HM Treasury Consultation: RRP for Financial Market Infrastructures

On 1 August 2012, HM Treasury published a consultation document entitled “Financial sector resolution: broadening the regime”.  Citing the collapses of Bear Stearns (an investment firm) and AIG (an insurer), the UK Government is reviewing the need to establish a resolution regime framework for non-banks on a more accelerated timetable than that currently envisaged in ongoing international work.

The consultation is open for responses until 24 September 2012.  It asks for views on the most appropriate type of policy response with respect to systemically important firms, specifically whether existing administration/run-off arrangements should be extended/strengthened or whether a new comprehensive resolution regime should be introduced.  The consultation paper addresses four broad sectors:

  • investment firms and parent undertakings;
  • central counterparties (CCPs);
  • non-CCP financial market infrastructures (non-CCP FMIs); and
  • insurers.

HM Treasury considers that each of the above categories may be systemically important.  In addition, it does not preclude the possibility that other types of non-bank financial institution may also be systemically important, specifically referring to hedge funds.  However, it accepts that the case against insurers in “less clear cut” and recognises that, in practice, it is likely that only some, if any, of each type of entity within a category will actually be systemically important.

The UK Government expects the benefit of taking action pursuant to a formal resolution regime to exceed the costs of disorderly failure.  As such, it believes that there is a strong case for introducing powers earlier than is expected as part of any European process.  However, it does not propose to introduce stabilisation powers for insurers, non-CCP financial market infrastructure or shadow banking entities at this stage.  A more detailed summary of the consultation paper is provided in the schedule below.


1. Investment Firms

The consultation paper notes that the UK Special Administration Regime (“SAR”) introduced under the Banking Act 2009 has strengthened the UK’s ability to manage the failure of investment firms.  However, due to the fact that the resolution powers established under the Banking Act 2009 only apply to deposit-taking institutions, it believes that there is no suitable regime for managing the failure of:

  • systemically important investment firms;
  • parent undertaking(s) of systemically important investment firms; or
  • parent undertaking(s) of deposit-taking institutions.

As such, the UK Government intends to legislation in order to plug this gap.

1.1 Investment firms that would be subject to the new resolution regime 

The UK Government believes that it would be inappropriate to apply a prescriptive definition of ‘systemic investment firm’ due to the fact that:

  • some factors which will be relevant in assessing systemic importance will inevitably change over time; and
  • too restrictive a definition may make it difficult to take action to resolve a non-systemic firm before it actually reaches the point of failure.

As such, all UK incorporate investment firms will be subject to the new resolution regime.  For these purposes, an ‘investment firm’ means a UK institution which is an investment firm for the purposes of the Capital Adequacy Directive.[1]  However, it is important to note that the proposed stabilisation powers would only be exercisable with respect to a systemic investment firm.  Nonsystemic firms would be entered into the existing SAR.

1.2 The application of the new resolution regime to parent undertakings

Certain restrictions will apply to the use of stabilisation powers with respect to parent undertakings:

  • the intended legislation will only provide resolution powers for UK firms and parent undertakings;
  • the proposed stabilisation powers will only be exercisable in relation to financial elements of the holding company; and
  • where there is an overall parent holding company which owns both financial and non-financial subsidiaries and an intermediate holding company which owns the systemic financial subsidiary, stabilisation powers will only be exercised at the intermediary level.

1.3 Trigger conditions for intervention

Intervention will only be possible with respect to a systemically important firm, and will require the relevant firm’s regulator to be satisfied that the firm is failing, or likely to fail, its regulatory threshold conditions and that it is not likely that action (other than resolution action) will be taken to enable the firm to meet its threshold conditions.

1.4 Objectives for the resolution of investment firms and parent undertakings

The objectives for resolution of a systemically important investment firm and its parent undertakings will largely mirror the objectives for resolution of a deposit-taking institution, but will include the following additional objectives:

  • protection of client funds and client assets; and
  • avoiding unnecessary interference with the operations of financial market infrastructure.

1.5 Design of stabilisation powers

The powers to resolve a systemically important investment firm and/or its parent will be broadly similar to those contemplated in the draft Recovery and Resolution Directive (the “RRD”) i.e. transfer to a third party purchaser or a bridge institution.  However, the following powers will not be implemented separately from the RRD process:

  • bail-in;
  • transfer to an asset management vehicle; and
  • a stay on the exercise of early termination and close-out netting rights in financial contracts held by counterparties of a failed firm.

1.6 Safeguards

Safeguards to protect property rights affected as a result of the exercise of property transfer powers will be established by secondary legislation.

2. Central counterparties

2.1 Scope of the intended resolution regime

The Government’s proposed resolution regime for CCPs would capture any clearing house  incorporated in the UK and recognised under Part 18 of FSMA 2000. However, only systemically important CCPs would be subject to the resolution powers.  Before being able to exercise a stabilisation power to resolve a failing clearing house, the Bank of England would have to be satisfied that the exercise of stabilisation powers is necessary in pursuance of specified public interest aims. The powers would be similar to the stabilisation powers proposed for investment firms albeit that it is not envisaged that HM Treasury would have the power to transfer a clearing house into public ownership.

2.2 Trigger conditions for intervention

Conditions for intervention in order to ensure the continuity of clearing services would be triggered where a clearing house had breached, or is likely to breach, the conditions which the clearing house must meet in order to be, and continue to be, a recognised clearing house.  Two further preconditions to intervention would be that:

  • it is not likely that other actions would enable the clearing house to once again meet its authorisation conditions; or
  • notwithstanding that other actions would restore the clearing house to compliance with its authorisation conditions, such actions would undermine the continuity of clearing services.

2.3 Resolution Powers over CCPs

2.3.1 Power to direct clearing houses

The Bank of England would have the power to direct the actions of a clearing house if it was satisfied that this is in the public interest with respect to:

  • protecting, or maintaining confidence in, the UK financial system; or
  • protecting or maintaining the continuity of the services provided by the CCP or the CCP itself.

This power would enable the regulator to direct a CCP to take, or refrain from taking, action to address risks to its solvency or any other matter.  Specifically, a CCP could be required to amend/activate its rules or introduce emergency rules.

2.3.1 Power of Direction over an Administrator

The resolution authority would have power to direct the administrator of a failed CCP (subject to certain conditions) to take action to address risks to financial stability and ensure the continuity of services in support of an acquirer of the CCP’s business.

2.4 Objectives for operation of a resolution regime for CCPs

The objectives of the authorities with respect to the resolution of clearing houses would closely follow those already applicable to deposit-taking institutions under the Banking Act 2009 but would include an additional objective reflecting the need to maintain the continuity of the provision of critical central counterparty clearing services. As such, the set of resolution objectives would be as follows:

  • to maintain the stability of the financial systems of the United Kingdom;
  • to protect and enhance public confidence in the stability of the financial systems of the United Kingdom;
  • to maintain the continuity of the provision of central counterparty clearing services;
  • to protect public funds; and
  • to avoid interfering with property rights in contravention of the Human Rights Act 1998.

2.5 Stabilisation powers for CCPs

The stabilisation powers applicable to CCPs would broadly follow the design of existing stabilisation powers for banks, namely enabling the transfer of securities, property, rights and liabilities to a private sector purchaser or a ‘bridge’ CCP.  In order to ensure that clearing services remain uninterrupted, the Bank of England would also have power to:

  • temporarily suspend termination rights and ensure that any application of the stabilisation powers did not constitute an event of default with respect to any of the CCP’s contracts;
  • transfer membership agreements and clearing member positions and transfer and/or amend the rules of operation of a failed clearing house for a specified period of time or until a specified event occurred;
  • direct the actions of any insolvency practitioner appointed in relation to a clearing house; and
  • impose liabilities on shareholders and/or members of a CCP (potentially subject to a liability cap), to require them to contribute funds to restore a clearing house to viability.

2.6 Safeguards

Safeguards will include:

  • requirements that creditors are not discriminated against on grounds of nationality;
  • compensation arrangements for those affected by the exercise of stabilisation powers; and
  • measures to protect against partial property transfers.

3. Non-CCP financial market Infrastructures

3.1 Improving the regulatory framework for managing the failure of non-CCP FMIs

Non-CCP FMIs include:

  • central securities depositories and securities settlement systems;
  • payment systems;
  • exchanges and trading platforms; and
  • trade repositories.

There is currently no resolution regime for non-CCP FMIs, which are subject to ordinary UK insolvency law.  However, the failure of a non-CCP FMI would likely result in the cessation of critical services.  As such, the UK Government believes there is a need to legislate in this area and identifies two broad approaches:

  • strengthening the existing insolvency arrangements to ensure that the available insolvency mechanisms are adequate; and
  • developing a new, comprehensive resolution framework.

The trigger for intervention seems likely to occur when a firm is failing, or likely to fail, to continue to meet its regulatory recognition/authorisation/operational requirements, with no reasonable prospect of remedial action to address this.

Under the first approach, a modified administration regime is contemplated under which an administrator would have the specific objective of ensuring the continuity of services, supplemented by additional powers to enforce a stay on early termination rights and a moratorium on payments to creditors.

Under the second approach, a new resolution regime would be put in place, supplemented by appropriate powers such as:

  • the power to transfer some or all of a non-CCP FMI’s operations to a third party provider or to a bridge institution;
  • loss allocation or cash-call powers under which the system’s owners or members/users could be required to bear losses and/or provide additional funding; and
  • step-in powers under which the authorities could take over the management of the FMI, irrespective of any insolvency proceedings.

4. Insurers

4.1 Improving the regulatory framework for managing the failure of insurers

The UK Government broadly accepts that disruption to core insurance activities in themselves is unlikely to cause financial instability.  However, it is of the opinion that insurance institutions can still have a degree of systemic potential depending on:

  • the complexity of business models, particularly interconnectedness with banks;
  • dependencies and inter-linkages with other financial institutions (including through undertaking non-traditional insurance activities);
  • institution size; and
  • market share in insurance products that are necessary, or compulsory, for the functioning of economic activity.

As such, the Government wants to ensure that, on the failure of any insurer:

  • an orderly market exist can be facilitated; and
  • an appropriate degree of policyholder protection should be achieved, including, where appropriate, though continuity of cover.

The UK does not have a specific resolution regime for insurers.  Presently, failed insurance firms are dealt with through ‘run off’.  However, this process can result in the effective subordination of longer-dated policyholders.  With the goal of ensuring the continuity of payments and protection for policyholders, particularly (though not exclusively) long-term policyholders, the consultation paper identifies two possible options for managing the failure of insurance firms:

  • reviewing the adequacy of existing insolvency arrangements; and
  • assessing whether evidence exists to justify the establishment of a comprehensive set of resolution stabilisation tools specifically for the insurance industry, including the power to transfer assets and liabilities from a failing insurer to a third party.

[1] Directive 2006/49/EC

Recovery and resolution of financial market infrastructures


On 31 July 2012, the Committee on Payment and Settlement Systems (“CPSS”) of the Bank for International Settlements (“BIS”) and the International Organization of Securities Commissions (“IOSCO”) published a joint consultation document on the recovery and resolution of financial market infrastructures (“FMI”s), i.e. systemically important payment systems, central securities depositories, securities settlement systems (“SSSs”), central counterparties (“CCPs”) and trade repositories (“TRs”).

Objectives of the consultation paper

The Financial Stability Board’s “Key Attributes of Effective Resolution Regimes for Financial Institutions” (the “Key Attributes”) requires that FMIs establish resolution regimes appropriate to their critical role in financial markets.  The main purpose of the CPSS-IOSCO consultation paper is to outline the issues that should be considered for different types of FMIs when putting RRP regimes in place in accordance with the Key Attributes and the CPSS-IOSCO “Principles for financial market infrastructures” (the “Principles”).

 Conclusions of the consultation paper

 In summary, the consultation document concludes that:

  • the fundamental aspect of RRP as applied to FMIs is ensuring the continuance of critical operations and services;
  • it is vital that robust arrangements exist for the recovery and resolution of FMIs;
  • the Principles set out a recovery framework for FMIs;
  • regulators will need to ensure that appropriate rules and policies are put in place;
  • In the event of recovery failing, the Key Attributes provide a framework for resolution of FMIs. The methodology for assessing compliance with the Key Attributes, currently being prepared by the Financial Stability Board, will need to contain FMI-specific elements.

 The consultation paper is broken down into five sections:

  • Introduction;
  • Relationship and continuity between the Key Attributes and the Principles;
  • Recovery and resolution approaches for different types of FMI;
  • Important interpretations of the Key Attributes when applied to FMIs; and
  • Cooperation and coordination among relevant authorities.

A summary of the consultation paper is provided in the Schedule below.  The consultation itself is open for comments until 28 September 2012, with further work on this issue is to be published later in 2012.


 1. Introduction

The consultation document makes clear that the fundamental aspect of RRP as applied to FMIs is ensuring the continuance of critical operations and services of the FMI during a financial crisis.

2. Relationship and continuity between the Key Attributes and the Principles

Six areas for avoiding and mitigating systemic risk through strong recovery and resolution capabilities are identified within the consultation document.

2.1 Preventive measures and recovery planning

Authorities should ensure that FMIs develop comprehensive plans that identify:

  • critical operations and services;
  • scenarios that may potentially prevent the FMI from continuing as a going concern, and
  • the strategies and measures necessary to ensure continued provision of critical operations and services should those scenarios occur.

2.2 Oversight and enforcement of preventive measures and recovery plans

Authorities should continually assess the adequacy of an FMI’s recovery plans and, where deficiencies exist, have the power to enforce observance of the Principles.

2.3 Activation and enforcement of recovery plans

Authorities should oversee and have the power to enforce the execution of recovery plans by FMIs, including the power to:

  • issue orders;
  • impose fines or penalties; and
  • force a change of management.

2.4 Beyond recovery

In order to ensure the continuation of critical operations and services, resolution regimes covering FMIs should be specifically incorporated into law due to the fact that traditional bankruptcy procedures do not have the preservation of financial stability as an objective.

2.5 Resolution planning

FMIs should be required to provide authorities with all data and information needed for the purposes of timely resolution planning.

2.6 Cooperation and coordination with other authorities

RRP preparation and implementation should be supported by ex ante and “in the moment” cooperation and coordination amongst authorities.

3. Recovery and resolution approaches for different types of FMI

The consultation document draws a distinction between FMIs that take on credit risk as principal (such as CCPs, SSSs that extend credit, and payment or settlement systems that operate on a deferred net settlement basis and in which the system operator provides performance guarantees), and those that do not (such as TRs).

3.1 FMIs that do not take on credit risk

3.1.1 Recovery

All FMIs should have minimum levels of capital resources as well as recovery plans to manage circumstances in which those reserves prove inadequate.

3.1.2 Resolution

Even where an FMI does not take credit risk, authorities should have the power to:

  • transfer some or all of the FMI’s operations to one or more third parties; and
  • place the FMI into some form of administration, with power to suspend or renegotiate contractual arrangements entered into by the FMI.

3.2 FMIs that take on credit risk

3.2.1 Recovery

A CCP, and any other FMI that faces credit risk, should establish rules that address how credit losses in excess of available financial resources are to be allocated.  Typically, this may be achieved via the application of haircuts to the margin and collateral owing to surviving participants.

3.2.2 Resolution

Where the resolution triggers of an FMI are satisfied, in order to ensure that critical services are protected, the resolution authority should have available to it a broad range of resolution tools relating, inter alia, to:

  • loss allocation;
  • transfers; and
  • stay on termination rights.

Loss allocation

Prior to resolution, the rules of the FMI may impose losses on some participants ahead of equity. Once in resolution, further loss allocation amongst creditors should follow the ranking in insolvency, meaning that equity should typically be written down ahead of debt.  Authorities should also have loss allocation powers which go beyond that contemplated by the rules affecting participants in the FMI, including the power to;

  • haircut margin; or
  • enforce outstanding obligations under the FMI’s rules to replenish default funds or make cash calls.

The above options result in losses being distributed in a different manner.   Enforcing outstanding default fund contributions and cash call obligations is likely to affect clearing members only.   In contrast, margin-haircutting solutions are likely to involve losses falling on the clients of clearing members as well as clearing members due to the fact that, typically, client contracts include provisions for any losses suffered by a clearing member to be passed on to the client.


Resolution authorities will need the power to transfer operations/assets to a third party purchaser/bridge institution.

Stay on Early Termination Rights

Resolution authorities should have the power to impose a stay on exercising termination rights (but not other contractual obligations):

  • against participants of an FMI, as the exercise of early termination rights in these circumstances could prevent the FMI from continuing critical operations and services and/or, in the case of a CCP, result in an  “unmatched book”; or
  • where an FMI is reliant upon services provided by an external third party for continuity of critical services (e.g. IT services).

4. Important interpretations of the Key Attributes when applied to FMIs

When interpreting the Key Attributes in the context of RRP for FMIs, the following should be borne in mind:

  • Deposits (Key Attribute 2):  the protection of depositors will not usually be relevant due to the fact that FMIs typically do not receive deposits;
  • Suspension of payments (Key Attribute 3.2(xi)): the suspension of payments by an FMI is likely to perpetuate or even amplify systemic disruption.  It could result in the full or partial stoppage of the system, possibly defeating the objective of continuity of critical operations and services;
  • Appointment of an administrator to effect an orderly wind-down (Key Attribute 3.2 (ii) and (xii)): the power to conduct an orderly wind-down of a firm may not be a credible resolution strategy for FMIs for which making payments is integral to their critical services;
  • Transfer of critical functions (Key Attribute 3.3):  the ability to transfer the ownership/assets/liabilities of an FMI to a transferee may be of limited value as:
    • there may be few (if any) alternative providers of its critical operations/services; and
    • there may be a number of practical issues that would hinder or prevent any transfer e.g. different participation requirements, IT system incompatibility or legal barriers (such as antitrust or competition laws);
  • Bridge institution (Key Attribute 3.4):  transfer to a bridge institution may be a more attractive option when resolving an FMI in that a bridge institution could more readily ensure continuity and stability while avoiding the legal and operational impediments that may arise with an outright transfer to a third party;
  • Bail-in within resolution (Key Attributes 3.5 and 3.6): unlike banks or investment firms, most FMIs typically do not issue debt securities, limiting the utility of bail-in as a resolution tool;
  • Setoff, netting, collateralisation, segregation of client assets (Key Attribute 4): it is particularly important for an FMI to create legal certainty regarding the legal framework governing setoff rights, contractual netting and collateralisation agreements, and the segregation of client assets;
  • Stays on early termination rights (Key Attributes 4.3 and 4.4): a stay on the termination rights of participants, other counterparties and third party service providers is an important resolution tool with respect to an FMI, particularly a CCP;
  • Safeguards (Key Attribute 5): the principal of “no creditor worse off than in liquidation” continues to apply.  However, with respect to FMIs, this concept should be assessed on the basis of creditor claims as they exist following the FMI’s ex ante rules and procedures for addressing uncovered credit and liquidity needs and the replenishment of financial resources;
  • Funding of FMIs in resolution (Key Attribute 6): Resolution regimes for financial institutions should include cost recovery frameworks so as to minimise taxpayer exposure.  However, for certain types of FMI, participant-based arrangements, such as CCP default arrangements, may be more appropriate.  The provision of temporary funding is possible but should be exceptional and subject to strict conditions that restricts moral hazard and ensures the right to recover any such funding;
  • Resolvability assessments (Key Attribute 10): resolution authorities are expected to regularly undertake resolvability assessments for global systemically important financial institutions.  However, resolvability assessments of an FMI should take into account FMIs’ specific role in the financial system and consider such aspects as:
    • the impact on FMI participants and linked FMIs; and
    • the ability of participants and linked FMIs to retain access to the FMI’s critical operations and services;
  • Recovery and resolution planning (Key Attribute 11):  an FMI should develop and maintain comprehensive plans addressing recovery, orderly wind-down and resolution issues within its governance, risk management and operational arrangements that:
    • identify scenarios that may threaten its ability to continue as a going concern;
    • include a substantive summary of key recovery strategies;
    • identify critical operations and services; and
    • describe measures needed to implement key strategies;
  • Access to information and information-sharing (Key Attribute 12): jurisdictions should ensure that no legal, regulatory or policy impediments exist that hinder the appropriate exchange of information.

5. Cooperation and coordination among relevant authorities

The international nature of many FMIs may mean that several supervisory and resolution authorities have responsibilities for an individual FMI.  Consequently, cooperation and coordination among and between these authorities is necessary in order to ensure that their respective responsibilities can be fulfilled efficiently and effectively at all times.