Systemically Important Financial Market Utilities and what the regulators want

The Harvard Law School Forum of Corporate Governance and Financial Regulation posted Financial Market Utilities: Is the System Safer?, a paper based on a PwC publication.

There has been lots of press about regulating Systemically Important Financial Market Utilities (SIFMU) and the risks they pose (including a recent Finadium paper “CCP Recovery and Resolution Plans: Players, Regulations and Ideas”) . Regulating the SIFMUs has fallen to the Fed. The SEC and CFTC can claim primary regulatory oversight in some cases, but the Fed has emerged as more equal.

From the report:

“…Although the FRB is the primary regulator of only two of the eight designated SIFMUs, it has been authorized by the Dodd-Frank Act to also supervise the other six SIFMUs indirectly as their backup regulator…”


“…all SIFMUs’ governance and risk management practices are being heavily influenced by the FRB. In this regard, our market observations indicate that a number of SIFMUs still need considerable infrastructure changes, process enhancements, and more skilled resources to meet the FRB’s expectations…”

Since the SIFMU designation was established, what has changed?

“…Since designation, SIFMUs have experienced significant changes in their regulatory relationships including more formal processes, heavier on-site examiner presence, and increased interaction between regulators and the board, senior management, risk managers, and internal audit. In addition, regulators have carried out more “surgically precise” examinations focusing on particularly high risk areas (e.g., default and liquidity risk management)…Regulators continue to push SIFMUs, based on their continued examination of SIFMUs’ business activities, in the following three major areas: governance, risk management, and recovery and wind-down planning (which is a critical subset of risk management)…”

Regulators have set out rules around governance, none of which should come as a surprise.

“…Senior management is required to ensure that the SIFMU’s activities and risks are managed under the direction of the board and consistently with board-approved policies, strategy, and risk appetite/tolerance. The board in turn is required to hold senior management accountable for discharging its duties, to exercise independent judgment, and to avoid conflicts of interest…”

“…Oversight by the SIFMU board has received particular scrutiny including an assessment of controls to facilitate effective board review of risk identification and to enable reporting that promotes directors’ understanding of issues…”

“…SIFMUs are expected to have directors who are not affiliated with the SIFMU’s owner(s), to bring an independent view to the governance process…”

Risk management is a bit more complicated. SIFMUs are required to have a chief risk officer as well as well-documented procedures. Liquidity management is a priority too.

“…SIFMUs that are central counterparties are additionally required to maintain sufficiently liquid resources to withstand a wide range of stress scenarios, including default by one or more clearing members. These firms must also conduct daily liquidity stress tests (using their own predetermined parameters and assumptions for the scenarios), and analyze the validity of their stress scenarios and their underlying assumptions on at least a monthly basis…”


“…SIFMUs’ liquidity risk management has particularly been a subject of heightened regulatory focus around liquidity stress scenario development and testing. Firms have faced challenges in this area, largely due to lack of detailed supervisory guidance. For example, regulators have made clear that they expect SIFMUs to develop scenarios that are sufficiently adverse, without providing guidance on scenario elements and the expected level of adversity…”

Regulators take a close look at recovery and wind-down paths, but aren’t necessarily saying the same things:

“…CFTC-regulated SIFMUs must maintain sufficient liquid resources to cover operating costs for a period of at least one year, calculated on a rolling basis. The FRB and SEC on the other hand require SIFMUs to hold sufficient liquid resources equal to the greater of the cost to implement their recovery or wind-down plans, or six months of current operating expenses…”


“…CFTC-supervised SIFMUs were required to prepare their recovery and wind down plans by year-end 2013, the FRB has mandated a December 31, 2015 compliance date, and the SEC has yet to finalize its relevant regulation…”

The article created a checklist for SIFMUs:

  1. Assess current governance structures, roles, and responsibilities to determine if they provide the adequate level of oversight, effective challenge, accountability, transparency, and independence.
  2. Ensure the board and senior management are aware of current and evolving regulatory requirements and their implications on the business model, strategies, and risk management approaches, and provide training where appropriate to facilitate understanding.
  3. Develop comprehensive risk management processes (policies, procedures, controls, and risk reporting and escalation requirements) to ensure accurate and reliable holistic risk exposure information, documentation, and recordkeeping/retention.
  4. Focus on strengthening risk model development and model validation practices, and collateral management processes.
  5. Enhance risk exposure reporting to ensure key participant information is monitored and reviewed, escalated, documented, and appropriately acted upon by senior management.
  6. Consider potential credit and liquidity stress events and have reliable plans in place to ensure the firm can meet its settlement obligations without causing instability in financial mark
  7. Regularly conduct end-to-end testing of default management processes with market participants (i.e., other SIFMUs and SIFMU participants) and incorporate lessons learned where appropriate.
  8. Evaluate and mitigate material risks that the firm poses to other entities, such as other FMUs, settlement banks, liquidity providers, or service providers as a result of interdependencies.
  9. Understand and manage material risks to the FMU posed by firms that are not members of the FMU but utilize its services (e., payment, clearing, and settlement) through their contracts with member firms.
  10. Prepare and continue to enhance recovery and wind-down plans, even in the absence of more regulatory clarity to ensure the plans are actionable, transparent, and free from impediments.

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