Financial Stability Standards for Securities Settlement Facilities – June 2024 Standard 17: FMI Links

Guidance

A link is a set of contractual and operational arrangements between two or more FMIs that connect the FMIs directly or through an intermediary. A securities settlement facility may establish a link with another securities settlement facility for the primary purpose of expanding its services to additional financial instruments, markets or institutions. For example, a securities settlement facility operating a central securities depository (referred to as an investor central securities depository) may establish a link to another central securities depository in which securities are issued or immobilised (referred to as an issuer central securities depository) to enable a participant in the securities settlement facility to access the services of the issuer central securities depository through the participant's existing relationship with the securities settlement facility. A securities settlement facility may also establish a link with a different type of FMI. For example, a central counterparty for securities markets may establish and use a link to a securities settlement facility operating a central securities depository to receive and deliver securities. This Standard covers links between securities settlement facilities, as well as links between a securities settlement facility and other types of FMI such as central counterparties, central securities depositories and trade repositories.^[43] If a securities settlement facility establishes a link, it should identify, monitor and manage its link-related risks, including legal, operational, credit and liquidity risks.^[44] Further, a securities settlement facility that establishes multiple links should ensure that the risks generated by one link do not affect the soundness of the other links and linked FMIs. Mitigation of such spillover effects requires the use of effective risk management controls, including additional financial resources or the harmonisation of risk management frameworks across linked FMIs.

Identifying link-related risks

17.1.1 Before entering into a link arrangement and on an ongoing basis once the link is established, a securities settlement facility should identify and assess all potential sources of risk arising from the link arrangement. The type and degree of risk varies according to the design and complexity of the securities settlement facility and linked FMIs and the nature of the relationship between them. In a simple case of a vertical link, for example, a securities settlement facility may provide basic services to another FMI, or vice versa, such as a central securities depository that provides securities transfer services to a securities settlement facility. Such links typically pose only operational and custody risks. Other links may be more complex and may pose additional risks to the securities settlement facility, such as credit and liquidity risks. In addition, links between a securities settlement facility and other FMIs may pose specific risks to the securities settlement facility or other FMIs in the link arrangement. For example, a central counterparty may have a link with a securities settlement facility that operates a central securities depository for the delivery of securities and settlement of margins. If the central counterparty poses risks to the securities settlement facility, the facility should manage those risks. In all cases, link arrangements should be designed such that the securities settlement facility is able to observe the SSF Standards.

Managing operational risk

17.1.2 A securities settlement facility should obtain an appropriate level of information about each linked FMI's operations in order for the securities settlement facility to perform effective periodic assessments of the operational risk associated with the link. In particular, securities settlement facilities should ensure that risk management arrangements and processing capacity are sufficiently scalable and reliable to operate the link safely for both the current and projected peak volumes of activity processed over the link (see SSF Standard 14 on operational risk). Systems and communication arrangements between the securities settlement facility and linked FMIs also should be reliable and secure so that the link does not pose significant operational risk to the securities settlement facility and the linked FMIs. Any reliance by a securities settlement facility on a critical service provider should be disclosed as appropriate to the linked FMI and the securities settlement facility should require reciprocal disclosure from the linked FMI. In addition, a linked securities settlement facility should identify, monitor and manage operational risks due to complexities or inefficiencies associated with differences in time zones, particularly as these affect staff availability. Governance arrangements and change management processes should ensure that changes in the securities settlement facility or a linked FMI will not inhibit the smooth functioning of the link, related risk management arrangements, or non-discriminatory access to the link (see SSF Standard 2 on governance and SSF Standard 15 on access and participation requirements).

Managing financial risk

17.1.3 A securities settlement facility in a link arrangement should effectively measure, monitor and manage its financial risk, including custody risk, arising from the link arrangement. A securities settlement facility should ensure that it and its participants have adequate protection of assets in the event of the insolvency of a linked FMI or a participant default in a linked FMI.

17.2.1 A link involving a securities settlement facility should have a well-founded legal basis, in all relevant jurisdictions, that supports its design and provides adequate protection to the securities settlement facility. Cross-border links may present legal risk arising from differences between the laws and contractual rules governing the linked FMIs and their participants, including those relating to rights and interests, collateral arrangements, settlement finality and netting arrangements (see SSF Standard 1 (on legal basis). For example, differences in law and rules governing settlement finality could lead to a scenario in which a transfer is regarded as final in the securities settlement facility but not final in the linked FMI, or vice versa. To limit any uncertainties arising from such a scenario, the respective rights and obligations of the linked FMIs and, where necessary, their participants should be clearly defined in the link agreement. In a cross-jurisdictional context, the terms of the link agreement should also set out an unambiguous choice of law that will govern each aspect of the link.

17.3.1 Prior to entering into a link arrangement with another FMI that is relevant to its operations in Australia, a securities settlement facility should consult with the Reserve Bank. As part of this consultation, the securities settlement facility should provide the Reserve Bank with a comprehensive description of the link arrangement. This description should include details of the legal basis of the link, and any financial obligations or operational interdependencies created by the link, including obligations created for both the securities settlement facility and the linked FMI. A securities settlement facility should provide sufficient detail to demonstrate that the link arrangement will not adversely affect its compliance with the SSF Standards. Where the Reserve Bank identifies aspects of the proposal that may create unacceptable risks for the securities settlement facility, the securities settlement facility should make any necessary changes to the proposal to control or mitigate these risks prior to implementation. These changes may be necessary to ensure that the securities settlement facility continues to comply with the SSF Standards and equivalent standards in other relevant jurisdictions.

17.3.2 Where a linked FMI's principal place of business is not in Australia, the Reserve Bank may also consult with the regulator of the linked FMI in its principal place of business, in order to understand the overseas regulator's assessment of the link arrangement and to ensure that all relevant legal, regulatory, operational and financial risk issues have been considered and addressed.

17.4.1 As part of its activities, a securities settlement facility operating a central securities depository may choose to establish a link with another central securities depository. If such a link is improperly designed, the settlement of transactions across the link could subject participants to new or increased risks. In addition to legal and operational risks, the securities settlement facility and its participants could also face credit and liquidity risks. For example, an operational failure or default in a linked central securities depository may cause settlement failures or defaults in a securities settlement facility and expose participants in the securities settlement facility, including participants that did not settle transactions across the link, to unexpected liquidity pressures or outright losses. The default procedures of a linked central securities depository, for example, could affect a securities settlement facility through loss-sharing arrangements. A securities settlement facility operating a central securities depository that has a link with another central securities depository should therefore identify, monitor and manage its credit and liquidity risks arising from the link arrangement. In addition, any credit extended to the linked central securities depository should be fully covered by high-quality collateral and subject to limits.

17.4.2 Furthermore, a securities settlement facility operating a central securities depository and any linked central securities depository should have robust reconciliation procedures to ensure that their respective records are accurate and current. Reconciliation is particularly important when three or more central securities depositories are involved in settling transactions (that is, the securities are held in safekeeping by one central securities depository or custodian while the seller and the buyer participate in one or more of the linked central securities depositories).

17.5.1 Some practices that may be adopted in link arrangements involving a securities settlement facility operating a central securities depository and other central securities depositories deserve particularly rigorous attention and controls. In particular, provisional transfers of securities between a securities settlement facility operating a central securities depository and the linked central securities depository should be prohibited or, at a minimum, the retransfer of provisionally transferred securities should be prohibited prior to the transfer becoming final.

17.6.1 In an indirect link arrangement, a securities settlement facility operating an investor central securities depository uses an intermediary (such as a custodian bank) to access the issuer central securities depository. In such cases, the securities settlement facility faces the risk that the custodian bank may become insolvent, act negligently or commit fraud. Although a securities settlement facility operating an investor central securities depository may not face a loss on the value of the securities, the ability of the facility to use its securities might temporarily be impaired. The securities settlement facility should measure, monitor and manage on an ongoing basis its custody risk (see also SSF Standard 13 on custody and investment risks) and provide evidence to the Reserve Bank and other relevant authorities that adequate measures have been adopted to mitigate this custody risk. In addition, the securities settlement facility should ensure that it has adequate legal, contractual and operational protections to ensure that its assets held in custody are segregated and transferable (see SSF Standard 9 on central securities depositories). Similarly, a securities settlement facility operating an investor central securities depository should ensure that any money settlement agents can perform as expected. In that context, the securities settlement facility should have adequate information on the business continuity plans of its intermediary and the issuer central securities depository to achieve a high degree of confidence that both entities will perform as expected during a disruptive event.