Corporate & Securities Law

By Jim Hamilton

The globalization of the cross-border clearance and settlement system underpinning the financial markets has increased incentives for financial institutions to reduce the risks and costs of their payment and settlement activities, according to a report issued by the BIS Committee on Payment and Settlement Systems. The committee, chaired by NY Fed President Timothy Geithner, said that the growing cross-border nature of clearance and settlement of securities trades has resulted in interdependence among settlement systems such that the smooth functioning of a single system is often contingent on the performance of other systems.

In addition, individual systems are often reliant on common third parties, financial markets or other factors. Consequently, the settlement flows and risk management procedures of individual systems are often materially interdependent with those of other systems.

Given these cross-border challenges, the report recommends that banks and other financial institutions adapt their risk management efforts to the increased potential for
disruptions to spread quickly and widely across systems. At a minimum, financial institutions should adopt broad risk management perspectives and implement risk management controls commensurate with their role in the global infrastructure.

Specifically, the Geithner report urges banks and other financial institutions to adopt comprehensive risk management perspectives that look beyond their direct operations and exposures and identify the broad range of disruptions that might affect them because of interdependencies. It is also crucial that they understand their role in the broader global infrastructure and in creating significant interdependencies among other systems.

In addition, it is important for financial institutions at the center of key interdependencies to have especially strong risk management controls. Strong business continuity arrangements become increasingly critical since operational outages can have widespread effects. The ability of systems to provide minimum service levels and the ability of systems and institutions to continue to conduct activity in the event of a problem are especially useful in containing the impact of a disruption.

The Geithner report urges banks and other financial institutions to regularly assess whether their risk management tools are proportionate to the risks they bear from and pose to other interdependent entities. Specifically, they should assess whether they have risk management tools that are well fitted to the operational and liquidity risks arising from interdependencies. Such tools might include business continuity arrangements that allow for the rapid recovery and resumption of critical activities, alternative settlement channels to process key transactions, and liquidity risk management techniques, for both systems and institutions that help address market-wide stress conditions.

Full post as published by Jim Hamilton's World of Securities Regulation on June 08, 2008 (boomark / email).