral directive. In developing scenario’s and the possible mitigation of the effects it may well be that, for example as an ultimate response, settlement instructions in a CSD should be unilaterally revoked. Part of the purpose of the SFD is to protect FMIs from transactions being revoked. In case of a failure of an FMI this purpose may impede a resolution of the FMI itself. However, any amendment should be analyzed thoroughly before implementation.
4. Do you consider that a common resolution framework applicable to CCPs and CSDs is desirable or do you favor specific regimes by type of FMIs?
CCPs and CSDs carry totally different risk profiles. Furthermore, there are different types of systemic risks involved in the central clearing versus the settlement services. Therefore it would be useful to consider different regimes for CCPs and CSDs. For CCPs articles 37 and 48 may serve as a starting point for the development of a common resolution & recovery framework.
5. Do you consider that it should only apply to those FMIs which attain specific thresholds in terms of size, level of interconnectedness and/or degree of substitutability, or to those FMIs that incur particular risks, such as credit and liquidity risks, or that it should apply to all? What would be an appropriate treatment of CSDs that do not incur credit and liquidity risks and those that incur such risks?
At this stage this question cannot be answered with full clarity. Further examination will be required, especially of the interconnectedness of CCPs and CSDs.
6. Regarding FMIs (some CSDs and some CCPs) that are also credit institutions, is the proposed bank recovery and resolution framework sufficient or should something in addition be considered? If so, what should the FMI-specific framework add to the bank recovery and resolution framework? How do you see the interaction between the resolution regime for banks and a specific regime for CCPs/CSDs?
We are of the opinion that the crucial difference between FMI and bank resolution lies in the fact that the failure of CCPs/CSDs may have even more systemic implications than that of a systemic credit institution. CCPs and CSDs are part of the financial infrastructure, partly meant to prevent systemic shocks to be transferred through the financial sector. Failure of an FMI therefore not only exposes the financial market to its failure but also removes an essential line of defense for other systemic shocks.
7. Do you agree that the general objective for the resolution of CCPs/CSDs should be continuity of critical services?
The general objective for the resolution of CCPs / CSDs should indeed be the continuity of critical services. The close down of a market would have serious negative effects on financial stability; the systemic disruption should be minimized. This is all the more important given the G20 decision in 2009 to clear all standardized OTC derivatives through CCPs. Discontinuation of services that are not critical to the markets and that could be taken over by other institutions, is acceptable.
8. Do you agree with the above objectives for the resolution of CCPs/CSDs?
Generally we do agree with the following objectives:
· Resolution should ensure the continuity of critical services, preserve financial stability and avoid contagion. All financial institutions, markets and participants are dependent on FMIs to conduct critical payment, clearing, settlement, and recording functions on a reliable and timely basis to process financial transactions, channel monetary policy, and transfer funds around the world;
· Operational objectives: adequate preparation for failure; ensure resolvability; provide legal certainty and predictability about the triggering of resolution;
· Designation of authorities responsible for resolution; develop adequate resolution powers and tools; develop coordination mechanisms among different jurisdictions and authorities.
9. Which ones are, according to you, the ones that should be prioritized?
In our view, all of the above mentioned objectives would require priority.
10. What other objectives are important for CCP/CSD resolution?
Other objectives that should be taken into account are:
· Protecting the assets of investors;
· Ensure, where possible, the timely completion of the settlements;
· To manage or close out the positions of a defaulting CM, and liquidate collateral in a prudential and orderly manner;
· Minimizing the costs of resolution;
· Providing a clear framework for accessing the liquidity facilities of the FMI;
· The method for identifying a default should be made clear, especially with regard to whether the identification is automatic or discretionary;
· Transparency / predictability through legal and procedural clarity;
11. What should be the respective roles of FMIs and authorities in the development and execution of recovery plans and resolution plans? Should resolution authorities have the power to request changes in the operation of FMIs in order to ensure resolvability?
Due to the systemic importance of CCPs and CSDs, public authorities should play a role in recovery and resolution plans (RRPs). A two track plan could be a possible solution: (i) FMIs should be given leeway to deal with RRPs (as it is in their own interest to be solvent), but at the same time (ii) public authorities should supervise these private initiatives.
The primary responsibility for planning and implementing an FMI’s recovery rests with the FMI itself. In this way, it should be able to avoid problems and be able to address those that do occur without public intervention. The relevant authorities should ensure that FMIs have those plans in place and monitor and assess these plans adequately, both on continued availability and if/when executed. Public authorities should have the necessary powers for effective enforcement in this context. Cooperation and information-sharing between the different authorities and FMIs is also necessary to ensure effectiveness. Authorities should have the power to require implementation of recovery measures so that they could drive optimal execution if the FMI itself would be unable to do so. These powers should include the issuance of orders, the imposition of fines / penalties, and enforcing a change of management.
12. To what extent do you think that CCPs/CSDs in cooperation with their users would be able to define efficient recovery and resolution plans on the basis of amendments to their contractual laws?
We refer to our answer to question 11.
13. Should resolution be triggered when an FMI has reached a point of distress such that there are no realistic prospects of recovery over an appropriate timeframe, when all other intervention measures have been exhausted, and when winding up the institution under normal insolvency proceedings would risk causing financial instability?