Working Group #2 - Report Credit & Liquidity Risk

Working Group #2 Principle #4 PFMI # 4 Risk: Credit 1.What constitutes "compliance" with the Principle? Describe (in specific terms) the state characteristics of a CSD that fully meets the requirements of the Principle. FMI type: multi or single jurisdiction Identifying all of the potential sources of credit risk for the particular FMI that you are o In-coming: Participants, issuers, investment banks, billing, quality of investments o Out-going: You may impose credit risk on your participant by not completing your activities (e.g., corporate actions) Establish a robust framework to measure, monitor, manage, audit and reporting credit exposures o Defined limits of credit risk tolerances at a BofD level with statute, policy and procedure governance Accountability, frequency of review, what are the key performance indicators o Appropriate oversight at management committee and BofD levels (escalation alerts of limit threshold limits breaches) o Measurement frequency ideally real-time o Validated timely pricing sources/models Sufficient financial resources to cover current and potential future exposure (PFE) o Securities Settlement Service (SSS): Fully at a high confidence level Collateral and other equivalent financial resources o Central Counterparty (CCP): Fully at a high confidence level Margin and other prefunded financial resources Should consider wide range of stress scenarios (multi/single jurisdiction) Frequency of stress tests o Daily monthly comprehensive analysis o Regular assessment of stress scenarios and results o Ensure appropriate parameters/indices are being stressed Periodic validation of risk model and business changes which may introduce new risks

Working Group #2 Principle #4 PFMI #4 Risk: Credit 1. What constitutes "compliance" with the Principle? Describe (in specific terms) the state characteristics of a CSD that fully meets the requirements of the Principle.

PFMI # 4 Risk: Credit 2. In relation to the Key Considerations for the Principle, what metrics/data should a CSD compile in order to demonstrate compliance? How might this data be sourced? The metric is the ability to evidence the governance framework e.g., the policy, the required monitoring of compliance, the validation of the model, the credit risk limits, etc. Tolerances set at the BofD level o Need a reporting framework which has transparency/alerts to the BofD – evidenced o Frequency of compliance reporting to Senior Management and the BofD – evidenced o Credit risk escalation levels with alerts escalation levels – evidenced Parameter validation o Price sources/models Adequacy of financial resources o Meet thresholds fully with a high degree of confidence o Understand 1% scenarios and discuss them at the highest levels Stress testing o Adequacy of stress scenarios give evolving market conditions Does the existing set of scenarios include potential market events Does your organization know what can take you out and develop warning signals to give you heads-ups Does the existing set of scenarios fully address the evolving portfolio of exposures New instrument classes Back testing o Model performs within acceptable tolerances Working Group #2 Principle #4

PFMI #4 Risk: Credit 2. In relation to the Key Considerations for the Principle, what metrics/data should a CSD compile in order to demonstrate compliance? How might this data be sourced? Working Group #2 Principle #4

PFMI # 4 Risk: Credit 3. What result levels" with respect to these metrics/data should a CSD achieve in obtaining "compliance"? Why? Working Group #2 Principle #4

PFMI #4 Risk: Credit 3. What result levels" with respect to these metrics/data should a CSD achieve in obtaining "compliance"? Why? Working Group #2 Principle #4

PFMI # 4 Risk: Credit 4. What, if any, provisions should you (as an FMI) be making to ensure continued adherence to the principle (s), for example in times of market or operational distress? Do not get a false sense of comfort o Look for the unexpected o Assess risks from different perspectives CCP: What is a sufficient prefunded resource in addition to margin? o At what confidence level? Provision for evolving market conditions is setting-up stress tests Provision for pricing when price feeds/or models are not indicative of prevailing/prospective market prices and other price parameters Continuing appropriateness of risk model should be assessed annually Working Group #2 Principle #4

PFMI #4 Risk: Credit 4. What, if any, provisions should you (as an FMI) be making to ensure continued adherence to the principle(s), for example in times of market or operational distress? Working Group #2 Principle #4

Working Group #2 Principle #5 PFMI # 5 Risk: Collateral 1.What constitutes "compliance" with the Principle? Describe (in specific terms) the state characteristics of a CSD that fully meets the requirements of the Principle. Collateral more valuable than positions it covers Demonstrated ability to price instruments and an independent dispute settlement mechanism Low credit risk High liquidity Low price volatility Low market risk o Mitigate cross-border risks (e.g., market risk includes foreign exchange risk) Low concentration risk Mitigate high concentration of highly correlated wrong-way risk collateral Frequent marking-to-market o Daily minimum o Pricing discretion to reflect prospective market liquidation prices Frequent testing of haircuts Stable haircuts which mitigate pro-cyclicality Collateral eligibility should be highly correlated to that collateral eligible to backstop your lines of credit Category credit rings and waterfall mechanisms and how collateral covers the corresponding risks o Balancing the risk mitigation goals and the participants collateral costs Custody access of collateral & legal contract enforceability

Working Group #2 Principle #5 PFMI #5 Risk: Collateral 1. What constitutes "compliance" with the Principle? Describe (in specific terms) the state characteristics of a CSD that fully meets the requirements of the Principle.

PFMI # 5 Risk: Collateral 2. In relation to the Key Considerations for the Principle, what metrics/data should a CSD compile in order to demonstrate compliance? How might this data be sourced? A well develop category credit ring structure and waterfall mechanism o Metrics which are well defined and capable of being evidenced Market depth of collateral eligible assets o Percentage of outstanding open interest limits o Haircuts may be adjusted to increase as posted collateral approaches percentage thresholds Credit risk metrics Stable haircuts o Mitigate risk and manage pro-cyclical risk Correlations of collateral eligible assets and participants Validation of pricing sources Ensure rights to collateral are legally enforceable across borders Working Group #2 Principle #5

PFMI #5 Risk: Collateral 2. In relation to the Key Considerations for the Principle, what metrics/data should a CSD compile in order to demonstrate compliance? How might this data be sourced? Working Group #2 Principle #5

PFMI # 5 Risk: Collateral 3. What result levels" with respect to these metrics/data should a CSD achieve in obtaining "compliance"? Why? Governance framework with appropriate monitoring, reporting and escalation mechanisms Establish thresholds which satisfy risk controls The legal and operational framework for rehypotication/reuse should be well managed and coordinated Understand the sources of recourse for liquidity in support of collateral short falls Periodic reviews/scans of the collateral management framework Working Group #2 Principle #5

PFMI #5 Risk: Collateral 3. What result levels" with respect to these metrics/data should a CSD achieve in obtaining "compliance"? Why? Working Group #2 Principle #5

PFMI # 5 Risk: Collateral 4. What, if any, provisions should you (as an FMI) be making to ensure continued adherence to the principle(s), for example in times of market or operational distress? Working Group #2 Principle # 5

PFMI #5 Risk: Collateral 4. What, if any, provisions should you (as an FMI) be making to ensure continued adherence to the principle(s), for example in times of market or operational distress? Working Group #2 Principle # 5

Working Group #2 Principle #6 PFMI # 6 Risk: Margin 1.What constitutes "compliance" with the Principle? Describe (in specific terms) the state characteristics of a CCP that fully meets the requirements of the Principle. Margin calculation should consider the relevant risk parameters of the underlying portfolio Daily mark-to-market (variation margin) o Should allow for more frequent calls for variation margin Should consider current and PFE o Risk adjusted margin models o PFE at a 99% CL o PFE should account for close-out period Should permit cross-margining when risks parameters can be demonstrated to be highly correlated Methodology should mitigate wrong-way risk and pro-cyclicality Methodology should be well documented and easy to replicate by participants Margin calls should have strict timelines associated with them o FMI should have the ability to impose fees when a participants margin is late Reliable price sources/models Regular model validation

Working Group #2 Principle #6 PFMI #6 Risk: Margin 1. What constitutes "compliance" with the Principle? Describe (in specific terms) the state characteristics of a CCP that fully meets the requirements of the Principle.

PFMI # 6 Risk: Margin 2. In relation to the Key Considerations for the Principle, what metrics/data should a CSD compile in order to demonstrate compliance? How might this data be sourced? The processes and controls should be easy to evidence Transparent reporting and escalation of thresholds limits Back testing of market risk Validation of pricing sources/models Periodic reviews of appropriateness of liquidity/close-out assumptions Periodic reviews of wrong-way risk/pro-cyclical mitigants Working Group #2 Principle #6

PFMI #6 Risk: Margin 2. In relation to the Key Considerations for the Principle, what metrics/data should a CSD compile in order to demonstrate compliance? How might this data be sourced? Working Group #2 Principle #6

PFMI # 6 Risk: Margin 3. What result levels" with respect to these metrics/data should a CSD achieve in obtaining "compliance"? Why? Working Group #2 Principle #6

PFMI #6 Risk: Margin 3. What result levels" with respect to these metrics/data should a CSD achieve in obtaining "compliance"? Why? Working Group #2 Principle #6

PFMI # 6 Risk: Margin 4. What, if any, provisions should you (as an FMI) be making to ensure continued adherence to the principle (s), for example in times of market or operational distress? Working Group #2 Principle # 6

PFMI #6 Risk: Margin 4. What, if any, provisions should you (as an FMI) be making to ensure continued adherence to the principle (s), for example in times of market or operational distress? Working Group #2 Principle # 6

Working Group #2 Principle #7 PFMI # 7 Risk: Liquidity 1.What constitutes "compliance" with the Principle? Describe (in specific terms) the state characteristics of a SSS & CCP that fully meets the requirements of the Principle. A governance framework to measure, monitor and manage liquidity risk o BofD approved tolerances, thresholds and reporting mechanisms o Sufficiency tests should be approved by the BofD Mechanisms should be in place to o Measure the liquidity risk and must have adequate resources to ensure that they are sufficient to manage the default of multiple of the single largest participant o Understand current and future liquidity needs Demonstrate that liquidity resources are available and collateral is in place as required in support of them Central bank to act as the ultimate banker in the event of a default o Providing liquidity subject to collateral

Working Group #2 Principle #7 PFMI #7 Risk: Liquidity 1. What constitutes "compliance" with the Principle? Describe (in specific terms) the state characteristics of a SSS & CCP that fully meets the requirements of the Principle.

PFMI # 7 Risk: Liquidity 2. In relation to the Key Considerations for the Principle, what metrics/data should a CSD compile in order to demonstrate compliance? How might this data be sourced? Working Group #2 Principle #7

PFMI #7 Risk: Liquidity 2. In relation to the Key Considerations for the Principle, what metrics/data should a CSD compile in order to demonstrate compliance? How might this data be sourced? Working Group #2 Principle #7

PFMI # 7 Risk: Liquidity 3. What result levels" with respect to these metrics/data should a CSD achieve in obtaining "compliance"? Why? Working Group #2 Principle #7

PFMI #7 Risk: Liquidity 3. What result levels" with respect to these metrics/data should a CSD achieve in obtaining "compliance"? Why? Working Group #2 Principle #7

PFMI # 6 Risk: Margin 4. What, if any, provisions should you (as an FMI) be making to ensure continued adherence to the principle(s), for example in times of market or operational distress? Working Group #2 Principle # 6

PFMI #6 Risk: Margin 4. What, if any, provisions should you (as an FMI) be making to ensure continued adherence to the principle(s), for example in times of market or operational distress? Working Group #2 Principle # 6

Mary Ann Callahan – DTCC Joseph Campos – CDS Dale Connock – Strate Gianinna Estrella – Cevaldom Roberto Oyos – Cavali Jorge Pelayo – Indeval Working Group #2 Members