Financial Stability Standards for Securities Settlement Facilities – December 2012 Standard 12: General Business Risk

Guidance

A securities settlement facility should have robust management and control systems to identify, monitor and manage general business risk. General business risk refers to the risks and potential losses arising from a securities settlement facility's administration and operation as a business enterprise that are neither related to participant default nor separately covered by financial resources under SSF Standard 4 on credit risk or SSF Standard 6 on liquidity risk. General business risk includes any potential impairment of the securities settlement facility's financial position (as a business concern) as a consequence of a decline in its revenues or an increase in its expenses, such that expenses exceed revenues and result in a loss that must be charged against capital. Such impairment can be caused by a variety of business factors, including poor execution of business strategy, negative cash flows or unexpected and excessively large operating expenses. Business-related losses also may arise from risks covered by other standards, for example, legal risk (in the case of legal actions challenging the securities settlement facility's custody arrangements), investment risk affecting the securities settlement facility's resources and operational risk (in the case of fraud, theft or loss).^[31] In these cases, general business risk may cause a securities settlement facility to experience an extraordinary one-time loss as opposed to recurring losses.

Identifying business risk

12.1.1 A securities settlement facility should identify and assess the sources of business risk and their potential impact on its operations and services, taking into account past loss events and financial projections. A securities settlement facility should assess and thoroughly understand its business risk and the potential effect that this risk could have on its cash flows, liquidity and capital positions. In doing so, a securities settlement facility should consider a combination of tools, such as risk management and internal control assessments, scenario analysis and sensitivity analysis. Internal control assessments should identify key risks and controls and assess the impact and probability of the risks and the effectiveness of the controls. Scenario analysis should examine how specific scenarios would affect the securities settlement facility. Sensitivity analysis should test how changes in one risk affect the securities settlement facility's financial standing; for example, how the loss of a key customer or service provider might impact the securities settlement facility's existing business activities. In some cases, a securities settlement facility may wish to consider an independent assessment of specific business risks.

12.1.2 A securities settlement facility should clearly understand its general business risk profile so that it is able to assess its ability to either avoid, reduce or transfer specific business risks, or accept and manage those risks. This requires the ongoing identification of risk mitigation options that the securities settlement facility may use in response to changes in its business environment. When planning an expansion of activity, a securities settlement facility should conduct a comprehensive enterprise risk assessment. In particular, when considering any major new product, service or project, the securities settlement facility should forecast potential revenues and expenses as well as identify and plan how it will cover any additional capital requirements. Further, a securities settlement facility may eliminate or mitigate some risks by instituting appropriate internal controls or by obtaining insurance or indemnity from a third party.

Measuring and monitoring business risk

12.1.3 Once a securities settlement facility has identified and assessed its business risk, it should measure and monitor these risks on an ongoing basis and develop appropriate information systems as part of a robust enterprise-wide risk management program. Key components of a robust enterprise-wide risk management program include establishing strong financial and internal control systems so that the securities settlement facility can monitor, manage and control its cash flows and operating expenses and mitigate any business-related losses (see SSF Standard 3 on the framework for the comprehensive management of risks). In particular, a securities settlement facility should minimise and mitigate the probability of business-related losses and their impact on its operations across a range of adverse business and market conditions, including the scenario that its viability as a going concern is questioned. A securities settlement facility should also ensure that it has rigorous and appropriate investment guidelines and monitoring procedures (see SSF Standard 13 on custody and investment risks).

12.2.1 A securities settlement facility should hold, or demonstrate that it has legally certain access to, liquid net assets funded by equity (such as common stock, disclosed reserves or retained earnings) so that it can continue operations and services as a going concern if it incurs general business losses.^[32] Equity allows a securities settlement facility to absorb losses on an ongoing basis and should be permanently available for this purpose. The amount of liquid net assets funded by equity a securities settlement facility should hold, or have access to, should be determined by its general business risk profile and the length of time required to achieve a recovery or orderly wind-down, as appropriate, of its critical operations and services if such action is taken.^[33] If these assets are not held by the securities settlement facility itself, the securities settlement facility must have legally certain arrangements in place that guarantee it can access liquid net assets held by an affiliated entity, including in circumstances where its own or the affiliated entity's financial standing was in doubt. Any such arrangement should be subject to approval by the Reserve Bank and other relevant authorities.

12.2.2 In order to estimate the amount of liquid net assets funded by equity that a particular securities settlement facility would need, the securities settlement facility should regularly analyse and understand how its revenue and operating expenses may change under a variety of adverse business scenarios as well as how it might be affected by extraordinary one-time losses. This analysis should also be performed when a material change to the assumptions underlying the model occurs, either because of changes to the securities settlement facility's business model or because of external changes. A securities settlement facility needs to consider not only possible decreases in revenues but also possible increases in operating expenses, as well as the possibility of extraordinary one-time losses, when deciding on the amount of liquid net assets to hold or make accessible to cover general business risk.

12.3.1 A securities settlement facility should maintain a viable plan to achieve recovery and orderly wind-down and should hold, or have access to, sufficient liquid net assets funded by equity to implement this plan.^[34] The appropriate amount of liquid net assets funded by equity will depend on the content of the plan and, specifically, on the size of the securities settlement facility, the scope of its activities, the types of actions included in the plan, and the length of time needed to implement them. A securities settlement facility should also take into consideration the operational, technological and legal requirements for participants to establish and move to an alternative arrangement in the event of an orderly wind-down. At a minimum, however, a securities settlement facility should hold, or have access to, liquid net assets funded by equity equal to at least six months of current operating expenses.^[35]

12.3.2 Assets held by a securities settlement facility to cover risks or losses other than business risk (for example, where relevant, the financial resources required under SSF Standard 4 on credit risk and SSF Standard 6 on liquidity risk) should not be included when accounting for liquid net assets available to cover business risk.^[36] However, any equity held under international risk-based capital standards should be included where relevant and appropriate to avoid duplicate capital requirements.

12.4.1 To ensure the adequacy of its own resources, a securities settlement facility should regularly assess and report its liquid net assets funded by equity relative to its potential business risks to the Reserve Bank and other relevant authorities (see also SSF Standard 19 on regulatory reporting).

12.5.1 A securities settlement facility should provide a viable capital plan for maintaining an appropriate level of equity. The capital plan should specify how a securities settlement facility would raise new capital if its equity capital were to fall close to or below the amount needed. This plan should be approved by the board of directors (or an appropriate board committee), reviewed at least annually and updated as appropriate. A securities settlement facility may also need to consult its participants and others during the development of its plan.

12.5.2 In developing a capital plan, a securities settlement facility should consider a number of factors, including its ownership structure and any insured business risks. For example, a securities settlement facility should determine if and to what extent specific business risks are covered by explicit insurance from a third party, or explicit indemnity agreements from a parent, owners or participants (for example, general loss allocation provisions and parent guarantees), which would be realisable within the recovery or orderly wind-down time frame. Given the contingent nature of these resources, a securities settlement facility should use conservative assumptions when taking them into account for its capital plan. Furthermore, these resources should not be taken into account when assessing the securities settlement facility's capital adequacy.