• European Central Bank Publishes 'Lessons Learned' Report
  • April 27, 2010 | Author: Matthew C. Sippel
  • Law Firm: Alston & Bird LLP - New York Office
  • Today, the European Central Bank (ECB) published its “Report On The Lessons Learned From The Financial Crisis With Regard to the Functioning of European Financial Market Infrastructures.”  The report focused on four challenges faced by European financial market infrastructures (FMIs), including systemically important payment systems, central counterparties and securities settlement systems, during the financial crisis: (1) information flows following a default; (2) default management; (3) behavioral factors that affected market liquidity conditions adversely; and (4) issues relating to over-the-counter (OTC) markets.

    The report identifies eight “lessons learned” from a series of interviews conducted by the Eurosystem central banks (the ECB and the national central banks of euro-zone countries), the Bank of England and Sveriges Riksbank with a representative sample of FMIs and financial institutions participating in the FMIs.

    Lesson 1: Once the relevant authority (e.g., the home supervisor or a competent court) has declared the insolvency of a critical counterparty, this information must be dispersed to the relevant authorities and, if possible, from these authorities to FMIs and to the market in general in an accurate, unambiguous, complete, transparent and timely manner.

    Lesson 2: Risk management frameworks of FMIs and of their participants are essential to minimize the contagion risks of a critical counterparty’s potential default. Where necessary, specific aspects of such risk management frameworks should be enhanced.

    Lesson 3: In a crisis situation, final decisions on the activation of preventive measures will be taken by the relevant FMIs and their participants. Market authorities and central banks may assist within the limit of their respective mandates. In this respect, the cooperation/coordination of market authorities and central banks is key, especially at a cross-border/global level.

    Lesson 4: Possible inconsistencies between FMIs’ default management rules should be identified. Interconnected FMIs should coordinate the implementation of their rules.

    Lesson 5: All relevant actors in the financial markets should better familiarize themselves with the default management procedures.

    Lesson 6: Difficulties in applying default management procedures should be evaluated.

    Lesson 7: FMIs should enhance their liquidity resilience.

    Lesson 8: The soundness, resilience and transparency of over-the-counter (OTC) derivatives markets should  be enhanced. In particular, the establishment of sound infrastructures for OTC derivatives should be promoted.

    Based on these lessons, the report identified a series of “follow-up” actions that have already been initiated, including (1) improving information sharing between authorities and, if possible, FMIs and their participants; (2) enhancing the coordination and cooperation of oversight authorities at the level of the European System of Central Banks (ESCB)/EU and at the global level; (3) evaluating the potential need to harmonize the default procedures of interconnected FMIs; (4) reviewing existing international oversight standards for FMIs, including liquidity management standards; and (5) establishing a sound infrastructure for OTC derivatives.

    The report also identified and proposed an additional series of “follow-up” actions that need to be taken, including: (1) enhancement of direct monitoring of critical counterparties’ creditworthiness, including reduced reliance on third-party credt ratings; (2) definition of criteria for, and identification of, their critical participants; (3) introduction of some flexibility for FMIs, where needed, when applying preventive measures in response to unforeseeable market conditions; (4) promotion of practical educational measures on default procedures; and (5) enhancement of FMIs’ stress-testing exercises.