Ensuring continuity of critical clearing services: approach to discretionary payments by central counterparties

1: Introduction

This Bank of England (the Bank) Policy Statement (PS) provides feedback to responses to the Consultation Paper (CP) on the Bank’s proposed approach to its power to temporarily restrict or prohibit discretionary payments to employees or shareholders of recognised UK central counterparties (referred to as ‘CCP’ or ‘CCPs’ in this PS)^{footnote [1]} in severe circumstances.

The Bank’s final Statement of Policy (SoP) on its approach to the power to temporarily prohibit or restrict discretionary payments is available in the Annex.

Feedback to the CP is considered in the PS below.

Background

Schedule 11 of the Financial Services and Markets Act 2023 (the Act) makes provision for a special resolution regime for CCPs and grants the Bank additional powers that support its financial stability objective. This includes the power to temporarily restrict or prohibit discretionary payments to employees and/or shareholders of CCPs in severe circumstances to ensure the continuity of critical clearing services. The Act requires the Bank to publish a SoP with respect to giving directions under this power.

The final SoP clarifies the types of factors the Bank may consider in assessing the statutory conditions for the use of the power, the types of circumstances that could lead to the statutory conditions being deemed to be met, and the process for giving any direction under this power. It also outlines the Bank’s approach to the use of the power to support its objective to protect and enhance UK financial stability through ensuring the continuity of critical clearing services.

In developing these proposals, the Bank has considered its objective to protect and enhance the financial stability of the UK, its statutory obligations, and other relevant considerations, including the Bank’s considerations on the costs and benefits of the proposals. The Bank considers that its proposed approach would not place an undue burden on firms and that the proposed approach is aligned with the Bank’s financial stability objective.

Overview of policy statement

The Bank has considered the responses made during its consultation and is publishing feedback to those responses.

The sections in this PS are set out as follows:

1. general comments;
2. scope of power;
3. duration of power;
4. resourcing implications; and
5. specific conditions.

Summary of responses

The Bank received two responses, one from a CCP and one jointly from two trade associations. Respondents were generally supportive of the proposals and welcomed the detail provided by the Bank, including the Bank’s consideration of maintaining public confidence in the UK financial system as part of the public interest condition. Some responses requested additional clarification, particularly around the scope and duration of the power.

Summary of changes to final policy text

We made only minor changes to the SoP. These changes are described in detail in later sections of this PS and can be summarised as follows:

1. We have clarified that five years is the maximum duration of the power, not a minimum, and that the power is to be used in severe circumstances only, not as part of the Bank’s business-as-usual supervisory response.
2. We explicitly brought out consideration of the impact of exercising the power on a CCP’s ability to hire and retain key staff needed to ensure the continuity of critical services in the SoP. This had been discussed in the CP.

Implementation and next steps

The final SoP will enter into effect from 16 February 2024. The Bank will be able to use the power from this date.

2: General comments

Both responses were broadly supportive of the Bank’s proposals. Respondents also welcomed the additional detail on the Bank’s approach to using the power, particularly around the conditions that might lead to the power’s use.

One respondent – a trade association – noted that while buy-side and sell-side members were broadly in agreement, CCP members were in disagreement. The Bank notes that only one response, which was broadly supportive, was received from a CCP and that CCPs also had the opportunity to provide comment on the substance of the proposals in HM Treasury’s (HMT’s) consultation in 2021. The power itself was given to the Bank by FSMA 2023; the 2023 consultation covers only the approach to the power, not the substance of the power itself.

One respondent expressed a desire for further public guidance on the Bank’s approach to exercising the power and, more broadly, its supervisory and resolution powers in relation to maintaining public confidence in the UK’s financial system. The Bank provides guidance on its approach to supervision in the Bank’s Supervision of Financial Market Infrastructures (FMIs) Annual Report, which also discusses new supervisory powers, including the power to temporarily restrict discretionary payments to ensure the continuity of critical clearing services. Separately, additional guidance on the Bank’s resolution powers can be found in HMT’s Code of Practice.

3: Scope of power

One respondent expressed concerns about the proportionality of the approach and urged the Bank to use discretion in exercising the power. In particular, the respondent noted that a CCP might fail to meet one of the conditions set out in paragraph 13(3) of Schedule 11 without posing a material risk to financial stability. The Act^{footnote [2]} sets out the conditions that the Bank must deem to be met before the Bank may exercise the power. These conditions set the scope for the type of severe circumstances in which the Bank might use the power. While these conditions are set out in the Act, the Bank retains its discretion in deciding whether using the power is appropriate on a case-by-case basis. This is already noted in the SoP, but we have clarified this point further.

One respondent noted that ‘unanticipated material general business’ risks should be considered material only when there is no short-term prospect of recovery. This is indicated under the section of the SoP that outlines example hypothetical scenarios suggesting when these conditions could be met. We note in the SoP that we would, for example, consider a CCP’s ability to meet its agreed impact tolerances – not being able to do so could lead to a determination of the condition being met, but the Bank would retain its discretion in making this assessment.

One respondent queried how restrictions of particular types of discretionary payments, eg equity remuneration, would have a material impact on the firm’s liquid resources or financial resilience. In the SoP, the Bank notes under the discussion of the public interest condition that the Bank ‘may consider using this power in a targeted way by restricting specific types of payments, while allowing other payments to proceed. Here, the Bank may take account of the relative impact of different types of discretionary payments on the financial situation of the CCP. The Bank may also take account of the impact of restricting specific types of discretionary payments, such as equity remuneration, on the operation of the CCP or its ability to maintain critical clearing services’.

4: Duration of power

One respondent noted concerns about the five-year duration of the tool and indicated a preference for restrictions on variable remuneration to be considered as a last resort. The SoP outlines that this is a power to be used in severe circumstances only, not as part of the Bank’s business-as-usual Supervisory approach, and that the five-year duration is a maximum, not a minimum. We have made this latter point more explicit in the SoP.

5: Resourcing implications

One respondent expressed concerns that the possibility of restrictions on discretionary payments would have a negative effect on hiring and staff retention, particularly combined with the upcoming Senior Managers and Certification Regime (SM&CR) for FMIs. We would reiterate that this is a power to be used only in severe circumstances and that the Bank will use its discretion when assessing whether using the power is appropriate, including in assessing the impact on a CCP’s ability to retain key staff, as discussed in the CP. This could, for example, include exercising discretion in both the use of the power and in the scope of any restriction. We have made this point more explicit in the SoP.

6: Specific conditions

One respondent requested additional guidance on the Bank’s approach to considering ‘the maintenance of public confidence in the UK financial system’ and ‘the wider financial system which the CCP serves’. The Bank also acknowledges the respondent’s request to consider the impact on public confidence in the UK financial system as part of the approach to assessing the impact of resolution powers on UK financial stability. As above, further guidance on the Bank’s resolution powers can be found in HMT’s Code of Practice.

Appendix

• Appendix 1: Final Statement of Policy

  Ensuring continuity of critical clearing services: The Bank of England’s approach to discretionary payments by central counterparties

  Statement of policy

  February 2024

  This document contains the Bank of England’s policy for exercising its power to give directions to restrict or prohibit discretionary payments to specified employees or shareholders of a CCP for a specified period under Schedule 11, paragraph 13 of the Financial Services and Markets Act 2023.

  1: Introduction

  This Statement of Policy (SoP) sets out the Bank of England’s (the Bank’s) approach to giving directions to temporarily restrict or prohibit discretionary payments to specified employees or shareholders of recognised UK central counterparties (CCPs)^{footnote [3]} in severe circumstances. This power is conferred by the Financial Services and Markets Act 2023 (the Act).^{footnote [4]} The Act requires the Bank to publish a statement of its policy with respect to giving directions under this power. This SoP is relevant to recognised UK CCPs supervised by the Bank – henceforth referred to as ‘CCP’ or ‘CCPs’ in this SoP.

  The Bank views this power as an important measure to ensure the continuity of critical clearing services in times of acute stress and uncertainty,^{footnote [5]} which supports the Bank’s objective to protect and enhance UK financial stability. The exercise of this power to direct CCPs to retain funds that may otherwise be paid to, for example, senior managers or shareholders of CCPs could support this objective, should the statutory conditions for the use of this power be met. The Bank’s ability to use the power is limited to severe circumstances set by the statutory conditions in the Act. This is reflected in the approach set out in this SoP.

  This SoP is set out as follows. Section 2 sets out the background and statutory framework of the power. Section 3 sets out the Bank’s approach to giving directions under the power and the conditions under which the Bank may use the power. Section 4 sets out the format and process the Bank will follow when giving directions under the power.

  2: Background and statutory framework

  CCPs play an important role in the functioning of financial markets through the critical services they provide. CCPs therefore play a crucial role in safeguarding financial stability. CCPs interpose themselves between the counterparties to contracts traded on one or more financial markets – becoming the buyer to every seller and the seller to every buyer. This ensures that the obligations of a trade can be fulfilled even if one counterparty fails, thus reducing counterparty credit risk in financial markets.

  Given the crucial role of CCPs in the financial system, it is important that CCPs maintain appropriate levels of resilience and have comprehensive arrangements in place to manage the default of one or more of its clearing members and other losses. CCPs are required to maintain recovery plans. Should these recovery plans be ineffective in ensuring the continued viability of the CCP, there is a process by which the Bank, as Resolution Authority, can intervene when recovery fails, or is likely to fail. The Act includes a special resolution regime for CCPs, which is aimed at limiting the risk to public funds, ensuring continuity of critical clearing services, and preventing contagion to the wider market.

  Power to temporarily restrict or prohibit discretionary payments

  The Act also introduces additional powers for the Bank, under its responsibilities to supervise financial market infrastructures (FMIs) including CCPs. This includes the power to temporarily restrict or prohibit CCPs from making certain discretionary payments to specified employees or shareholders of the CCP – jointly referred to as ‘temporary restrictions’ in this SoP. This power the Bank can only use when no stabilisation powers are being exercised by the Bank, as Resolution Authority, in relation to the CCP in question. It is aimed at maintaining and enhancing the resilience of the CCP in severe circumstances such as when there is a material risk of a threat to the ability of the CCP to maintain critical clearing services. There is an equivalent power to similarly restrict or prohibit discretionary payments in a resolution context – the Bank’s use of that power (paragraph 102 of Schedule 11 of the Act) is not covered by this SoP.^{footnote [6]}

  Paragraph 13 of Schedule 11 of the Act sets out the detail of this power. ‘Discretionary payments’ refers to those payments made otherwise than under a contractual obligation and are defined as dividend payments; share buy-backs; equity remuneration; and variable remuneration including, where an employee is a senior manager, bonuses, discretionary pension benefits and severance payments.

  The Act sets out the conditions that the Bank must consider and be satisfied are met prior to giving directions under this power. These conditions are set out briefly below and in detail in Section 3 of this SoP.

  The Bank may by direction temporarily restrict or prohibit such discretionary payments to specified employees or shareholders of a CCP for a specified period of no more than five years, and subject to a three-monthly review, under the following conditions (‘the conditions’):

  1. A stabilisation power is not being exercised in relation to the CCP; and
  2. The exercise of the power is necessary or desirable having regard to the public interest in the stability of the UK financial system, or the continuity of critical clearing services; and
  3. At least one of the following conditions is met:
     
     a. there is or is likely soon to be a significant deterioration in the financial situation of the CCP;
     b. there is a material risk of a threat to the ability of the CCP to maintain critical clearing services;
     c. there is a risk of a significant disruption to the operation of the CCP; or
     d. the operation of the CCP poses a risk to the UK’s financial stability.

  At least once every three months after giving the direction, the Bank must review whether the conditions for exercising this power continue to be met. Should they cease to be met, the Bank must revoke the direction with immediate effect. The Bank may also make variations to the direction as necessary and at any time provided the conditions continue to be met. There is no minimum duration given by Schedule 11, but the maximum period is set at five years. The Bank will utilise its discretion in setting the appropriate duration on a case-by-case basis.

  A direction under this power ceases to have effect if the Bank, as Resolution Authority, exercises a stabilisation power in respect of the CCP.

  As is the case with any public body in the exercise of its functions, the Bank will have regard to relevant principles of public law, in particular the requirement to act reasonably and in accordance with common law principles of procedural fairness when exercising its power of direction.

  3: Approach to giving a direction to restrict or prohibit discretionary payments

  The Bank considers that the objective of the conditions (paragraph 9 of this SoP) is to ensure the power is only used in severe circumstances where the Bank considers that its exercise of the power may mitigate risks to UK financial stability by addressing risks to the continuity of critical clearing services. The Bank’s use of the power would seek to improve the financial situation of the CCP by requiring the CCP to retain specific funds, which would help to absorb potential losses in, for example, the scenarios outlined in this Section.

  As set out in Section 2 of this SoP, a set of statutory conditions must be met before the Bank can give a direction to temporarily restrict or prohibit discretionary payments to specified employees or shareholders of the CCP. These conditions set the scope for the type of severe circumstances in which the Bank might use the power. This Section sets out what factors the Bank will consider when assessing whether the conditions are met. These factors are non-exhaustive, and the Bank will assess the conditions and take any decision to give a direction on a case-by-case basis. The factors set out in this Section could cover a range of scenarios where the Bank would consider exercising the power, but not be obligated to do so. This includes circumstances in which it may be uncertain when and to what extent the CCP’s viability is threatened, ie up to and including the point where losses are incurred. The scope of the statutory conditions that have to be met limit the Bank’s use of the power to severe circumstances.

  A: A stabilisation power is not being exercised. The first condition that must be met as a pre-requisite for the use of this power is that no stabilisation power is being exercised at the time in relation to the CCP in question. This means that the direction may be given by the Bank up to the point where the Bank, as Resolution Authority, assesses that the CCP meets the conditions for resolution set out in statute and so decides to exercise a stabilisation power in relation to the CCP in question. The Act also provides an equivalent power (paragraph 102 of Schedule 11), which enables the Bank, as Resolution Authority, to temporarily restrict or prohibit discretionary payments to specified employees or shareholders of CCPs in a resolution context by specifying it as a provision in a resolution instrument, a share transfer instrument, or a property transfer instrument. This SoP, and the approach outlined herein, does not apply to the Bank’s use, as Resolution Authority, of the power under paragraph 102.

  As soon as the Bank, as Resolution Authority, exercises a stabilisation power in respect of the CCP in question, any direction given by the Bank under paragraph 13 ceases to have effect.

  B: Necessary or desirable having regard to the public interest. A further condition that must be met for the Bank’s use of this power is that the exercise of the power is necessary or desirable having regard to the public interest in UK financial stability or the continuity of critical clearing services. In assessing whether the use of this power would be necessary or desirable having regard to the specified public interest, the Bank expects to consider whether the exercise of the power would be likely to mitigate risks to the stability of the UK financial system or whether it would be likely to maintain the continuity of critical clearing services.

  The Bank expects to consider the maintenance of public confidence in the UK financial system as part of the public interest in UK financial stability. This includes the maintenance of public confidence in markets and the banking and wider financial system which the CCP serves. One factor the Bank may consider in having regard to the specified public interest could be the levels of uncertainty resulting from a stress situation at a CCP. In making its determination, the Bank is not required to prove the impacts of any risks if those risks were to crystallise.

  The Bank would also consider whether there is a material risk to the continuity of critical clearing services. Should the continuity of any critical clearing service become threatened, and the Bank considers that the withdrawal of any critical clearing service could create risks to UK financial stability, the Bank would be likely to deem the exercise of this power to be in the public interest. The Bank may consider using this power in a targeted way by restricting specific types of payments, while allowing other payments to proceed. Here, the Bank may take account of the relative impact of different types of discretionary payments on the financial situation of the CCP. The Bank may also take into account the impact of restricting specific types of discretionary payments, such as equity remuneration, on the operation of the CCP or on its ability to maintain critical clearing services. The Bank would consider any impact on a case-by-case basis in line with the statutory conditions.

  C: Further conditions, of which at least one needs to be met. In addition to the conditions set out in sub-section A and B of this Section, to use the power the Bank will need to determine that at least one of Condition 1, 2, 3 or 4 set out below is met.

  Condition 1:	There is or is likely soon to be a significant deterioration in the financial situation of the CCP.footnote [7]
  Condition 2:	There is a material risk of a threat to the ability of the CCP to maintain critical clearing services.footnote [8]
  Condition 3:	There is a risk of a significant disruption to the operation of the CCP.
  Condition 4:	The operation of the CCP poses a risk to the financial stability of the United Kingdom.

  The Bank will consider these four conditions concurrently during its assessment and its determination that at least one of Conditions I to IV is met will be based on the specific circumstances at the time. The Bank considers that there are scenarios that could occur that may result in more than one of Conditions I to IV being met.

  A non-exhaustive, hypothetical set of circumstances, which the Bank considers could lead to one, or more, of Conditions I to IV being deemed to be met would include:

  • Major novel risks to UK financial stability that the Bank judges could transmit to a CCP. The risk does not need to originate from within the CCP. Contagion risks may transmit stress across markets to CCPs. Some historical examples of situations where the Bank would consider that the conditions are met include the Covid-19 pandemic and the 2022 Russian invasion of Ukraine – these presented material external risk factors, including uncertainty, which could have resulted in disruption to critical clearing services and risks to UK financial stability. Once it becomes clear at any point that such external risk factors, including uncertainty, are material enough to threaten, or are likely to threaten, the CCP’s ability to absorb market shocks and/or to maintain the continuity of its critical clearing services, the Bank may deem one or more of Conditions I to IV to be met.
  • A shock to a CCP that results in material financial losses. The Bank may consider the exercise of the power appropriate where a CCP experiences a material financial loss that it is required to absorb. The Act provides that a deterioration in the financial situation of a CCP is significant if the deterioration places the CCP at risk of failing or being likely to fail. If, during the Bank’s assessment, it becomes clear that the losses are threatening the viability of the CCP or its ability to maintain critical clearing services, the Bank could deem one or more of Conditions I to IV to be met.
  • Unanticipated material general business risks to a CCP. One or more of Conditions I to IV could be deemed to be met without material financial losses at the CCP occurring. One example could be a breakdown in the systems or processes used by a CCP to operate its services. This could crystalise through a cyber / IT related event which results in the CCP not being able to perform services that are required to maintain the continuity of its critical clearing services and/or which result in a significant disruption to the operation of the CCP. The Bank would likely consider a disruption to the operation of the CCP significant if it has a material impact on the CCP’s ability to continue important business services. Where the disruption is significant enough that the CCP may not be able to meet its agreed impact tolerances for important business services, the Bank may consider it a significant disruption to the operation of the CCP.^{footnote [9]}

  Approach to the scope of directions

  Once the conditions for the use of the power have been deemed to be met and the Bank determines that it is appropriate to exercise the power, it will decide the scope of any restriction. This includes the types of payments affected and the duration and extent to which they are restricted or prohibited. These determinations will depend on the exact circumstances that prompted the Bank to assess whether the conditions are met.

  In line with the intention of the power, the Bank only expects to restrict, or prohibit, those discretionary payments where the Bank deems that this action would mitigate risks to the continuity of critical clearing services, and the stability of the UK financial system. An important consideration for the Bank would be the CCP’s quantum of funds and how this relates to the range of discretionary payments made by the CCP. It is likely that a CCP’s dividend payments to shareholders would be significantly larger than discretionary payments to employees and therefore are likely to have a more material impact on the CCP’s capital base. The Bank would expect to consider this a relevant factor when determining the scope of any direction it gives under this power.

  It is important that the Bank can exercise discretion to set the scope of any direction on a case-by-case basis, provided that the conditions set out in this Section are met, as there are circumstances where restricting certain types of discretionary payments may in fact hinder efforts to maintain the continuity of the CCP’s critical clearing services. This could, for example, include where doing so might affect the CCP’s ability to retain key staff needed to ensure the continuity of critical clearing services, in which case the Bank would consider exercising discretion. The Bank may therefore limit the scope of any direction or may determine not to exercise the power despite the necessary conditions being met.

  4: Process of giving directions

  Once the Bank has decided to exercise the power and has determined which discretionary payments should be temporarily restricted or prohibited, it will issue a formal written direction to that effect. Any direction given under this power can be varied at any time by the Bank. The direction will include the information for the CCP to implement the direction, including among other things:

  Reason for the Bank’s direction: This will specify the reason the Bank is giving the direction based on the conditions set out in Section 3 of this SoP, eg to mitigate risks to the stability of the UK financial system or to maintain the continuity of critical clearing services.

  Duration of the restriction: The direction will also set out how long the restriction(s) for the discretionary payment(s) specified in the direction will be in place. The direction will be in effect up to a maximum period of five years as provided for in the Act. The direction will also include the date by which the direction will be reviewed by the Bank, which must happen at least once every three months while the direction is in force. If, during that time, the Bank becomes aware that the conditions for the exercise of the power cease to be met, the Bank must revoke the direction with immediate effect. The direction will also cease to have effect if, at any point while the direction is in force, a stabilisation power is exercised in respect of the relevant CCP.

  Scope of the restriction: The direction will specify the types of discretionary payments that are to be restricted or prohibited by the CCP as well as the employees or shareholders to whom the direction applies.

  Provision of direction: The Bank will provide the direction in writing. The direction will specify the employees and/or shareholders that the direction applies to and to whom the direction must be given in writing. The Bank will inform the relevant CCP if the Bank has made a variation to the direction or if it revokes the direction.