## cr18192

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**Canonical URL:** [cr18192](https://www.imf.org/-/media/files/publications/cr/2018/cr18192.pdf)

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---

### Overview of China’s FMIs
- Landscape: “one of the largest and most complex in the world.”
- Composition: payment, clearing and settlement systems, including several interbank payment systems, securities settlement systems and central counterparties (CCPs).
- Interlinkages: all systems settle directly or indirectly (through their settlement banks) in the real-time gross settlement system, the HVPS, operated by the PBC.
- Selected size indicators:
  - HVPS is the fourth largest payment system in the world.
  - China Securities Depository and Clearing Corporation (CSDC) ranks as the sixth largest securities CCP.
  - China Futures Exchange (CFFEX) ranked number five in 2015.
- Recent structural changes: establishment of CIPS and a CCP for OTC derivatives; rapid development of internet payments and other innovative products.
- Systemic role:
  - HVPS clears approximately 16 percent of the annual GDP on a daily basis.
  - The three CSDs and all CCPs are considered systemically important.
  - BEPS could be considered a SIPS due to high volumes and critical retail/corporate role.

### Analytical focus and standards used
- Objective: analyze financial stability issues related to FMIs using international standards and good practices.
- Focus areas:
  - Regulatory, supervisory and oversight framework; supervisory practices; resources; transparency; adoption of international standards; domestic and cross-border cooperation.
  - Identification and management of system-wide risks (legal gaps, cyber risks, recovery and resolution).
  - Risk analysis of SIPS and CCPs, including HVPS and SHCH for OTC derivatives.
- Standards and guidance referenced: CPSS-IOSCO Principles for Financial Market Infrastructures (PFMI), FSB guidance, CPMI-IOSCO guidance on resolution/recovery and cyber resilience.

### Five Responsibilities of Authorities under the PFMI
- Responsibility A: Regulation, Supervision, and Oversight of FMIs.
- Responsibility B: Regulatory, Supervisory, and Oversight Powers and Resources.
- Responsibility C: Disclosure of Policies with Respect to FMIs.
- Responsibility D: Application of the Principles for FMIs.
- Responsibility E: Cooperation with Other Authorities.

### Principal findings — supervision, risks, resources, legal
- PFMI adoption and implementation:
  - Public adoption of the PFMI by authorities in 2013 and establishment of an interagency PFMI assessment platform (the ‘PFMI office’).
  - Full implementation of the PFMI by FMIs remains the next step; levels of implementation vary greatly across systems.
- Risk management weaknesses:
  - CSDC should improve delivery versus payment (DVP) arrangements and modernize credit and liquidity risk management.
  - The four futures exchanges should reorganize the risk management function across their organizations.
- Human resources constraints:
  - PSD has 32 staff members; financial markets department has 36 staff members.
  - CSRC market supervision department has approximately 40 members covering all equity exchanges and CSDC, of which 3 staff members are engaged in CCP and CSD supervision.
  - CSRC futures supervision department has 27 full time staff resources, of which 1 staff member is involved in supervision of the CCPs.
  - Recommendation: increase staff numbers and expertise, including knowledge of (quantitative) risk models for CCPs (margin, credit and liquidity models).
- Legal framework vulnerabilities:
  - Lack of a statutory framework for futures markets creates potential legal uncertainty about CSRC powers.
  - Weaknesses in legal framework regarding finality and netting may expose FMIs and participants to significant credit and liquidity risks.
  - Recommendation: enact a comprehensive statute or adopt statutory provisions to provide legal certainty for settlement finality, protection of netting arrangements, bankruptcy remoteness of pledged collateral, close-out netting, and prescriptions to overcome any zero-hour rules.
- Cyber risk:
  - Cyber security law issued in 2016 and will come into effect as per June 2017.
  - Cyberspace Administration of China conducts cyber security tests at national level.
  - Recommendation: strengthen joint efforts and address cyber resilience explicitly under the PFMI office; develop joint crisis coordination mechanisms and test crisis communication protocols.
- Central bank services and liquidity backstops:
  - PBC currently provides settlement services to CCDC and SHCH.
  - Consider extending central bank services to the CSDC and other CCPs, conditioned on strengthened FMI risk management, CSRC supervision, and macroprudential oversight by the PBC.
  - Principle: private sector liquidity first line of defense; central bank emergency liquidity against adequate collateral in extreme circumstances.

### Key recommendations (timing ST: Short-term; MT: Medium-term)
- Strengthen legal and supervisory framework (PBC, CSRC)
  - Develop a dedicated law on supervision of FMIs, adopt the Futures Market Law, revise Securities Market Law, and draft an NPS Law. — ST-MT
  - Ensure a sufficient number of staff with relevant expertise. — ST
  - Strive for full and consistent PFMI implementation, including:
    - Update supervisory regulations and FMI rules to reflect the PFMI;
    - Improve DVP arrangements within the CSDC;
    - Implement a risk governance structure within the four futures exchanges. — ST-MT
  - Explicitly evaluate risks related to links of the CSDC with other CSDs. — MT
- Manage system-wide risks (PBC, CSRC)
  - Adopt finality and netting at a statutory level in line with international standards. — ST-MT
  - Supervise cyber resilience of FMIs as part of the PFMI office. — ST
  - Develop recovery and resolution planning in line with international guidance. — MT
  - Adopt policy to provide central bank services to FMIs. — MT
- HVPS recommendations (PBC responsible)
  - Review fees and the timings of the intraday repo window. — ST
  - Review use of open market operations (OMO) for intraday liquidity requirements. — MT
  - Review collateral haircut methodology and ensure independent validation. — ST
  - Operationalize mark-to-market module. — ST
  - Revise priority levels of instant transfer transactions. — ST
  - Prescribe a cut-off time for withdrawal of transactions in queue. — MT
  - Examine introduction of time varying fees for payment instructions. — MT
  - Complete and disclose publicly CPSS-IOSCO Disclosure framework. — ST
- SHCH recommendations (PBC, SHCH responsible)
  - Appoint independent chair at the Risk Management Committee (RMC). — ST-MT
  - Ensure regular reporting of operational and IT risks to chief risk officer (CRO). — ST
  - Dispose of exposure thresholds per clearing member. — ST
  - Apply haircuts to cash collateral. — MT
  - Ensure independent validation of credit models at least annually. — ST
  - Conduct liquidity stress tests on a daily basis. — ST
  - Further develop business continuity plans by introducing a hot site. — MT
  - Increase the number of liquidity providers and settlement banks. — MT

### Implementation priorities and expected benefits
- Priority actions: legal reform (finality/netting), staff resourcing and training, full PFMI implementation across FMIs, targeted risk-management improvements at CSDC, futures exchanges, SHCH, enhanced cyber resilience coordination, and policies for central bank services to systemically important FMIs.
- Expected outcomes: enhanced resilience and stability of FMIs; reduced credit and liquidity risk transmission; clarified supervisory powers and legal certainty; improved preparedness for operational and cyber incidents; strengthened capacity to manage extreme liquidity events while preserving market stability.

### FMI ownership and supervisory responsibilities
- Ownership:
  - All FMIs are state-owned.
  - Main payment systems owned and operated by the PBC.
  - PBC and/or the state have ownership, directly or indirectly, in the CCDC, CIPS and SHCH.
  - Securities and futures market CCPs and CSDC are owned by members or shareholders, many partly or fully state-owned institutions.
- Supervisory responsibilities:
  - PBC: main supervisor of payment systems and FMIs for interbank bond, FX and OTC derivatives markets.
    - PBC Payment and Settlement department: HVPS, BEPS, IBPS, CIS, CIPS, FCPS, China Union Pay, Clearing Center for City Commercial Banks, Rural Credit Banks Funds Clearing Center. Main law: PBC Law.
    - PBC Financial Market department: responsible for CCDC, SHCH. Main law: PBC Law.
  - CSRC: supervises CSDC, and futures CCPs (CFFEX, DCE, SHFE, ZCE). Main law for securities: Securities Law; no dedicated futures law.
  - SAFE involved for FX-related product approvals for SHCH in coordination with PBC.
  - MOF and CBRC are stakeholders for CCDC.

### Disclosure, PFMI implementation and governance
- Disclosure:
  - PBC discloses policies and regulations via annual report, website, press announcements.
  - PBC policy objective for HVPS: “maintain normal operation of payment system and clearing systems”.
  - PBC policy objective for CCDC and SHCH: “ensure efficiency, security and protection of investors’ legitimate rights”.
  - CSRC policy objective for securities FMIs: “ensuring safety and high efficiency.”
- PFMI implementation:
  - Authorities publicly stated adoption of PFMI via Circulars Yin Ban Fa [2013] No.187 and Zheng Jian Fa [2013] No.42; assessment Circular Yin Ban Fa [2013] No.239.
  - PBC and CSRC fully adopt PFMI; established Steering Group on FMIs and PFMI office (Document Yin Ban Fa [2014] No.106).
  - Self-assessments and external assessments were carried out with set timelines of January and March 2014 respectively.
  - Compliance varies: CCDC and SHCH largely adopted; other FMIs need further implementation.
- Transparency and governance:
  - Principle 23: regulators should advise FMIs to complete and publicly disclose CPMI-IOSCO Disclosure framework responses. SHCH and CCDC have disclosed responses in English and Chinese.
  - Recommendation: recalibrate governance of CCDC to distinguish roles of PBC, MOF, and CBRC and establish PBC as overseeing authority for CCDC as an FMI.
  - Capacity building: CSRC may hold PFMI workshops periodically for FMI staff.

### Legal framework, finality and netting
- Finding: Finality and netting addressed in regulations, measures and rules, but concepts not unambiguously included in the Securities Law.
- Risks: regulatory-level treatment does not provide watertight protection against revocation of transactions or collateral payments, or unwinding of netted positions following bankruptcy.
- Recommendation: unambiguously include finality and netting concepts in statutory law to provide high legal certainty covering all FMIs, including:
  - recognition of settlement finality in the event of insolvency of a participant;
  - recognition of multi-lateral netting;
  - provisions for bankruptcy remoteness of pledged collateral;
  - close out netting;
  - prescriptions to overcome any zero-hour rules.
- Implementation options: introduce concepts in new/revised laws or enact a comprehensive statute on finality and netting.
- Benefit: improved consistency with the Bankruptcy Law and facilitation of Chinese CCPs being determined as qualifying CCPs (QCCPs) by foreign authorities or banks.

### Cyber resilience
- Context: cyber risk identified as an important supervisory topic for FMIs.
- Legal development: cyber security law issued in 2016 and will come into effect as per June 2017; identifies FMIs as critical institutions.
- Industry and supervisory action:
  - 2016 CSRC-organized industry-wide contingency test with more than 10 institutions participating.
  - PBC and CSRC issued information security requirements and focus on strengthening autonomous control of information systems for FMIs.
- Recommendation: strengthen joint PFMI-office efforts, use CPMI-IOSCO cyber resilience guidance (June 2016) as benchmark, improve joint crisis coordination mechanisms and test crisis communication protocols.

### Recovery, resolution and liquidity support
- Status:
  - Some FMIs have recovery plans; others need development beyond BCP and default management.
  - Resolution planning is at an early stage; no legal framework or resolution authority appointed. PBC is studying arrangements.
- Central bank considerations:
  - PBC provides settlement services to CCDC and SHCH; may consider extending services to CSDC and other CCPs conditional on strengthened FMI risk management and macroprudential oversight by PBC.
  - Private sector liquidity is primary; in extreme circumstances special financing arrangements by central bank could ensure continuity of payments and market stability.
  - Provision of central bank accounts can reduce FMIs’ exposure to commercial banks.

### HVPS analysis and recommendations
- System profile:
  - HVPS is an RTGS system owned and operated by the PBC with a “V” topology.
  - HVPS version 2 features: liquidity saving offsetting mechanism; single point access to participants; ISO 20022 message formats; operating hours 8:30 am to 5:00 pm (normal settlement) and 5:00 pm to 8:30 pm (specific business).
  - Business continuity: three operating centers in two locations (third center becoming functional this autumn).
- Participants (end-2016):
  - 305 direct participants
  - 141,023 indirect participants
- Credit and liquidity arrangements:
  - Transactions settled in real time on a gross basis based on availability of funds.
  - PBC provides intraday liquidity as fully collateralized intraday repos with a fee; intraday liquidity must be repaid by end of day or converted to overnight facility at penal rate.
  - Participants often use OMO or interbank market borrowing as cheaper liquidity sources.
- Issues and recommendations:
  - Review intraday repo fee and timing: intraday repo available only till 5:00 pm though system operates till 8:30 pm.
  - Review reliance on OMO for intraday liquidity: examine risks if OMO unavailable or market timing mismatches.
  - Collateral management: uniform haircut ratio of 10 percent (set in 2004) should be reviewed; mark to market module exists but not operational.
    - Recommendations: review haircut methodology; mark to market collateral daily; subject haircut methodology and procedures to independent validation at least once a year.
  - Priority of instant transfers: currently priority level 7 (lowest); recommend raising to priority level 3 or 4.
  - Additional measures: prescribe a cut-off time for withdrawal of queued transactions; consider time varying fee structure to incentivize early payments.
  - Transparency: HVPS should complete and publicly disclose CPSS-IOSCO Disclosure framework responses in Chinese and English.

### SHCH analysis and recommendations
- Overall: SHCH risk management practices generally well designed and in line with PFMI; modern systems, risk management department, RMC, and practices to manage operational and financial risks.
- Governance and reporting:
  - Current: Chairman of the Board also chairs the RMC.
  - Recommendation: appoint a sufficiently knowledgeable independent chair of the RMC, independent of SHCH executive management.
  - Operational and IT risks: currently not regularly reported to the CRO.
    - Recommendation: risk management department should also cover operational and IT risks, or operational/IT staff responsible for risk management should have direct reporting line to the CRO.
- Credit exposures and margining:
  - SHCH monitors exposures during the day but relies on exposure thresholds per clearing member; intraday margin called only if thresholds reached.
  - Principle gap: Principle 4 not fully implemented; recommendation to ensure initial margin covers potential future exposures with a single-tailed confidence level of 99 percent.
- Cash collateral and haircuts:
  - SHCH does not apply a haircut to cash collateral; USD collateral is a small part of margins.
  - Recommendation: adopt haircuts for cash collateral in line with PFMI and international practice.
- Model validation:
  - Credit risk models, including margin and haircut models, are not validated by sufficiently independent reviewers.
  - Recommendation: independent validations by personnel with sufficient expertise, independent of model developers and users; validations at least annually.
- Liquidity stress testing:
  - Currently quarterly; recommendation: conduct liquidity stress tests on a daily basis in line with Principle 7.
- Business continuity and disaster recovery:
  - BCP well-developed with main operational center in Shanghai and disaster recovery sites in Shanghai and Beijing; residual issues include transport of staff to backup and limited full-load testing.
  - Recommendation: full and regular switching of operations between primary and secondary sites; establish a hot backup site.
- Liquidity providers and settlement bank concentration:
  - SHCH has contracted 2 banks as USD liquidity providers and 2 banks for credit lines in other currencies.
  - SHCH selected 2 settlement banks for USD settlements and 1 for other currencies.
  - Recommendation: increase number of liquidity providers and settlement banks for non-RMB to mitigate concentration risks.

### System-wide interdependencies and contagion risk
- Network statistics and membership overlap:
  - Consolidated membership set: 609 members (318 banks, 239 brokers, 2 insurers, and 50 other).
  - Data dates: September 30, 2016, except HVPS (December 31, 2016) and SHCH (November 24, 2016).
  - HVPS largest node, followed by CCDC (largest settlement values and highest number of members), CSDC third largest in turnover, SHFE third largest in number of members.
  - Concentration: nine banks have membership in all FMIs (eight Chinese banks and one U.S. bank); another eight banks have membership in seven FMIs; 76 banks have membership in four FMIs.
  - Overlaps:
    - ZCE and DCE overlap more than 90 percent.
    - CFFEX overlaps with other three futures exchanges for more than 80 percent.
    - CSDC overlaps with four futures CCPs (~40 percent of CSDC’s members).
    - Overlap between members of CCDC and SHCH is more than 50 percent.
- Contagion risk:
  - High interconnectivity suggests contagion from a financial or operational failure of an FMI or critical member could spread quickly.
  - Example impacts:
    - Default of the two participants with largest exposures in CSDC would coincide with default of these participants in another 5-12 FMIs, including several CCPs.
    - For CCDC, default of the two largest participants (measured in turnover) would coincide with default of these entities in 4-8 other FMIs.

*Source: EXECUTIVE SUMMARY and selected chapters (cr18192) — IMF staff note for the 2017 China FSAP.*

### EXECUTIVE SUMMARY __________________________________________________________________________ 5

### EXECUTIVE SUMMARY

### Overview of China’s FMIs
- China’s landscape for Financial Market Infrastructures (FMIs) is “one of the largest and most complex in the world.”
- Composition: a range of payment, clearing and settlement systems, including several interbank payment systems, securities settlement systems and central counterparties (CCPs).
- Interlinkages: systems are interlinked and settle all directly or indirectly (through their settlement banks) in the real-time gross settlement system, which is the HVPS, operated by the PBC.
- Selected size indicators:
  - HVPS is the fourth largest payment system in the world.
  - China Securities Depository and Clearing Corporation (CSDC) ranks as the sixth largest securities CCP.
  - China Futures Exchange (CFFEX) ranked number five in 2015.
- Recent structural changes: establishment of a cross-border interbank payment system (CIPS) and a CCP for over-the-counter (OTC) derivatives; rapid development of internet payments and other innovative products.

### Purpose and Analytical Focus
- Main objective: analyze financial stability issues related to FMIs in China using international standards and good practices.
- Analytical focus areas:
  - The regulatory, supervisory and oversight framework, supervisory practices, available resources, transparency, adoption of international standards and domestic and cross-border cooperation and coordination.
  - Identification and management of system wide risks or common issues of concern for FMIs (legal gaps, cyber risks, recovery and resolution planning).
  - Risks related to systemically important payment systems (SIPS) and CCPs, including HVPS and the SHCH for OTC derivatives.
- Standards and guidance used: CPSS-IOSCO Principles for Financial Market Infrastructures (PFMI), FSB guidance, CPMI-IOSCO guidance on resolution/recovery and cyber resilience.

### The Five Responsibilities of Authorities under the PFMI (Box 1)
- Responsibility A: Regulation, Supervision, and Oversight of FMIs — FMIs should be subject to appropriate and effective regulation, supervision, and oversight by a central bank, market regulator, or other relevant authority.
- Responsibility B: Regulatory, Supervisory, and Oversight Powers and Resources — Authorities should have the powers and resources to carry out effectively their responsibilities.
- Responsibility C: Disclosure of Policies with Respect to FMIs — Authorities should clearly define and disclose their regulatory, supervisory, and oversight policies with respect to FMIs.
- Responsibility D: Application of the Principles for FMIs — Authorities should adopt the PFMI and apply them consistently.
- Responsibility E: Cooperation with Other Authorities — Authorities should cooperate domestically and internationally to promote safety and efficiency of FMIs.

### Principal Findings
- Supervision and oversight progress:
  - Public adoption of the PFMI by the authorities in 2013 and establishment of an interagency PFMI assessment platform (the ‘PFMI office’) are important achievements.
  - Full implementation of the PFMI by FMIs remains the next step; levels of implementation vary greatly across systems.
- Risk management weaknesses identified:
  - CSDC should improve delivery versus payment (DVP) arrangements and modernize credit and liquidity risk management to limit potential significant credit and liquidity losses.
  - The four futures exchanges should reorganize the risk management function over the full length of their organizations.
- Human resources constraints:
  - Resources to fulfill mandates are tight for the PBC and the CSRC.
  - The number of staff has not increased in line with new tasks under the PFMI and market developments.
  - Need for increased staff numbers and increased expertise, including knowledge of (quantitative) risk models for CCPs (margin, credit and liquidity models).
- Legal framework vulnerabilities:
  - Lack of a statutory framework for futures markets creates potential legal uncertainty about the CSRC’s powers to enforce change.
  - Weaknesses in the legal framework regarding finality and netting of transactions potentially expose FMIs and participants to significant credit and liquidity risks.
  - Recommendation: enact a comprehensive statute or adopt statutory provisions to provide high legal certainty for settlement finality, protection of netting arrangements, bankruptcy remoteness of pledged collateral, close-out netting, and prescriptions to overcome any zero-hour rules.
- Cyber risk:
  - Cyber risk is an important supervisory topic for FMIs.
  - A cyber security law was issued in 2016 and will come into effect as per June 2017.
  - The Cyberspace Administration of China conducts cyber security tests at a national level.
  - Authorities may strengthen joint efforts and address cyber resilience explicitly under the PFMI office; joint crisis coordination mechanisms and testing of crisis communication protocols are recommended.
- Central bank services and liquidity backstops:
  - PBC currently provides settlement services to CCDC and SHCH.
  - Consideration: extending central bank services to the CSDC and other CCPs, conditioned on strengthened FMI risk management, CSRC supervision, and macroprudential oversight by the PBC.
  - Rationale: while private sector liquidity should be the first line of defense, in extreme circumstances FMIs may require access to emergency central bank liquidity against adequate collateral to continue payments and preserve market stability; provision of central bank accounts can reduce FMIs’ exposure to commercial banks.

### Key Recommendations (Table 1 — Timing and Responsible Authorities)
- Timing legend: MT: Medium-term; ST: Short-term.

- Strengthen legal and supervisory framework
  - Strengthen legal framework for the regulation and supervision of FMIs, through the development of a dedicated law on the supervision of FMIs, the adoption of the Futures Market Law, changes to the Securities Market Law, and the drafting of a NPS Law. — ST-MT — PBC, CSRC
  - Ensure a sufficient number of staff with relevant expertise. — ST — PBC, CSRC
  - Strive for full and consistent implementation of the PFMI, in particular:
    - Update supervisory regulations and FMI rules to reflect the PFMI;
    - Improve DVP arrangements within the CSDC;
    - Implement a risk governance structure within the four futures exchanges. — ST-MT — PBC, CSRC
  - Explicitly evaluate risks related to links of the CSDC with other central securities depositories (CSDs). — MT — CSRC

- Manage system wide risks
  - Adopt finality and netting at a statutory level in line with international standards. — ST-MT — PBC, CSRC
  - Supervise cyber resilience of FMIs as part of the PFMI office. — ST — PBC, CSRC
  - Develop recovery and resolution planning in line with international guidance. — MT — PBC, CSRC
  - Adopt policy to provide central bank services to FMIs. — MT — PBC

- HVPS (High-Value Payment System) recommendations — PBC responsible
  - Review fees and the timings of the intraday repo window. — ST
  - Review use of open market operations (OMO) for intraday liquidity requirements. — MT
  - Review collateral haircut methodology and ensure independent validation. — ST
  - Operationalize mark-to-market module. — ST
  - Revise priority levels of instant transfer transactions. — ST
  - Prescribe a cut-off time for withdrawal of transactions in queue. — MT
  - Examine introduction of time varying fees for payment instructions. — MT
  - Complete and disclose publicly CPSS-IOSCO Disclosure framework. — ST

- SHCH (Shanghai Clearing House) recommendations — PBC, SHCH responsible
  - Appoint independent chair at the Risk Management Committee (RMC). — ST-MT
  - Ensure regular reporting of operational and IT risks to chief risk officer (CRO). — ST
  - Dispose of exposure thresholds per clearing member. — ST
  - Apply haircuts to cash collateral. — MT
  - Ensure independent validation of credit models at least annually. — ST
  - Conduct liquidity stress tests on a daily basis. — ST
  - Further develop business continuity plans by introducing a hot site. — MT
  - Increase the number of liquidity providers and settlement banks. — MT

### Implementation Priorities and Expected Benefits
- Priority actions: legal reform (finality/netting), staff resourcing and training, full PFMI implementation across FMIs, targeted risk-management improvements at major FMIs (CSDC, futures exchanges, SHCH), enhanced cyber resilience coordination, and policies for central bank services to systemically important FMIs.
- Expected outcomes: enhanced resilience and stability of FMIs; reduced credit and liquidity risk transmission; clarified supervisory powers and legal certainty; improved preparedness for operational and cyber incidents; strengthened capacity to manage extreme liquidity events while preserving market stability.

*Source: EXECUTIVE SUMMARY (cr18192) — IMF staff note for the 2017 China FSAP.*

### Appendix III    contains key statistics per FMI.

### Appendix III    contains key statistics per FMI.

### FMI landscape and systemic importance
- The HVPS clears approximately 16 percent of the annual GDP on a daily basis and has direct and indirect links to all other FMIs, making it systemically important.
- The three CSDs are systemically important due to their central role in the interbank bond and securities markets and their role as custodian for CCP collateral.
- All CCPs are considered systemically important as risk concentrators in various financial markets.
- The bulk electronic payment system (BEPS) could be considered a SIPS, due to high volumes and its critical role for retail and corporate payments.
- Appendix IV (not reproduced here) contains an overview of systemic indicators for the main FMIs (size, interconnectedness, substitutability and unique functions, such as facilitating monetary operations and collateral management).

### Ownership of FMIs
- All FMIs are state-owned.
- Main payment systems are owned and operated by the PBC.
- The PBC and/or the state have ownership, directly or indirectly, in the CCDC, CIPS and SHCH.
- Securities and futures market CCPs and CSDC are either owned by their members or shareholders, many partly or fully state-owned institutions.

### Supervisory and oversight framework
- Authorities responsible: PBC and CSRC.
  - PBC is the main supervisor of payment systems and FMIs for the interbank bond, foreign exchange (FX) and OTC derivatives markets.
  - PBC Payment and Settlement department: responsible for HVPS, BEPS, internet banking payment system (IBPS), CIS, CIPS, FCPS, China Union Pay, Clearing Center for City Commercial Banks, Rural Credit Banks Funds Clearing Center. Main law: PBC Law.
  - PBC Financial Market department: responsible for CCDC, SHCH. Main law: PBC Law.
  - CSRC Market Supervision department: regulates and supervises the CSDC. Main law: Securities Law.
  - CSRC Futures Supervision department: regulates and supervises CFFEX, DCE, SHFE, ZCE. Main law: No law, but futures regulation.
- SAFE (State Administration of Foreign Exchange), a subsidiary of the PBC, is involved in supervision of SHCH for FX-related product approvals, in coordination with the PBC.
- MOF and CBRC are stakeholders for CCDC:
  - MOF is shareholder of the CCDC and issues government securities, regulating debt issuance, payment and custody matters related to CCDC operations.
  - CBRC is responsible for appointment of the chairman of the CCDC and has outsourced maintenance of three registers to the CCDC.

### Recent developments
- Market and regulatory changes stem from G20-related reforms, opening markets to foreign investors, cross-border trading, and private sector innovation.
- Specific developments:
  - In January 2014, SHCH started clearing OTC derivatives, i.e., Chinese Yuan (CNY) interest rate swaps (IRS).
  - In July 2014, clearing of CNY IRS became mandatory onshore in China for dealers and clients.
  - In October 2015, CIPS was launched to facilitate clearing and settlement of cross-border renminbi payments; CIPS is an RTGS directly linked to the HVPS.
  - Use of e-money instruments offered by nonbank payment providers (e.g., Alipay, Tenpay) has grown exponentially. Regulatory framework includes Administrative measures for payment services provided by nonfinancial institutions of 2010, and Administrative measures on online payment by nonbank payment institutions of 2015.
  - Volume and value details of e-money instruments from 2013 to 2015 are provided in Table 6 in Appendix III (table not reproduced here).
- The mission notes that retail payments from nonbank providers could become systemically important in coming years and failures could impact public confidence in non-cash retail payments.

### Analysis of supervisory alignment with PFMI (Responsibility A)
- Legal framework is segmented across different markets and laws; statutory supervisory coverage differs by segment and clear criteria for identifying FMIs subject to regulation are not always available.
- PBC Law prescribes PBC responsibilities (Article 4(9), Article 27) but does not include explicit criteria for FMIs to be subject to PBC regulation, supervision and oversight.
- PBC has published multiple notices and amended regulations:
  - 2011: Notice of Business Supervision and Management Rules of the China Foreign Exchange Trade System.
  - 2016: Notice on Amending the Related Management System of the Payment System (amending six regulations on HVPS and identifying “Settlement finality” in HVPS and BEPS).
  - PBC publicly declared it will apply the PFMI to CNCC, CIPS, China Union Pay, Clearing Center for City Commercial Banks, and Rural Credit Banks Funds Clearing Center.
  - 2011: Notice of Business Supervision and Management Rules of SHCH, and of CCDC.
  - 2014: Notice related to establishment of a CCP for OTC derivatives, effectively mandating central clearing for certain CNY IRS contracts.
  - PBC declared it will apply the PFMI to CCDC and SHCH.
- CSRC regulatory coverage:
  - Securities law (Articles 155 and 157) specifies CCPs and CSDs for the securities market are subject to CSRC supervision.
  - CSRC identified CSDC as a CSD/CCP under its supervision and declared PFMI apply to the CSCD.
  - Futures markets regulated by CSRC via Regulations on Administration of Futures Trading (2017 revision) and Measures for the Administration of Futures Exchanges (2007); no dedicated futures law exists.
  - CSRC identified SHFE, DCE, ZCE, CFFEX, and CSDC as CCPs under its supervision and declared PFMI apply to these exchanges.
  - OTC futures transactions are not covered by existing regulations.
- Legal risks and potential vulnerabilities:
  - Lack of a statutory framework for futures markets may create legal uncertainty about CSRC powers to enforce changes, as CSRC powers are based on secondary legislation.
  - PBC’s statutory basis lacks clear criteria for FMIs subject to its oversight, possibly creating confusion about scope and powers between authorities.
  - Growth of market and new cross-sector products (e.g., OTC derivatives) could expose gaps or overlaps in regulation with associated systemic risks.

### Ongoing legal initiatives and recommendations (Responsibility A)
- Ongoing initiatives welcomed by the mission:
  - Development of ‘China Financial Infrastructure Supervisory Rules’ intended to become a law, outlining regulatory, supervisory and oversight responsibilities for all relevant authorities for FMIs and reflecting PFMI principles.
  - Revision of the securities market Law to add new requirements for risk management frameworks of securities CCPs and CSDs.
  - CSRC drafted a comprehensive futures market law to provide legal basis to regulate and supervise futures markets, including CCPs; draft may include PFMI-based requirements (finality and netting). The draft law has been sent to the National People’s Congress of the People’s Republic of China. No timeline has been set yet for promulgation.
  - Drafting of a national payments law to provide clear legal basis for regulation and supervision of payment systems and payment instruments.
- Recommendation: Authorities may benchmark national supervisory model against jurisdictions with comparable market size and complexity (example: United States Dodd-Frank Act, Title VIII approach to identifying primary regulators and expanding Federal Reserve role in systemically important FMIs).

### Powers and resources (Responsibility B)
- PBC powers:
  - PBC has sufficient powers under PBC law and Administrative Measures (Articles 4 (9), 27, 32 and 46) to obtain information and induce change or enforce corrective action.
  - Administrative measures include: (i) Measures for the administration of the entry and exit payment system of banking financial institutions; (ii) Administrative measures of PBC payment system participants; (iii) Business approach of HVPS; (iv) Operational management approach of payment system of PBC; (v) Crisis management plan for payment and settlement systems.
  - CNCC (operator of main payment systems) is a public entity within the PBC; CCDC and SHCH supervised by PBC, allowing information access and approval of FMIs’ risk management measures, extending to critical service providers (CSPs).
- CSRC powers:
  - Under securities law and relevant regulations, CSRC can: request information; approve articles of association and business operational rules and appointment/removal of general manager; approve business implementation rules, systems, new products and business models; require major incidents to be reported; evaluate annual performance of CSDC and four CCPs including board and management; and use enforcement tools (penalties, warnings, orders to correct, confiscation of illegal gains, orders to close down, warnings or disqualification of responsible staff).
  - CSRC can supervise CSPs and published Information System Audit Standards for Securities and Futures Industries enabling comprehensive IT assessments and on-site inspections of CSDC and four CCPs.
- Resource constraints:
  - PBC departments: PSD has 32 staff members; financial markets department has 36 staff members. These numbers are described as tight given responsibilities.
  - CSRC resources: Market supervision department has approximately 40 members covering all equity exchanges and CSDC, of which 3 staff members are engaged in CCP and CSD supervision. Futures supervision department has 27 full time staff resources, of which 1 staff member is involved in supervision of the CCPs.
- Recommendation: Authorities should ensure appropriate staff levels in quantity and quality, including staff with knowledge of international standards and quantitative risk models for CCPs (margin, credit and liquidity models), to adequately regulate and supervise FMIs in line with the PFMI.

*Source: IMF staff report — Appendix III (contains key statistics per FMI).*

### 29. The PBC discloses its policies and regulations related to payment systems. The basic

### 29. The PBC discloses its policies and regulations related to payment systems. The basic

### Disclosure of policies and institutional objectives
- The basic policy objective of the PBC on HVPS is to “maintain normal operation of payment system and clearing systems” as stated in the PBC Law.
- The PBC discloses the regulations and any revisions to the regulations to the public through its annual report, website, and press announcements.
- The PBC discloses its policies and regulations on the securities depository and the CCP for the OTC interbank derivatives bond market. The basic policy objective of the PBC for the CCDC and SHCH is “ensure efficiency, security and protection of investors’ legitimate rights”.
- The PBC law, administrative measures on bond register and custody in the inter-bank bond market and regulations on SHCH have defined the roles and the basic institutional arrangements of SHCH and CCDC.
- The CSRC discloses its policies and regulations on securities depositories, clearing institutions, securities and derivatives FMIs. The basic policy objective of the CSRC on these FMIs is “ensuring safety and high efficiency.”
- Securities law, regulations on the administration of futures trading, measures for the administration of securities registration and clearing, measures for the administration of futures exchange and other relevant laws and regulations have defined the roles and the basic institutional arrangements for these FMIs.

### Implementation of the PFMI (Responsibility D)
- Authorities publicly stated that they adopt the PFMI pursuant to:
  - Circular on Implementation of Principles for Financial Mark Infrastructures (Yin Ban Fa [2013] No.187 and Zheng Jian Fa [2013] No.42)
  - Circular on Conducting Assessment on Financial Market Infrastructures (Document Yin Ban Fa [2013] No.239)
- The PBC and the CSRC fully adopt the FMI principles.
- Governance and coordination arrangements:
  - PBC and CSRC established a Steering Group on FMIs: Notice on Establishment of Steering Group and its secretariat on Financial Market Infrastructures (Document Yin Ban Fa [2014] No.106).
  - A PFMI office has also been established by both regulators.
  - Steering group responsibilities: guiding development and reform of FMIs, coordinating on major issues, and jointly promoting implementation of the PFMI.
- Assessment activity:
  - All relevant FMIs carried out a self-assessment as requested by authorities.
  - Self-assessment was followed by an external assessment by a joint team of experts from the PBC and the CSRC under the umbrella of the steering group and PFMI office.
  - Set timelines for self-assessment and external assessment were January and March 2014 respectively.
  - The PBC is currently deciding what the next step should be.

### Recommended strengthening and areas for further implementation
- General recommendation:
  - Strengthen implementation of the PFMI by reviewing and where necessary strengthening regulations and measures of the authorities, and the rules of the FMIs.
  - CSRC is referencing the PFMI to review its regulations and measures for possible improvements.
  - Rules of the CSDC and four futures CCPs could be further updated to reflect practices in line with the PFMI, taking into account results of the self-assessment and external assessment.
- Compliance observations:
  - Compliance with the PFMI varies among FMIs; CCDC and SHCH appear largely adopted, while other FMIs need further implementation in organization and daily processes.

### CSDC-specific recommendations
- Delivery-versus-payment (DVP) arrangements and principal risk:
  - DVP is addressed in the legal framework but actual arrangements do not sufficiently protect counterparts against loss of the full principal value.
  - Recommendation: implement DVP by linking final settlement of securities to final settlement of the funds leg.
  - Current practice: final settlement of securities on T+0 and final funds settlement on T+1 exposes CSDC to principal and replacement cost risks.
  - Article 49 in Chapter 6 of the Regulations on Securities Registration and Settlement states settlement should take place in a DVP mode, but buyer can sell securities before making payment and before settlement of the funds leg.
  - Claw-back provision exists but is ex-post and does not mitigate principal risk.
  - Suggested ex-ante measures:
    - (i) blocking the delivered securities in the buyer’s account till settlement of the funds leg is completed with CSDC enjoying a lien on the blocked securities in the account of the buyer; or
    - (ii) create a special securities account of CSDC where the securities are lodged till completion of settlement of the funds leg and transfer the securities to the buyer’s account thereafter.
  - Adoption of such measures would mitigate credit risk and result in DVP.
- Margin models and validation:
  - Valuation models used for calculation of initial margin should be independently validated by a qualified external expert on an annual basis to mitigate model risk.
  - At a minimum, validation should be carried out by staff with sufficient expertise who are independent of the developers and the users of the margin model.
  - Margin calculation and back-testing should be carried out on a daily basis; back-testing to evaluate exceptions to initial margin coverage.
  - The model used to determine the adequacy of the default waterfall financial resources should also be subjected to validation.

### Futures exchanges: risk management and governance
- Risk management department:
  - Futures exchanges should establish a dedicated risk management department, in line with international best practices.
  - Risk management department should have an independent reporting line to the Council (equivalent to the Board of directors).
  - Current arrangements often divide risk management between business departments and market supervision.
- Risk governance realignment:
  - Make the risk management department responsible for enterprise-wide risk management, rather than the RMC (executive level body comprising heads of departments and the CEO).
  - The risk management department should produce a clear and documented enterprise-wide risk management strategy, approved by the RMC and endorsed by the Council.
  - The RMC should be chaired by a sufficiently knowledgeable individual who is independent of executive management and should have an independent reporting line to the Council with regular reporting on all matters pertaining to risk management.
- Default waterfall and stress testing:
  - Closer scrutiny on composition of the default waterfall and its use for participant default management is needed; the composition also includes resources for overcoming liquidity shortfalls.
  - Financial resources in the revised waterfall should be subjected to ongoing regular stress tests by individual exchanges and by the China futures monitoring center (responsible for stress tests across all futures exchanges).
  - Results of the China futures monitoring center’s examinations should be shared with the CSRC, if not already done so, to enable the regulator to obtain an overarching view and support supervision and oversight.

### Transparency and governance recommendations
- Principle 23 transparency:
  - Regulatory authorities should advise all FMIs under their jurisdictions to complete and publicly disclose their responses to the CPMI-IOSCO Disclosure framework for financial market infrastructures.
  - SHCH and CCDC have publicly disclosed their responses to the disclosure framework in English and Chinese.
- CCDC governance recalibration:
  - Recalibrate governance and oversight arrangements over CCDC to clearly distinguish roles of the PBC, MOF, and CBRC.
  - Recalibration should establish the PBC as the authority responsible for overseeing the functioning of the CCDC as an FMI.
  - Reset respective roles of MOF and CBRC to provide clear reporting lines to CCDC, avoid conflicts of interest, and minimize regulatory arbitrage.
- Capacity building:
  - CSRC may hold dedicated workshops on the PFMI for FMI staff on a periodical basis to facilitate capacity building and contribute to PFMI implementation. (PBC already provides such workshops.)

### Operator and overseer roles for payment systems
- In line with international best practices, operator and overseer roles of the PBC regarding the HVPS and other payment systems are distinct:
  - HVPS is operated by the CNCC, a separate public entity in the PBC.
  - PSD is responsible for oversight and regulation of all payment systems including the HVPS.
  - CNCC and PSD are staffed by different personnel of the PBC.

### Cooperation among authorities (Responsibility E)
- PBC–CSRC cooperation on PFMI:
  - Cooperation is well established via the Steering Group for FMIs and the PFMI office; could be further strengthened in law.
  - PBC is responsible for overall planning and coordination of PFMI implementation and reports progress to the State Council and international organizations.
  - PFMI office in the PBC consists of technical staff of both regulators; PBC and CSRC invite each other into assessment teams, exchange self-assessment reports, and jointly facilitate PFMI implementation.
  - CSRC and PBC hold periodical meetings with deliberations recorded in minutes to facilitate coordination.
  - Reviews of the legal framework (Responsibility A) could reflect these cooperation practices to further strengthen and formalize them.
- Domestic multi-tiered cooperation:
  - Cooperation among PBC, CBRC, CSRC, and CIRC occurs via:
    - (i) coordinating and cooperating through the State Council (responsible for overall financial stability and crisis management);
    - (ii) cooperating through the Financial Regulatory Coordination Joint Ministerial Committee (JMC);
    - (iii) others.
  - In a crisis event related to FMIs, authorities coordinate under the State Council to establish an interim work team to facilitate communication, consultation, and coordination.
  - The JMC is tasked with coordination in maintaining financial stability and mitigating regional and systemic risks and reports to the State Council.

### Cross-border links and cooperation
- Multiple roles and links:
  - CSDC and SHCH have multiple roles as a CCP, CSD, and SSS. CSDC, CCDC, and SHCH are FMIs that have cross-border links.
  - CSDC has link arrangements with the Hong Kong Stock Exchange under the Shanghai-Hong Kong and Shenzhen-Hong Kong Stock Connect programs.
  - CSDC has a link arrangement with the CSD in Singapore to support transfer of share stocks, limited to the shares of one listed company and the volume and value of trades is insignificant.
  - CCDC and SHCH linked to the central money-markets Unit after the launch of the Bond Connect pilot program on July 3, 2017.
- CSRC–HKSFC cooperation:
  - CSRC and Hong Kong Securities and Futures Commission (HKSFC) have a memorandum of understanding (MOU) on strengthening regulatory and enforcement cooperation under Shanghai-Hong Kong Stock Connect and Shenzhen-Hong Kong Stock Connect.
  - CSRC has established a periodical coordination and supervisory cooperation mechanism with HKSFC for safe and efficient functioning of the FMIs involved.
- Link risk evaluation:
  - Link related risks should be evaluated by the CSRC.
  - Evidence of exchange of information between authorities concerning PFMI assessments of involved FMIs was not available in English to the assessment team.
  - Stock Connect cross-border link arrangements should be evaluated to identify, monitor and manage legal, credit, and liquidity risks, including a high level of protection of investor rights of the investor CSD participants.

### FCPS and multicurrency services
- The FCPS provides multicurrency services.
- Before adding a new currency, the PBC consults with relevant central banks of issue for comments and suggestions.
- The PBC does not designate FCPS as a SIPS, as its turnover is not very significant.
- The PBC notifies the volume and value of the foreign currency transaction to the relevant authorities on a quarterly basis.

### System-wide risks — interdependencies between FMIs and financial institutions
- Network and membership statistics:
  - The landscape for FMIs is an interconnected network with significant overlap of members between multiple FMIs.
  - Figure 2 displays the network for the main FMIs in China and 609 members, consisting of 318 banks, 239 brokers, 2 insurers, and 50 other.
  - The number of 609 is a consolidated cleaned membership set, based on the top 200 members of the CCDC and all members of the other FMIs.
  - Data is of September 30, 2016, except for HVPS and SHCH, for which the dates are December 31, 2016 and November 24, 2016, respectively.
- FMI centrality and links:
  - The largest FMI node is HVPS, followed by CCDC (largest settlement values and highest number of members).
  - CSDC is the third largest FMI in turnover, and SHFE the third largest FMI in number of members.
  - HVPS has direct links to CCDC, SHCH, and CIPS and indirect links to remaining FMIs.
- Concentration of memberships:
  - Nine banks have membership in all FMIs (eight Chinese banks and one U.S. bank).
  - Another eight banks have membership in seven FMIs.
  - 76 banks have membership in four FMIs.
- Overlapping clusters (Table 3 and Figure 4):
  - Four futures CCPs have a highly overlapping member base:
    - ZCE and DCE’s overlap is more than 90 percent;
    - CFFEX’s member base overlaps with the other three futures exchanges for more than 80 percent.
  - Turnover and exposures are somewhat concentrated with approximately a quarter to a third of the member base responsible for 80 percent of turnover and exposure.
  - CSDC highly overlaps with the four futures CCPs, with around 40 percent of CSDC’s members also being members of these CCPs.
  - Overlap between members of CCDC and SHCH is more than 50 percent.
  - HVPS member base is more related to CCDC and SHCH, illustrating CCDC and SHCH settle cash payments directly in the HVPS.
- Contagion risk:
  - High interconnectivity suggests contagion from a financial or operational failure of an FMI or critical member could quickly spread through the financial system if proper safeguards are not in place.
  - Data for CSDC and CCDC show that default of the two participants and their affiliates with the largest losses not only affects these FMIs but also other FMIs due to multiple memberships.
  - Example impacts:
    - Default of the two participants with the largest exposures in CSDC coincides with default of these participants in another 5-12 FMIs, including several CCPs.
    - For CCDC, default of the two largest participants (measured in turnover) would coincide with default of these entities in 4-8 other FMIs.

*IMF staff summary based on the provided chapter text.*

### 57. This analysis emphasizes the need for: i) resilient FMIs that are able to stop a contagion of

### cr18192 - 57. This analysis emphasizes the need for: i) resilient FMIs that are able to stop a contagion of

### Finality and Netting
- Finding: Finality and netting are addressed in China at the level of regulations, measures and rules, with measures taken since the FSAP in 2011 by the PBC, CSRC, and individual FMIs.
- Risk: The concepts of finality and netting are not unambiguously included in the Securities Law, and therefore current regulatory-level treatment does not provide watertight protection against:
  - revocation of transactions or collateral payments;
  - unwinding of netted positions following the bankruptcy of a bank.
- Rationale: Finality and enforceability of netting and collateral arrangements should be at the level of the law because they derogate from the Insolvency statute; a lower level of regulatory norm (or FMI self-regulation) cannot validly and with legal certainty do it.
- Recommendation: Unambiguously include finality and netting concepts in statutory law to provide a high degree of legal certainty covering all FMIs, including provisions for:
  - recognition of settlement finality in the event of insolvency of a participant;
  - recognition of multi-lateral netting;
  - provisions for bankruptcy remoteness of pledged collateral;
  - close out netting;
  - prescriptions to overcome any zero-hour rules.
- Implementation options:
  - introduce these concepts at a statutory level when drafting new laws or reviewing existing laws; or
  - enact a comprehensive statute on finality and netting.
- Benefit: Strengthening the legal basis will improve consistency with the Bankruptcy Law and facilitate determination of Chinese CCPs as qualifying CCPs (QCCPs) by foreign authorities or banks.

### Cyber Resilience of FMIs
- Context: Authorities have identified cyber risk as an important supervisory topic for financial institutions, including FMIs.
- Legal development: A cyber security law was issued in 2016 and will come into effect as per June 2017; the law applies to all critical institutions in China and specifically identifies FMIs as critical institutions for financial stability.
- Industry action: In 2016, the CSRC organized an industry-wide contingency test on information security with more than 10 institutions participating, including securities exchanges, futures exchanges, CSDC and market institutions; the test was jointly planned with the Ministry of Industry and Information Technology and the National Energy Administration, and observed by the Cyberspace Administration of China and the PBC.
- Supervisory posture: The PBC and CSRC have both issued information security requirements and focus on strengthening autonomous control of information systems for FMIs under their responsibility.
- Recommendation:
  - Authorities may strengthen joint efforts and address cyber resilience explicitly under the PFMI office.
  - Use the CPMI-IOSCO guidance on cyber resilience for FMIs (issued in June 2016) as a benchmark.
  - Improve joint crisis coordination mechanisms and test crisis communication protocols.
  - Address identified weaknesses in the PBC’s and the CSRC’s supervisory activities as a priority.

### Recovery, Resolution and Liquidity Support
- Status of plans:
  - FMIs: Some FMIs have developed recovery plans in line with international standards; others need further development beyond business continuity planning (BCP) and default management.
  - Resolution: Resolution planning is at an early stage; no legal framework has been developed nor a resolution authority appointed. The PBC is studying features of these arrangements in the Chinese context.
- Central bank services and resilience:
  - Current: The PBC currently provides settlement services to CCDC and SHCH.
  - Consideration: The PBC may consider extending central bank settlement services to the CSDC and other CCPs, conditional on FMIs strengthening risk management and being subject to macroprudential oversight by the PBC in addition to CSRC supervision.
- Liquidity support principles:
  - Private sector liquidity should be the first line of defense for FMIs against liquidity shortfalls.
  - In extreme circumstances where liquid resources are insufficient or unavailable, special financing arrangements by the central bank could ensure FMIs can continue payments to counterparties and maintain market stability.
  - Provision of central bank accounts will reduce FMIs’ dependence on collateral services provided by commercial banks and may be used for settlement purposes, significantly reducing credit and liquidity risks related to settlement banks.

### Analysis of HVPS (High-Value Payment System)
- System profile and upgrades:
  - HVPS is an RTGS system owned and operated by the PBC with a “V” topology.
  - HVPS version 2 features include: (i) liquidity saving offsetting mechanism; (ii) single point access to the participants; (iii) ISO 20022 message formats; and (iv) an increase in operating hours which is 8:30 am to 5:00 pm for normal settlement and 5:00 pm to 8:30 pm for specific business.
  - Business continuity and disaster recovery: three operating centers in two locations (with the third operating center becoming functional this autumn).
- Legal basis: The PBC Law (Article 27 and Article 4 (9)) provides the legal basis for the PBC to operate the HVPS and to maintain the normal operation of the payment, clearing and settlement systems.
- Governance: A dedicated RMC for the HVPS, chaired by the Deputy Governor, is responsible for overall risk management; the RMC meets every quarter and includes heads of relevant PBC departments and select participants.
- Participants (end-2016):
  - 305 direct participants
  - 141,023 indirect participants
- Credit and liquidity risk management:
  - Transactions are settled in real time on a gross basis based on availability of funds.
  - The PBC provides intraday liquidity support on a fully collateralized basis as intraday repos with a fee; intraday liquidity must be repaid by end of day or converted into an overnight facility at a penal rate.
  - Participants tend to use the OMO facility or borrow in the interbank market as cheaper liquidity sources.
- Issues identified and recommendations:
  - Review intraday repo fee and timing: The intraday repo fee acts as a disincentive; intraday repo is available only till 5:00 pm though system operates till 8:30 pm, potentially imposing liquidity pressures in stressed conditions.
  - Review reliance on OMO for intraday liquidity: Using OMO (a monetary policy tool) for HVPS intraday needs should be reviewed; participants’ exposure to liquidity risk if OMO is unavailable or interbank market timings do not match HVPS hours.
  - Collateral management: A uniform haircut ratio of 10 percent (set in 2004) should be reviewed; the mark to market module exists but has not been made operational. Recommendations:
    - review haircut methodology;
    - mark to market collateral on a daily basis;
    - subject haircut methodology and procedures to independent validation at least once a year.
  - Priority of instant transfers: Instant transfers (DVP transactions and net clearing settlement files from FMIs) are currently assigned the lowest priority at priority 7; recommendation to assign instant transfers a higher priority, on par with either priority level 3 or 4, to mitigate system-wide liquidity risks.
  - Additional liquidity risk mitigation tools to deploy:
    - prescribe a cut-off time in system rules after which a participant cannot withdraw a transaction pending in the queue for settlement (to avoid creating liquidity risks);
    - introduce a time varying fee structure so payments sent earlier pay lower fees and those sent towards the end of operating hours attract higher fees to improve liquidity flows.
- Operational resilience:
  - RMC manages operational risk; HVPS has a main operating center and a backup center 300 kilometers away, with a third center coming into service this autumn.
  - HVPS adheres to recovery point objective (RPO) and recovery time objective (RTO) and maintains holistic BCP involving the central system, participants and other FMIs; around 70 key direct participants also have backup centers.
- Transparency recommendation: HVPS should complete and publicly disclose responses to the CPSS-IOSCO Disclosure framework for financial market infrastructures on a regular basis, in both Chinese and English.

### Analysis of SHCH (Shanghai Clearing House)
- Overall assessment: Risk management practices of the SHCH are generally well designed and in line with the PFMI, with modern risk management systems, a risk management department, an RMC, and rules, procedures and practices to manage operational and financial risks.
- Governance issue and recommendation:
  - Current: The Chairman of the Board of Directors also chairs the RMC.
  - Concern: This arrangement does not support independent analysis of risks within the RMC and may introduce business considerations into risk assessment.
  - Recommendation: Appoint a sufficiently knowledgeable independent chair of the RMC, independent of SHCH’s executive management, to lead independent risk analysis and reporting to the Board of Directors, enabling the Board to receive complete and unbiased information and exercise objective judgment.

*PEOPLE’S REPUBLIC OF CHINA*

### 81. Operational and IT risks should be regularly reported to the CRO. Currently, the risk

### cr18192 - 81. Operational and IT risks should be regularly reported to the CRO. Currently, the risk

### Reporting and risk governance
- Finding: The risk management department is the only department within SHCH that reports to the CRO.
- Finding: The risk management department ‘only’ covers the management of credit, liquidity and market risks; operational and IT risks are not regularly reported to the CRO.
- Recommendation: Preferably have the risk management department also cover operational and information technology (IT) risks.
- Alternative recommendation: Staff of the Operational and IT Departments that are responsible for risk management should have a direct reporting line to the CRO.
- Process note: The CRO reports all types of risks to the RMC through his/her direct reporting line.

### Credit exposures, intraday margining, and initial margin adequacy
- Finding: SHCH monitors its exposures towards clearing members during the day but has defined exposure thresholds per clearing member.
- Risk: SHCH will only call for intraday margin if thresholds are reached; this means the CCP may be exposed to credit risks during the day.
- Principle gap: The requirement of Principle 4 that ‘current and potential future exposures to each participant should be fully met’ is not fully implemented by SHCH.
- Recommendation: SHCH’s initial margin calculation should be further developed to ensure that its potential future exposures are covered with a single-tailed confidence level of 99 percent.

### Cash collateral and haircuts
- Finding: SHCH does currently not apply a haircut to cash collateral.
- Context: Only the CCP service for FX spot and derivatives transactions accepts foreign currency, i.e., USD. USD collateral currently comprises only a small part of all margins.
- Recommendation: Adopt haircuts for cash collateral in line with the PFMI and international practices to protect the CCP against potential fluctuations in the exchange rate.

### Model validation and independence
- Finding: The credit risk models, including the margin and haircut models, are not validated by reviewers that are sufficiently independent.
- Recommendation: Validation of the models should be performed by personnel with sufficient expertise, who are independent of the personnel that created and use the models.
- Implementation options: These experts could be drawn from within SHCH or be external experts, such as academics or consultants.
- Frequency recommendation: Independent validations should take place at least annually.

### Liquidity stress testing
- Finding: Currently, SHCH conducts liquidity stress tests on a quarterly basis.
- Principle requirement: In line with Principle 7, FMIs should be able to effect intraday and multiday settlement and meet other payment obligations on time under a wide range of potential stress scenarios.
- Recommendation: FMIs should be able to conduct liquidity stress testing on a daily basis.

### Business continuity planning (BCP) and disaster recovery
- Finding: BCP is well-developed; SHCH has a main operational center in Shanghai, and disaster recovery sites in Shanghai and in Beijing. BCP plans are developed and regularly tested.
- Residual issues:
  - Backup sites can take over IT operations, but operational staff needs to be transported from the primary to the secondary site.
  - Testing does not necessarily test the full load of operations at the backup site.
- Recommendation: Further strengthen BCP by, for example:
  - Full and regular switching of all operations between the primary and secondary sites.
  - Establishment of a hot backup site.

### Liquidity providers and settlement bank concentration
- Finding: SHCH has contracted 2 banks as liquidity provider for USD liquidity needs and 2 banks for credit lines in other currencies.
- Finding: SHCH has selected 2 settlement banks for USD settlements and 1 for other currencies.
- Risk: Concentration risks and interdependencies may materially impact SHCH’s ability to fulfil its obligations as a CCP if one supporting bank fails.
- Scenario example: In times of stress, one of SHCH’s liquidity providers may default, resulting in no or reduced access to credit lines, causing potentially significant liquidity risk to SHCH. The loss of a settlement bank exposes SHCH to operational problems.
- Recommendation: Increase the number of liquidity providers and settlement banks for non-RMB to mitigate concentration risks and interdependencies.

*People’s Republic of China — content extracted from cr18192.*

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_Source: https://www.imf.org/-/media/files/publications/cr/2018/cr18192.pdf_