## _cr11148 — Executive Summary and Selected Chapters

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### Major findings: role and structure of the financial sector
- Luxembourg hosts a large international financial center that is a key driver of domestic economic growth and plays an important role in EU financial markets.
- The financial sector represents about one-fourth of Luxembourg’s GDP, one-third of its tax revenues, and 12.5 percent of its labor force.
- Sector composition and scale:
  - Banking industry: total assets surpassing 20 times GDP.
  - Investment fund industry: assets under management equivalent to around 50 times GDP.
  - Insurance industry: aggregate balance sheet of about four times GDP.
- Linkages: strong linkages with France, Germany, Italy, the Kingdom of the Netherlands, the United Kingdom, and the United States.
- Monetary and financial institutions (MFIs) intermediate about 16 percent of total cross-border exposures among euro area MFIs.

### Banking sector structure, exposures, and key metrics
- Structure and ownership:
  - The banking sector accounts for about 28 percent of total financial sector assets.
  - As of June 2010, there were 149 banks operating in Luxembourg.
  - Most banks and 90 percent of total bank assets are foreign-owned.
  - Majority of groups operate through both subsidiaries and branches.
  - Local banking system is a net provider of liquidity to parent banks (“upstreaming”).
  - Interbank positions represent about half of bank assets and liabilities (compared to an average of about 28 percent in the euro area).
  - Two thirds of these interbank positions are cross-border exposures.
  - Intra-group exposures account for about 40 percent of total bank assets.
- Funding profile (As of June 2010):
  - Funding from Group: 39%
  - Deposits (excl. interbank): 29%
  - Interbank funding: 10%
  - Securities: 9%
  - Derivative Instrument: 2%
  - Central bank funding: 2%
  - Other: 0%
  - Own Funds: 9%
- Asset and liability composition (As of June 2010):
  - Loans to credit institutions: 47%
  - Securities other than shares: 23%
  - Shares and other equities: 1%
  - Other assets: 6%
  - Loans to other sectors: 23%
  - Amounts owed to credit institutions: 48%
  - Capital and reserves: 6%
  - Amounts owed to general government: 1%
  - Amounts owed to other sectors: 34%
  - Debt securities issued: 11%
- Financial soundness indicators (selected exact entries from Table 2):
  - Regulatory capital to risk-weighted assets: 2005 Dec 15.5; 2006 Dec 15.3; 2007 Dec 14.3; 2008 Dec 15.4; 2009 Jun 17.1; 2009 Dec 18.9; 2010 Jun 18.0; 2010 Dec 17.0
  - Regulatory Tier 1 capital to risk-weighted assets: 2005 Dec 12.9; 2006 Dec 12.7; 2007 Dec 12.2; 2008 Dec 13.0; 2009 Jun 14.8; 2009 Dec 17.0; 2010 Jun 16.0; 2010 Dec 15.0
  - Capital to assets: 2005 Dec 4.0; 2006 Dec 4.0; 2007 Dec 4.0; 2008 Dec 4.0; 2009 Jun 5.0; 2009 Dec 5.5; 2010 Jun 5.0; 2010 Dec 5.0
  - Return on assets: 2005 Dec 0.7; 2006 Dec 0.9; 2007 Dec 0.8; 2008 Dec 0.2; 2009 Jun 0.7; 2009 Dec 0.6; 2010 Jun 0.7; 2010 Dec 0.7
  - Return on equity: 2005 Dec 17.0; 2006 Dec 22.1; 2007 Dec 20.4; 2008 Dec 5.5; 2009 Jun 14.4; 2009 Dec 11.6; 2010 Jun 13.0; 2010 Dec 13.0
  - Liquid assets to total assets: 2005 Dec 53.3; 2006 Dec 52.0; 2007 Dec 50.0; 2008 Dec 59.0; 2009 Jun 56.0; 2009 Dec 55.9; 2010 Jun 54.0; 2010 Dec 56.0
  - Liquid assets to short-term liabilities: 2005 Dec 64.3; 2006 Dec 63.0; 2007 Dec 61.0; 2008 Dec 67.8; 2009 Jun 63.6; 2009 Dec 64.7; 2010 Jun 64.0; 2010 Dec 66.0
  - Customer deposits to total (non-interbank) loans: 2005 Dec 189.0; 2006 Dec 196.0; 2007 Dec 165.0; 2008 Dec 134.7; 2009 Jun 139.6; 2009 Dec 137.5; 2010 Jun 120.0; 2010 Dec 131.0
  - Foreign currency denominated loans to total loans: 2005 Dec 41.4; 2006 Dec 42.3; 2007 Dec 34.5; 2008 Dec 30.2; 2009 Jun 28.7; 2009 Dec 28.0; 2010 Jun 29.0; 2010 Dec 30.0
  - Net open foreign exchange to capital: 2005 Dec -7.8; 2006 Dec -14.0; 2007 Dec 3.1; 2008 Dec 1.6; 2009 Jun -0.4; 2009 Dec -0.6; 2010 Jun 0.2; 2010 Dec 0.3
- Solvency and liquidity highlights:
  - Average bank solvency ratios (Basel II regulatory capital-to-risk-weighted assets) are high at 19.5 percent.
  - Over 85 percent of aggregate regulatory capital consists in Tier 1 capital.
  - Aggregate Tier 1 solvency ratio stands at about 17 percent.
  - Aggregate Tier 1 capital increased by 20 percent in 2009 (from €31.7 billion to €38 billion). About one third of this increase reflected the public recapitalization of the former local subsidiary of Fortis.
  - Aggregate liquidity ratio stands well above the minimum of 30 percent; as of mid-2010 it was about 64 percent on aggregate.
  - Banks retain a significant proportion (about half) of their portfolios in liquid assets.
  - Loan impairment rates remained below 1 percent in retail portfolios.

### Investment funds and insurance: scale, linkages, and structure
- Investment funds:
  - Luxembourg is the world’s second largest center for investment funds after the United States.
  - Investment funds domiciled and marketed in Luxembourg account for about 70 percent of its total financial sector assets, and about 30 percent of total assets under management by European funds.
  - MMFs represent a fifth of Luxembourg’s investment funds and more than 25 percent of total European MMF assets under management.
  - Fund sponsors mainly originate from Europe and the United States; funds domiciled in Luxembourg are generally managed from other international financial centers.
  - Distribution and investment patterns:
    - Luxembourg-based UCITS are sold globally: 75 percent in Europe and 15 percent in Asia; they are invested worldwide (45 percent in the euro area).
    - About half of investment funds’ assets (€1 trillion) are invested in nonbank financial institutions (NBFIs), particularly other investment funds.
    - €350 billion are placed in MFIs.
    - €320 billion are placed in government securities.
    - Cross-shareholdings between investment funds exceed € 110 billion.
    - Bank deposits related to investment funds amount to €72 billion, representing about 9 percent of total bank balance sheets.
    - From the banking side, banks hold about €13 billion assets in investment funds, and provide depository and custodian services.
    - Luxembourg funds hold about €12 billion deposits in euro area banks, compared to €2 trillion total cross-border deposits in euro area MFIs.
    - Luxembourg funds hold less than €100 billion debt securities issued by euro area MFIs, compared to the total outstanding amount of about €5 trillion.
  - Exposures to GIIPS sovereign are about 20 percent of total sovereign exposures, and most are with Italy.
- Insurance industry:
  - Most insurance and reinsurance companies are subsidiaries of key international players, particularly major European (re)insurance groups.
  - Nondomestic premiums represent more than 90 percent of total premiums.
  - The industry is highly concentrated, with about 75 percent of total assets held by the top ten companies.
  - Life insurance and reinsurance companies account for about 60 and 35 percent of total assets respectively.
  - Clearstream Banking Luxembourg (CBL) and market infrastructure:
    - Luxembourg accounts for about 15 percent of total bonds issued globally (LSE activity driven by primary issuance).
    - CBL is one of the two largest international ICSD in the world, provides services to more than 1,200 financial institutions in about 110 countries, and custodial/settlement activities involve very large amounts of collateral.

### Crisis experience, fiscal impact, and immediate policy response
- Crisis impact:
  - Global financial crisis exposed vulnerabilities mainly due to large cross-border exposures to foreign parent banks.
  - Bank balance sheets contracted significantly during the crisis, mainly through reduced cross-border intra-group transactions; in aggregate, bank balance sheets shrank by almost 15 percent in 2009.
  - Subsidiaries of three Icelandic banks failed on contagion from their parent groups.
  - Liquidity and solvency problems at Fortis and Dexia affected Luxembourg-based affiliates; government support was provided by Belgium, France, the Netherlands and Luxembourg.
  - Investment fund industry faced sizable redemptions; some funds with significant exposures to structured products suspended redemptions.
  - Domestic credit market effects were muted owing to the dual nature of the banking system, relatively low household indebtedness, and resilient housing markets.
- Fiscal support and resolution costs:
  - Governments of Belgium, France, the Netherlands and Luxembourg granted state support to Fortis and Dexia totaling €22.9 billion, of which €2.9 billion were provided by Luxembourg.
  - For Luxembourg the cost of such support amounted to about 7 percent of GDP (which may be recovered with the sale of associated government claims).
  - Public support to Dexia and Fortis entailed significant use of fiscal resources and moral hazard.
  - Staff estimates that total fiscal contingencies associated with the current DGS under an extreme adverse scenario could amount to 7.5 percent of GDP.

### Ongoing vulnerabilities and systemic risks
- Key vulnerabilities:
  - Heavy outward orientation of insurance sector and dominance of nondomestic premiums (more than 90 percent).
  - High concentration of insurance assets among top firms (about 75 percent held by top ten).
  - Large cross-border and intra-group exposures of banks (cross-border exposures account for more than 70 percent of bank balance sheets).
  - Vulnerability of Luxembourg subsidiaries to parent bank distress (19 counterparties identified whose failure could cause at least one Luxembourg bank failure).
  - Concentration of GIIPS sovereign exposures in a small set of banks (about 10 percent of the system).
  - Given the large size of the financial sector relative to GDP, potential fiscal consequences of severe distress could be significant.
  - Systemic importance of Luxembourg as a global investment fund hub introduces potential cross-border spillover risks.

### Stress testing, network analysis, and resilience findings
- Macro and network stress testing:
  - Top-down sensitivity and macro-stress tests applied to a sample of banks holding over 80 percent of the total assets in the system, using data as of June 2010.
  - Macro scenario-based stress tests cover a two-year horizon; the adverse scenario assumes a global double-dip recession and further distress on sovereign exposures.
- Key stress test findings:
  - Luxembourg-based subsidiaries of foreign banks are vulnerable to distress in their parent banks; tests identify 19 counterparties, any one of whose failure could cause the failure of at least one bank in Luxembourg.
  - Interbank contagion risks within Luxembourg appear limited; failure of a local subsidiary would likely not directly cause that of other banks due to limited interbank balance sheet linkages.
  - The overall banking sector has enough capital to withstand substantial losses from GIIPS sovereign securities; however, exposures are concentrated in a small group of banks (about 10 percent of the system), which could become undercapitalized.
  - Other risks, including market risks, appear fairly contained due to the limited size of trading book activities.
  - About 85 percent of the total capital requirement (actual) owes to covering credit risk, followed by operational risks (9 percent).
- Insurance stress tests:
  - Several top-down and bottom-up stress tests (market, credit, and catastrophe risks) were applied to all life and nonlife insurance companies.
  - The insurance system appears resilient, reflecting improved risk management practices and high levels of technical provisions and capitalization.
  - Under the credit risk stress scenario (failure of the largest depository bank), ten small nonlife companies would record a solvency shortfall.
  - The effect of prolonged low interest rates was not assessed.

### Supervisory, regulatory, and crisis-preparedness shortcomings
- Identified shortcomings:
  - Weaknesses in regulatory and supervisory frameworks, crisis preparedness and resolution, crisis detection, and cross-border and inter-agency communication.
  - Flaws in governance, risk management practices, and supervision of foreign bank subsidiaries.
  - Need for strengthened oversight of systemic liquidity and financial market infrastructures.
- Institutional independence and governance concerns:
  - CSSF is under direct authority of the Minister; Board members are appointed by government upon proposals from supervised entities and the Minister; executives appointed/dismissed by government.
  - Perceived conflict between CSSF’s prudential duties and other roles; recommended to secure full operational independence.
  - CAA (insurance supervisor) is under direct authority of the Minister; licensing/de-licensing of insurance intermediaries is the responsibility of the Minister based on CAA recommendations.
- Operational shortcomings:
  - Heavy reliance on moral suasion; reluctance to use formal remedial powers and sanctions.
  - Modest number of on-site inspectors relative to the large number of institutions; delays in reporting and follow-up.
  - Need for clarified and formalized cooperation between BCL and CSSF, especially on liquidity risk and financial market infrastructures.

### Key policy recommendations (priorities and time frames summarized)
- Overall financial sector oversight
  - Make the CSSF’s oversight procedures and remedial actions more expeditious and effective (CSSF ¶22,26). Priority: High. Time Frame: Near-term.
  - Continue to increase resources and skills for the supervision of banks, the investment fund industry, and financial market infrastructures to better perform risk-focused inspections and enforcement, and reduce reliance on the compliance-oriented work of external auditors (CSSF ¶22,25). Priority: High. Time Frame: Medium-term.
  - Revise the legal framework to ensure full operational independence of the CSSF (CSSF, MoF ¶21, 26). Priority: Medium. Time Frame: Near-term.
  - Clarify respective responsibilities of the BCL and CSSF in financial supervision, especially as relates to liquidity risk and financial market infrastructures, and formalize modalities of collaboration and information exchanges (BCL, CSSF ¶21). Priority: Medium. Time Frame: Near-term.
- Banking oversight
  - Continue to closely monitor exposures to affiliate and parent banks, and take action to limit them, including through the use of formal sanctions, when necessary (CSSF ¶22). Priority: High. Time Frame: Near-term.
  - Consider establishing a “ladder” of remedial actions and related triggers to reduce reliance on moral suasion.
- Investment funds / securities markets oversight
  - Enhance the duties of investment fund depositaries and clarify investment fund shareholder/ownership rights (CSSF ¶26). Priority: Medium. Time Frame: Near-term.
  - Strengthen investor protection: clarify and strengthen segregation and protection of client assets; clarify fund ownership rights.
  - Increase CSSF staffing and expert resources for fund supervision; intensify routine and surprise on-site inspections.
- Crisis management and safety net
  - Strengthen the deposit insurance scheme through ex ante funding, speedier and automatic payments, the use of funds for bank restructuring, and improved governance (CSSF, MoF ¶38). Priority: High. Time Frame: Near-term.
  - Strengthen the bank resolution framework, including by providing for earlier control of problem banks and enhanced resolution tools (CSSF, MoF ¶36). Priority: High. Time Frame: Near-term.
  - Finalize contingency plans to ensure the continuity of Luxembourg’s ICSD, including arrangements to move participants’ positions to a solvent intermediary and to continue core functions (BCL, CSSF ¶31). Priority: High. Time Frame: Medium-term.
  - Formalize a multipartite domestic framework providing for specific operational procedures to facilitate crisis prevention and decisive, quick and early intervention (BCL, CSSF, CAA, MoF, and deposit insurance fund ¶37). Priority: Medium. Time Frame: Near-term.
- ELA and central bank protection
  - Clarify conditions under which the BCL’s special privilege (lien) over debtor assets for ELA would be exercised, including triggers, scope, and articulation with bank insolvency procedures.
  - Consider additional protections for the central bank against ELA-related losses (e.g., enhanced collateral requirements).
- Securities market infrastructure (CBL) recommendations
  - Finalize contingency plan for a potential CBL default, including pre-defined arrangements to move participants’ positions to a solvent intermediary and continue core functions.
  - Increase resources and skills at BCL and CSSF for risk-focused inspections; perform more systematic liquidity and credit risk stress-testing, including multiple participant failures and the liquidity impact of the participant with the largest exposure.
  - Address operational and governance recommendations (e.g., unilateral revocation of matched transactions, access criteria, governance transparency, independent board members).

### Risk Assessment Matrix — selected scenarios, likelihoods, and impacts (as presented)
- Failures of parent banks
  - Likelihood (Over Next Three Years): Medium
  - Impact on Macro-Financial Stability: High
  - Key points: failure of a parent bank would likely lead to that of its Luxembourg affiliates; large contingent fiscal liabilities possible.
- Global macroeconomic and financial distress (e.g., double dip recession)
  - Likelihood (Over Next Three Years): Medium
  - Impact on Macro-Financial Stability: Medium/High (if severe stress on parent bank)
- Sovereign distress (e.g., in Europe)
  - Likelihood (Over Next Three Years): High
  - Impact on Macro-Financial Stability: High
  - Key points: Non-negligible number and share of banks could face severe stress through direct losses from GIIPS securities; these exposures represent about half of Luxembourg’s aggregate bank capital (most are in hold-to-maturity account).
- Loss of confidence in investment fund industry
  - Likelihood (Over Next Three Years): Low/Medium
  - Impact on Macro-Financial Stability: Medium (domestic)/High (global)
- Potentially adverse impact of ongoing regulatory reforms
  - Likelihood (Over Next Three Years): Low/Medium
  - Impact on Macro-Financial Stability: High

### Key statistics and fiscal risk estimates
- Insured deposits represent only about 3.5 percent of aggregated bank balance sheets, but add up to 70 percent of GDP.
- There are eight banks in the system with insured deposits exceeding the current level of AGDL reserves.
- The risk-based target in the draft law is 1.9 percent of covered deposits.
- By end September 2010, total assets under management in the investment fund industry had increased to about €2.1 trillion.
- In December 2010, the value of assets under custody in CBL was around €5 trillion; about 20 million settlement transactions were processed in 2010, for a value of around €63 trillion.
- Aggregate Tier 1 capital increased by 20 percent in 2009 (from €31.7 billion to €38 billion). By year end 2009, the total stock outstanding of the lump-sum provision was 1,3bn€ (72 banks).

### Recommended sequencing and institutional reforms (summary)
- Strengthen operational independence of the CSSF and CAA to reduce potential conflicts arising from ministerial authority and to improve supervisory credibility.
- Clarify and codify supervisory cooperation and segregation of duties between CSSF and BCL to avoid overlaps and jurisdictional uncertainty.
- Make CSSF enforcement more effective and expeditious (consider ladder of remedial actions; increase use of formal powers and sanctions).
- Increase CSSF staffing and expert resources for banking and investment fund supervision; intensify on-site inspections and ex-ante supervision.
- Finalize contingency and resolution planning for CBL/ICSD continuity and for cross-border bank resolution; promote participation in colleges of supervisors and home-host cooperation.
- Revamp multipartite high-level group for financial stability (MoF, BCL, CSSF, CAA, DGS/fund) with institutionalized procedures for interagency cooperation, information sharing, and crisis drills.

*Source: IMF staff report content from _cr11148 (Executive Summary; Chapters 4, 16, 40; Appendices and Assessments) provided in the supplied content unit.*

### Executive Summary ......................................................................................................

### _cr11148 - Executive Summary ......................................................................................................

### Major findings: role and structure of the financial sector
- Luxembourg hosts a large international financial center that is a key driver of domestic economic growth and plays an important role in EU financial markets.
- The financial sector represents about one-fourth of Luxembourg’s GDP, one-third of its tax revenues, and 12.5 percent of its labor force.
- Sector composition and scale:
  - Banking industry: total assets surpassing 20 times GDP.
  - Investment fund industry: assets under management equivalent to around 50 times GDP.
  - Insurance industry: aggregate balance sheet of about four times GDP.
- Linkages: strong linkages with France, Germany, Italy, the Kingdom of the Netherlands, the United Kingdom, and the United States.
- Monetary and financial institutions (MFIs) intermediate about 16 percent of total cross-border exposures among euro area MFIs.

### Banking sector structure and exposures
- The banking sector accounts for about 28 percent of total financial sector assets.
- As of June 2010, there were 149 banks operating in Luxembourg.
- Most banks and 90 percent of total bank assets are foreign-owned.
- Business model and exposures:
  - Majority of groups operate through both subsidiaries and branches.
  - Local banking system is a net provider of liquidity to parent banks (“upstreaming”).
  - Interbank positions represent about half of bank assets and liabilities (compared to an average of about 28 percent in the euro area).
  - Two thirds of these interbank positions are cross-border exposures.
  - Intra-group exposures account for about 40 percent of total bank assets.

### Investment funds and insurance
- Luxembourg is the world’s second largest center for investment funds after the United States.
- Investment funds domiciled and marketed in Luxembourg account for about 70 percent of its total financial sector assets, and about 30 percent of total assets under management by European funds.
- Fund sponsors mainly originate from Europe and the United States; funds domiciled in Luxembourg are generally managed from other international financial centers.
- MMFs represent a fifth of Luxembourg’s investment funds and more than 25 percent of total European MMF assets under management.

### Crisis experience and fiscal impact
- The global financial crisis exposed significant vulnerabilities mainly due to large cross-border exposures to foreign parent banks.
- Bank balance sheets contracted significantly during the crisis, mainly through reduced cross-border intra-group transactions.
- A few bank subsidiaries failed on contagion from their parent groups.
- The investment fund industry faced sizable redemptions at the peak of the crisis.
- Domestic credit markets effects were muted owing to the dual nature of the banking system, relatively low household indebtedness, and resilient housing markets.
- Authorities’ response:
  - Large public support to systemically important financial institutions under stress (in coordination with neighboring countries).
  - A fivefold increase in the deposit guarantee (consistent with EU-wide increases).
- Public support to Dexia and Fortis banks entailed significant use of fiscal resources and moral hazard.

### Ongoing vulnerabilities and systemic risks
- Luxembourg remains vulnerable to renewed international instability, especially through parent bank and sovereign risk exposures.
- Specific concerns:
  - Local subsidiaries’ exposures to liquidity and counterparty risks stemming from their parent banks.
  - Concentrated exposures to sovereign risk given recent deterioration in European sovereign markets.
  - Given the large size of the financial sector relative to GDP, the potential fiscal consequences of severe distress could be significant.
  - The systemic importance of Luxembourg as a global investment fund hub introduces potential cross-border spillover risks.

### Supervisory, regulatory, and crisis-preparedness shortcomings identified
- Crisis uncovered weaknesses in regulatory and supervisory frameworks, and significant weaknesses in crisis preparedness and resolution, including crisis detection and cross-border and inter-agency communication.
- Flaws in governance, risk management practices, and supervision of foreign bank subsidiaries were identified.
- Need for strengthened oversight of systemic liquidity and financial market infrastructures; some steps have been taken (BCL granted stronger responsibility; CSSF increased supervisory focus) but further improvements are needed.

### Key policy recommendations (priorities and time frames summarized)
- Overall financial sector oversight
  - Make the CSSF’s oversight procedures and remedial actions more expeditious and effective (CSSF ¶22,26). Priority: High. Time Frame: Near-term.
  - Continue to increase resources and skills for the supervision of banks, the investment fund industry, and financial market infrastructures to better perform risk-focused inspections and enforcement, and reduce reliance on the compliance-oriented work of external auditors (CSSF ¶22,25). Priority: High. Time Frame: Medium-term.
  - Revise the legal framework to ensure full operational independence of the CSSF (CSSF, MoF ¶21, 26). Priority: Medium. Time Frame: Near-term.
  - Clarify respective responsibilities of the BCL and CSSF in financial supervision, especially as relates to liquidity risk and financial market infrastructures, and formalize modalities of collaboration and information exchanges (BCL, CSSF ¶21). Priority: Medium. Time Frame: Near-term.
- Banking oversight
  - Continue to closely monitor exposures to affiliate and parent banks, and take action to limit them, including through the use of formal sanctions, when necessary (CSSF ¶22). Priority: High. Time Frame: Near-term.
- Investment funds / securities markets oversight
  - Enhance the duties of investment fund depositaries and clarify investment fund shareholder/ownership rights (CSSF ¶26). Priority: Medium. Time Frame: Near-term.
- Crisis management and safety net
  - Strengthen the deposit insurance scheme through ex ante funding, speedier and automatic payments, the use of funds for bank restructuring, and improved governance (CSSF, MoF ¶38). Priority: High. Time Frame: Near-term.
  - Strengthen the bank resolution framework, including by providing for earlier control of problem banks and enhanced resolution tools (CSSF, MoF ¶36). Priority: High. Time Frame: Near-term.
  - Finalize contingency plans to ensure the continuity of Luxembourg’s ICSD, including arrangements to move participants’ positions to a solvent intermediary and to continue core functions (BCL, CSSF ¶31). Priority: High. Time Frame: Medium-term.
  - Formalize a multipartite domestic framework providing for specific operational procedures to facilitate crisis prevention and decisive, quick and early intervention (BCL, CSSF, CAA, MoF, and deposit insurance fund ¶37). Priority: Medium. Time Frame: Near-term.

### Strategic and EU-level considerations
- Further strengthening home-host supervisory collaboration and cross-border bank resolution frameworks is crucial; Luxembourg should continue active participation in colleges of supervisors and, pending completion of EU reforms, seek pragmatic solutions to facilitate coordination in resolution of cross-border banks.
- The financial center faces potential headwinds from proposed international and EU regulatory changes, including more restrictive rules on bank liquidity and intra-group exposures (e.g., Basel III) and changes to European and global regulatory frameworks governing investment fund activities.
- Continued reforms will be needed to meet these challenges, including those highlighted above and efforts to foster a competitive and flexible financial system.

*Executive Summary from _cr11148 - Executive Summary ......................................................................................................*

### 4. Luxembourg’s insurance industry is largely outward-oriented. Most insurance

### _cr11148 - 4. Luxembourg’s insurance industry is largely outward-oriented. Most insurance

### Insurance industry structure
- Most insurance and reinsurance companies are subsidiaries of key international players, particularly major European (re)insurance groups.
- Nondomestic premiums represent more than 90 percent of total premiums.
- Despite a large number of insurance companies, the industry is highly concentrated, with about 75 percent of total assets held by the top ten companies.
- Life insurance and reinsurance companies account for about 60 and 35 percent of total assets respectively.

### Financial market infrastructures and securities listing
- Luxembourg is an international financial center for securities listing and hosts systemically relevant market infrastructures.
- Activity on the Luxembourg Stock Exchange (LSE) is driven by primary issuance; Luxembourg accounts for about 15 percent of total bonds issued globally.
- Clearstream Banking Luxembourg (CBL) is one of the two largest international ICSD in the world and provides settlement, safekeeping, and administration of securities for more than 1,200 financial institutions in about 110 countries.
- CBL has developed services for collateral management and investment funds; large amounts of collateral are involved, making CBL’s operational and financial soundness relevant to international financial stability.

### Interconnectedness and investment fund sector
- Luxembourg’s banking cross-border exposures account for more than 70 percent of their total balance sheets, reflecting interbank and intra-group transactions with parent groups in Germany, France, Italy, the United States, the United Kingdom, Spain, Netherlands and Belgium.
- Luxembourg-based UCITS are sold globally: 75 percent in Europe and 15 percent in Asia; they are invested worldwide (45 percent in the euro area).
- Investment fund balance sheet links:
  - About half of investment funds’ assets (€1 trillion) are invested in nonbank financial institutions (NBFIs), particularly other investment funds.
  - €350 billion are placed in MFIs.
  - €320 billion are placed in government securities.
- Cross-shareholdings between investment funds exceed € 110 billion.
- Bank deposits related to investment funds amount to €72 billion, representing about 9 percent of total bank balance sheets.
- From the banking side, banks hold about €13 billion assets in investment funds, and provide depository and custodian services.
- Luxembourg funds hold about €12 billion deposits in euro area banks, compared to €2 trillion total cross-border deposits in euro area MFIs.
- Luxembourg funds hold less than €100 billion debt securities issued by euro area MFIs, compared to the total outstanding amount of about €5 trillion.
- Exposures to GIIPS sovereign are about 20 percent of total sovereign exposures, and most are with Italy.
- Balance sheet linkages between the investment fund industry and the rest of the domestic financial system are limited.

### The financial crisis: impact and immediate policy response
- The subsidiaries of three Icelandic banks failed on contagion from their parent groups and were placed under resolution procedures.
- Liquidity and solvency problems at Fortis and Dexia affected Luxembourg-based affiliates; government support was provided by Belgium, France, the Netherlands and Luxembourg.
- In aggregate, bank balance sheets shrank by almost 15 percent in 2009 (essentially through interbank deleveraging).
- A few insurance companies showed serious problems due to high levels of intra-group concentrated risk exposures.
- The investment fund industry endured large outflows at the peak of the crisis; some funds with significant exposures to structured products suspended redemptions.
- Domestic credit markets were relatively muted, aided by moderate household indebtedness and a resilient housing market.
- Immediate policy response:
  - Aggressive monetary easing and emergency liquidity provision in the euro area.
  - Decisive action in Luxembourg to identify and address investment fund problems and to support systemically important financial institutions.
  - A fivefold increase in the deposit guarantee in Luxembourg.
  - These interventions prevented contagion to the rest of the financial system; absence of further bank failures is noted.

### Resolution of troubled banks (Box 2 highlights)
- Fortis and Dexia received concerted government support; for Luxembourg the cost of such support amounted to about 7 percent of GDP (which may be recovered with the sale of associated government claims).
- Governments of Belgium, France, the Netherlands and Luxembourg granted state support to Fortis and Dexia totaling €22.9 billion, of which €2.9 billion were provided by Luxembourg.
- Local subsidiaries of three Icelandic banks faced severe liquidity strains and were placed under suspension of payments and resolution procedures; deposits were reimbursed or transferred.
- Restructuring and liquidation processes proceeded: BNP Paribas acquired majority stakes in Fortis’ Luxembourg subsidiary, BGL; Dexia exited the government guarantee program earlier than anticipated and is implementing an EU-approved restructuring plan.
- Some German Landesbanken’ Luxembourg subsidiaries are undergoing restructuring after large investment portfolio losses.

### Regulatory reforms and supervisory enhancements
- Authorities created a macro-financial stability unit in the BCL.
- The framework for liquidity risk supervision was revised; the BCL was entrusted with enhanced monitoring of systemic liquidity and liquidity management by market operators, including daily liquidity reporting requirements and development of quantitative tools for on- and off-site assessments.
- The CSSF issued new regulations on qualitative aspects of liquidity risk management and sharpened supervisory focus on banks’ risk management practices and risk profiles.
- Revisions of prudential regulations governing quantitative aspects of liquidity risk are pending until issuance of a European Commission directive reflecting the new Basel III framework.
- A completely new draft law to revamp the deposit guarantee scheme (DGS) was prepared but awaits finalization of EC proposals.

### Financial soundness, performance, and liquidity
- Average bank solvency ratios (Basel II regulatory capital-to-risk-weighted assets) are high at 19.5 percent.
  - Over 85 percent of aggregate regulatory capital consists in Tier 1 capital.
  - The aggregate Tier 1 solvency ratio stands at about 17 percent.
  - Aggregate Tier 1 capital increased by 20 percent in 2009 (from €31.7 billion to €38 billion). About one third of this increase reflected the public recapitalization of the former local subsidiary of Fortis.
- Asset quality improved: non-performing large exposures declined from a peak of 0.8 percent of total large exposures in June 2009 to 0.2 percent at end-2010.
- By end September 2010, total assets under management in the investment fund industry had increased to about €2.1 trillion.
- Aggregate liquidity ratio stands well above the minimum of 30 percent; as of mid-2010 it was about 64 percent on aggregate.
- Banks retain a significant proportion (about half) of their portfolios in liquid assets.
- Credit quality in retail portfolios remained relatively high during the crisis, with loan impairment rates remaining below 1 percent.

### Stress testing and resilience
- Top-down sensitivity and macro-stress tests were implemented based on supervisory data; network analysis was used to assess vulnerabilities linked to large and concentrated exposures and funding sources.
- Macro scenario-based stress tests cover a two-year horizon; the adverse scenario assumes a global double-dip recession and further distress on sovereign exposures.
- Tests were applied to a sample of banks holding over 80 percent of the total assets in the system, using data as of June 2010.
- Key stress test findings:
  - Luxembourg-based subsidiaries of foreign banks are vulnerable to distress in their parent banks, through both credit and funding exposures; tests identify 19 counterparties, any one of whose failure could cause the failure of at least one bank in Luxembourg.
  - Interbank contagion risks within Luxembourg appear limited; the failure of a local subsidiary would likely not directly cause that of other banks due to limited interbank balance sheet linkages.
  - The overall banking sector has enough capital to withstand substantial losses from GIIPS sovereign securities; however, exposures are concentrated in a small group of banks (about 10 percent of the system), which could become undercapitalized.
  - Other risks, including market risks, appear fairly contained due to the limited size of trading book activities.
  - About 85 percent of the total capital requirement (actual) owes to covering credit risk, followed by operational risks (9 percent).
- Insurance sector stress tests:
  - Several top-down and bottom-up stress tests (market, credit, and catastrophe risks) were applied to the balance sheets of all life and nonlife insurance companies.
  - The insurance system appears resilient, reflecting improved risk management practices and high levels of technical provisions and capitalization.
  - While marginal in aggregate, linkages between banks and insurance companies may have a significant impact for several smaller nonlife insurance companies: under the credit risk stress scenario (failure of the largest depository bank), ten small companies would record a solvency shortfall.
  - The effect of prolonged low interest rates was not assessed.

### Summary of vulnerabilities and policy implications
- Key vulnerabilities:
  - Heavy outward orientation of insurance sector and dominance of nondomestic premiums (more than 90 percent).
  - High concentration of insurance assets among top firms (about 75 percent held by top ten).
  - Large cross-border and intra-group exposures of banks (cross-border exposures account for more than 70 percent of bank balance sheets).
  - Vulnerability of Luxembourg subsidiaries to parent bank distress (19 counterparties identified whose failure could cause at least one Luxembourg bank failure).
  - Concentration of GIIPS sovereign exposures in a small set of banks (about 10 percent of the system).
- Policy responses and priorities already implemented or underway:
  - Strengthen liquidity risk supervision and monitoring (BCL daily reporting and quantitative tools; CSSF qualitative regulations).
  - Enhance macro-financial surveillance capacity (macro-financial stability unit in BCL).
  - Revise prudential frameworks in line with EU and Basel III developments (pending EC directives).
  - Revamp deposit guarantee scheme (new draft law awaiting EC proposals).
  - Continue close monitoring of restructuring of systemically important banks and cross-border coordination in crisis resolution.

*Source: IMF staff report content from _cr11148 - 4. Luxembourg’s insurance industry is largely outward-oriented. Most insurance (PDF chapter).*

### 16. Luxembourg will remain subject to substantial macro-financial stability risks in

### 16. Luxembourg will remain subject to substantial macro-financial stability risks in

### Risk overview
- Luxembourg faces substantial macro-financial stability risks in the period ahead, with relevance to broader European financial markets.
- The potential impact of adverse shocks is magnified by:
  - the size of Luxembourg’s financial sector relative to its economy, and
  - its high degree of international interconnectedness.
- Key sources of risk: banking sector exposures to parent banks and sovereigns; systemic importance and concentration in the investment fund industry.

### Banking sector — key risks and findings
- Main vulnerabilities:
  - Large exposures to parent banks and to sovereign risk.
  - Lack of a well-defined cross-border resolution framework.
- Stress test implications:
  - Solvency or liquidity pressures affecting large parent banks could have adverse impacts on their Luxembourg affiliates.
  - Direct and indirect GIIPS sovereign exposures (including through parent banks incorporated in vulnerable euro area countries) are a key source of vulnerability.
  - Potentially large contingent fiscal liabilities could result from the lack of international burden-sharing mechanisms if a large European bank with local presence fails.
  - The potential fiscal cost of domestically-active bank failures seems manageable: there are only a few such banks, and stress tests indicate limited scope for interbank contagion within Luxembourg.
- Basel III and capital/liquidity context:
  - Preliminary estimates from the CSSF indicate that the common equity Tier 1 capital ratio qualifying for Basel III was above 14 percent for the system as of June 2010, compared to a current Tier 1 ratio of about 17 percent.
  - Under conservative assumptions, up to €1.3 billion of additional common equity (i.e., about 3 percent of current aggregate Tier 1 capital) would be needed on total by 16 smaller banks in order to achieve compliance with the Basel III requirement.
  - A full impact study is expected in late 2011.
- Supervisory assessment and improvements needed:
  - Overall observance of Basel Core Principles is high.
  - CSSF is the competent authority for prudential supervision; Basel II and IFRS standards have been fully implemented.
  - Need to better guarantee the operational independence of the CSSF:
    - CSSF is under direct authority of the Minister; Board members are appointed by government upon proposals from supervised entities and the Minister; executives appointed/dismissed by government.
    - CSSF mission includes “orderly expansion” of Luxembourg’s financial center, raising potential conflicts with supervisory independence.
  - Clarify supervisory cooperation and segregation of duties between the CSSF and the BCL to avoid overlaps and jurisdictional uncertainties, especially in crisis circumstances.
  - Make oversight procedures and remedial actions more expeditious and effective:
    - Heavy reliance on moral suasion and reluctance to use formal remedial powers, including sanctions.
    - Modest number of on-site inspectors relative to the large number of institutions; internal review and decision-making processes delay presentation of on-site inspection reports and follow-up.
    - Consider establishing a “ladder” of remedial actions and related triggers to reduce reliance on moral suasion.
  - Continue close monitoring of exposures to parent banks and be ready to limit them when necessary.
  - Strengthen home-host supervisory collaboration; CSSF’s active participation in colleges of supervisors should continue.

### Investment fund sector — key risks and supervisory findings
- Systemic importance:
  - Luxembourg is a systemically-important hub for investment fund business in and out of Europe: about 60 percent of European investment funds distributed internationally are domiciled in Luxembourg.
  - Concentration of global activity and on European UCITS raises risks—fraud events or tarnishing of UCITS brand quality could affect global investor confidence and trigger knock-on effects across European and global financial systems.
- Spillover likelihood:
  - The likelihood of spillovers from investment funds to the domestic banking system may be small due to limited balance sheet exposures, but sudden redemption pressures may create liabilities for sponsoring banks.
  - During the crisis, liquidity facilities from sponsoring banks were called upon in some cases, but overall such spillovers were limited due to: small direct exposures; regulatory safeguards (e.g., limits to bank credit to investment funds); and the operational nature of investment fund deposits with sponsoring banks.
- Regulatory change risks:
  - Forthcoming Basel III liquidity regulations could have a material impact.
  - Changes in capital and liquidity requirements in banking and insurance should have repercussions for global investment fund activities and thus for Luxembourg.
  - International reforms to taxation, bank secrecy and investment fund regulation (including EU-level directives) will impact Luxembourg’s international role in the sector.
  - It is difficult to determine in which direction the financial center will evolve; historically Luxembourg has shown strong capacity to adapt and maintain comparative advantages in fund domiciliation.
- Supervisory framework and practices:
  - Regulatory framework largely compliant with IOSCO principles; CSSF approves and registers Luxembourg-based UCI(TS) on its official list.
  - The framework closely transposes relevant European directives while retaining flexibility that is a comparative advantage.
  - Historically CSSF structure and procedures were reactive and focused on ex-post review of reports, due to delegated investment management functions abroad.
  - Recently CSSF has increased staff resources and undertaken a more pro-active supervisory approach (routine/specific on-site inspections and questions to funds/operators); these efforts should be further intensified, including additional increases in expert staffing.
- Priority reforms for investor protection and stability:
  - Address lack of operational independence of the CSSF.
  - Intensify effective and expeditious enforcement of rules.
  - Strengthen investor protection rules: clarify and strengthen segregation and protection of client assets, and make fund ownership rights clearer.
  - Remain proactive in cooperating with foreign counterparts and implementing EU-level rules; UCITS IV Directive transposition is underway and expected to lead to a high level of harmonization of risk management rules across the EU.
  - Notes on fund composition: About 75 percent of Luxembourg-based investment funds are UCITS funds.

### Insurance sector — supervisory developments
- The Commissariat aux Assurances (CAA) is the competent authority for prudential supervision in insurance, under direct authority of the Minister in charge of the financial sector.
- Licensing and de-licensing of insurance intermediaries is the responsibility of the Minister (Minister of Treasury), based on CAA recommendations; this role of the Minister introduces potential weakness in CAA operational independence.
- Supervisory enhancements:
  - CAA almost doubled its staff and has been performing stress testing on an ongoing basis.
  - Cooperation with domestic and foreign supervisory agencies has intensified.
  - CAA plans to introduce a quarterly solvency statement for all supervised entities from the fourth quarter 2010 onwards and is developing a framework for risk-based supervision consistent with Solvency requirements.

### Risk Assessment Matrix — key scenarios, likelihoods, and impacts
- Failures of parent banks
  - Likelihood (Over Next Three Years): Medium
  - Impact on Macro-Financial Stability: High
  - Key points:
    - Most banks in Luxembourg are subsidiaries or branches of major European banks and are exposed to parent banks through large intra-group positions and reputation effects.
    - Failure of a parent bank would likely lead to that of its Luxembourg affiliates.
    - In the absence of sufficient information exchanges and burden-sharing arrangements, authorities may not appropriately assess and address banking system risks; weak crisis management may result in inefficient and costly resolution.
    - The financial sector is extremely large relative to the economy; resolution costs beyond deposit insurance may entail large contingent fiscal liabilities.

- Global macroeconomic and financial distress (e.g., double dip recession)
  - Likelihood (Over Next Three Years): Medium
  - Impact on Macro-Financial Stability: Medium/High (if severe stress on parent bank)
  - Key points:
    - Relatively small macro and/or financial shocks could develop into a global double-dip recession.
    - Luxembourg banks generally have strong capital buffers to weather severe macroeconomic shocks absent major failure of relevant parent banks.
    - If severe stress affects parent banks, liquidity pressures on local subsidiaries could quickly materialize due to sizable intra-group exposures and reputational effects.

- Sovereign distress (e.g., in Europe)
  - Likelihood (Over Next Three Years): High
  - Impact on Macro-Financial Stability: High
  - Key points:
    - Sovereign distress in countries with weak fundamentals (e.g., GIIPS) is a key risk and could be aggravated by contagion.
    - Non-negligible number and share of banks could face severe stress through direct losses from GIIPS securities; these exposures represent about half of Luxembourg’s aggregate bank capital (most are in hold-to-maturity account).
    - Subsidiaries would also face losses through indirect exposures (parent group solvency and liquidity pressures); extent is hard to assess without group-wide examination.

- Loss of confidence in investment fund industry
  - Likelihood (Over Next Three Years): Low/Medium
  - Impact on Macro-Financial Stability: Medium (domestic)/High (global)
  - Key points:
    - Damage to Luxembourg funds’ brand could arise from negative reputational effects from large global investment fund failures.
    - Renewed turbulence in bond or asset markets could lead to large scale fund redemptions.
    - Low exposure of Luxembourg-domiciled funds to GIIPS bonds and to asset-backed securities limits likelihood of strong redemption pressures through direct losses.
    - Major damage to Luxembourg’s fund industry could affect the European UCITS brand and lead to contagion in other European countries’ fund industries.
    - Major runs on funds could depress asset prices and create needs for sponsor banks to provide liquidity despite regulatory limits; linkages to domestic banks seem limited; direct impact on bank funding in Europe through fire sales by Luxembourg MMFs appears limited.

- Potentially adverse impact of ongoing regulatory reforms
  - Likelihood (Over Next Three Years): Low/Medium
  - Impact on Macro-Financial Stability: High
  - Key points:
    - Calibration of the new prudential regulatory regime is critical for Luxembourg even though implementation will be gradual.
    - A strong tightening of prudential regulations on liquidity, particularly regarding interbank and intra-group exposures, could disproportionately affect Luxembourg banks and impair cross-border activities.
    - Reforms to international taxation and bank secrecy regimes, and near-term EU directives on investment funds (e.g., UCITS IV, AIFM Directive), could erode some comparative advantages and have a critical impact on the industry.

### Policy recommendations — prioritized actions
- Strengthen operational independence of the CSSF and CAA to reduce potential conflicts arising from ministerial authority and to improve supervisory credibility.
- Clarify and codify supervisory cooperation and segregation of duties between CSSF and BCL to avoid overlaps and jurisdictional uncertainty.
- Make CSSF enforcement more effective and expeditious:
  - Consider a “ladder” of remedial actions and triggers to reduce reliance on moral suasion.
  - Increase use of formal remedial powers, including sanctions, when necessary.
- Increase CSSF staffing and expert resources for both banking and investment fund supervision; intensify on-site inspections and ex-ante supervision.
- Continue close monitoring and, where necessary, restriction of exposures to parent banks; strengthen home-host supervisory collaboration and participation in colleges of supervisors.
- Strengthen investor protection in the investment fund sector:
  - Clarify and strengthen segregation and protection of client assets.
  - Clarify fund ownership rights.
- Remain proactive in implementing EU-level rules (e.g., UCITS IV) and cooperating with foreign counterparts to ensure harmonized risk management practices.

*Source: _cr11148 - 16. Luxembourg will remain subject to substantial macro-financial stability risks in*

### 2011. Luxembourg is likely to be amongst the first countries to do so.

### _cr11148 - 2011. Luxembourg is likely to be amongst the first countries to do so.

### Securities Markets
- Two markets operated by Société de la Bourse de Luxembourg (SBL): the LSE and a multilateral trading facility (Euro MTF).
- Establishment of a regulated market requires written authorization from the Minister responsible for the CSSF.
- Organization and operations of regulated markets are supervised by the CSSF; the operation of the MTF is part of the investment services and activities defined in the law.
- The LSE reports on a daily basis and on all transactions to the CSSF, which performs market surveillance and enforcement.
- Key findings and recommendations:
  - Strengthen cooperation between oversight authorities for Luxembourg’s ICSD, CBL, to ensure continuity of this core market infrastructure.
  - Increase resources and skills for more risk-focused inspections and to shorten the period needed to complete assessments.
  - Establish a more formal framework detailing respective roles and tasks of the BCL and CSSF to reduce uncertainty and potential overlap and to facilitate crisis management.
  - Establish a formal supervisory arrangement with Belgian authorities.
  - Complete contingency plans in case of CBL’s default, including arrangements to move participants’ positions to a solvent intermediary and to continue core functions.

### AML-CFT
- FATF February 2010 mutual evaluation found numerous shortcomings; Luxembourg was placed under enhanced scrutiny by the FATF’s International Cooperation Review Group (ICRG).
- Authorities implemented a speedy remedial action plan, including adoption of AML/CFT legislation addressing deficiencies in financial and nonfinancial sectors and increased supervisory actions in the financial sector.
- At its latest plenary meeting, the FATF noted authorities have responded rapidly and agreed to remove Luxembourg from the ICRG process, although the effectiveness of newly implemented measures has not yet been ascertained.
- Luxembourg will continue to provide updates as part of the regular FATF follow-up process for assessed members.

### Crisis Preparedness and Safety Nets — Overview
- The crisis management framework needs improvement to limit macro-financial risks; Luxembourg has very little capacity to bear large resolution costs relative to its financial sector size.
- Crisis prevention enhancements recommended:
  - Set up institutional arrangements for macro-prudential oversight, earlier intervention and resolution, and more effective depositor protection.
  - Allocate a consistent set of policy objectives, functions, instruments, and powers across agencies charged with macro-prudential oversight.
  - Each supervisor should initiate corrective actions well before institutions undergo distress, build an industry database to identify macro-prudential risks, and communicate a macro-prudential opinion to the entity in charge of macro-prudential supervision.

### Cross-Border Challenges
- Dependence on foreign parent banks is central to assessing crisis preparedness; resolution of Fortis and Dexia was relatively successful but costly and involved ad hoc multi-country decision-making.
- Authorities had to pass a law authorizing the government to raise public funds for extra-budgetary expenditures to preserve financial stability during the crisis.
- Recommendations:
  - Promote gradual moves towards an enhanced coordination framework for resolution of cross-border banks.
  - Enhance existing mechanisms to facilitate cross-border resolution, for example by introducing mechanisms for mutual recognition of insolvency or reorganization measures.
- Large uncertainties remain on handling cross-border insolvency, particularly legal treatment of large-scale liquidity transfers by Luxembourg-based subsidiaries providing unsecured funding to parent companies.

### Domestic Bank Resolution Framework
- Current framework could be strengthened:
  - Trigger intervention earlier than under current suspension of payment proceeding, for example based on graduated and objective quantitative thresholds such as capital ratios.
  - De-link suspension of payment from appointment of an administrator to allow authorities to take control on a going-concern basis.
  - Introduce a fully-fledged specific regime for bank resolution rather than relying on bankruptcy provisions for commercial enterprises.
  - Involve the supervisor more closely in the liquidation phase to inform the judicial process and preserve financial stability during asset and liability disposals.
- The Law of April 5, 1993 currently provides a two-step process: (i) suspension of all payments and appointment of administrators by court with only protective acts allowed; (ii) if viability not restored, winding-up judicial proceeding with official receiver and liquidators appointed by the court.

### High-level Multipartite Group for Financial Stability
- The multipartite high-level group led by the MoF and including the BCL, CSSF, CAA, and the reformed deposit insurance scheme (or the two-part financial stability fund, if introduced) should be revamped and formalized.
- The revamped framework should:
  - Feature institutional arrangements and procedures for interagency cooperation and information sharing.
  - Define roles and responsibilities of each agency.
  - Develop strategies to deal with potential crises.
  - Meet regularly to assess systemic risks and review plans to address them.
- For crisis management, reference can be drawn from BCL procedures that assign responsibilities, set rules for proceeding, and provide contact information.

### Safety Net and Deposit Guarantee Scheme (DGS)
- The draft revision of the DGS law is a significant improvement but still falls short of international best practices.
  - During the crisis, the current DGS allowed full repayment of insured deposits at no fiscal cost, but payouts were delayed due to procedural inefficiencies.
  - Current framework does not allow use of DGS funds to assist bank restructuring.
  - Banks are encouraged but not required to build AGDL reserves to cover payouts.
  - No ex-ante funding mechanisms or contingent financing alternatives existed under the current system.
- MoF’s draft deposit insurance law:
  - Increases coverage.
  - Speeds payouts to 20 days.
  - Allows for risk-based ex-ante funding.
  - Provides the deposit guarantee fund with backup sources of liquidity.
- Mission recommended additional changes to bring the framework closer to EU proposals and international good practices, including (but not limited to):
  - End dominance of bankers on the DGS board.
  - Require banks to maintain the “single customer view” on each customer’s covered deposits.
  - Secure automatic payouts within seven days.
  - End set-off.
  - Reduce the number of types of deposits excluded from DGS coverage.
- Consider introducing promptly changes that do not require legal amendments or are not precluded by existing laws while awaiting EU requirements.

### Key Statistics and Fiscal Risk Estimates
- Insured deposits represent only about 3.5 percent of aggregated bank balance sheets, but add up to 70 percent of GDP.
- There are eight banks in the system with insured deposits exceeding the current level of AGDL reserves.
- Staff estimates that total fiscal contingencies associated with the current DGS under an extreme adverse scenario could amount to 7.5 percent of GDP.
- The risk-based target in the draft law is 1.9 percent of covered deposits.

_Excerpted from IMF staff report: _cr11148 - 2011. Luxembourg is likely to be amongst the first countries to do so._

### 40. Given potentially large liabilities from emergency liquidity assistance (ELA) to

### _cr11148 - 40. Given potentially large liabilities from emergency liquidity assistance (ELA) to

### Emergency liquidity assistance (ELA) and BCL capital protection
- The BCL, like other national central banks in the euro area, bears the potential financial costs arising from its ELA provision.
- Given the exceptionally large size of the local banking system, such costs may threaten the capital position of the BCL.
- The BCL has established a special privilege over all assets held in Luxembourg by a debtor for claims arising from operations in the context of monetary or exchange policies, as well as ELA.
- Going forward, the conditions under which this lien would be exercised need to be clarified, including:
  - triggers;
  - scope; and
  - articulation with bank insolvency procedures.
- Clarification should aim to address potential unintended consequences on bank resolution.
- Other means to protect the central bank against potential ELA-related losses may also be considered (e.g., enhanced collateral requirements).

### Banking sector structure and key risks
- Luxembourg's banking sector is very large in relation to the economy.
- Most banks are foreign-owned and specialize in intra-group liquidity management.
- The large proportion of interbank assets and liabilities is a key feature of Luxembourg's banking system.
- Funding profile of Luxembourg banks (As of June 2010):
  - Funding from Group: 39%
  - Deposits (excl. interbank): 29%
  - Interbank funding: 10%
  - Securities: 9%
  - Derivative Instrument: 2%
  - Central bank funding: 2%
  - Other: 0%
  - Own Funds: 9%
- Bank assets composition (As of June 2010):
  - Loans to credit institutions: 47%
  - Securities other than shares: 23%
  - Shares and other equities: 1%
  - Other assets: 6%
  - Loans to other sectors: 23%
- Bank liabilities composition (As of June 2010):
  - Amounts owed to credit institutions: 48%
  - Capital and reserves: 6%
  - Provisions: 0%
  - Amounts owed to general government: 1%
  - Amounts owed to other sectors: 34%
  - Debt securities issued: 11%

### Financial soundness indicators (banks) — highlights and exact metrics from tables/figures
- Table 2 selected indicators (exact entries preserved):
  - Regulatory capital to risk-weighted assets: 2005 Dec 15.5; 2006 Dec 15.3; 2007 Dec 14.3; 2008 Dec 15.4; 2009 Jun 17.1; 2009 Dec 18.9; 2010 Jun 18.0; 2010 Dec 17.0
  - Regulatory Tier 1 capital to risk-weighted assets: 2005 Dec 12.9; 2006 Dec 12.7; 2007 Dec 12.2; 2008 Dec 13.0; 2009 Jun 14.8; 2009 Dec 17.0; 2010 Jun 16.0; 2010 Dec 15.0
  - Capital to assets: 2005 Dec 4.0; 2006 Dec 4.0; 2007 Dec 4.0; 2008 Dec 4.0; 2009 Jun 5.0; 2009 Dec 5.5; 2010 Jun 5.0; 2010 Dec 5.0
  - Return on assets: 2005 Dec 0.7; 2006 Dec 0.9; 2007 Dec 0.8; 2008 Dec 0.2; 2009 Jun 0.7; 2009 Dec 0.6; 2010 Jun 0.7; 2010 Dec 0.7
  - Return on equity: 2005 Dec 17.0; 2006 Dec 22.1; 2007 Dec 20.4; 2008 Dec 5.5; 2009 Jun 14.4; 2009 Dec 11.6; 2010 Jun 13.0; 2010 Dec 13.0
  - Liquid assets to total assets: 2005 Dec 53.3; 2006 Dec 52.0; 2007 Dec 50.0; 2008 Dec 59.0; 2009 Jun 56.0; 2009 Dec 55.9; 2010 Jun 54.0; 2010 Dec 56.0
  - Liquid assets to short-term liabilities: 2005 Dec 64.3; 2006 Dec 63.0; 2007 Dec 61.0; 2008 Dec 67.8; 2009 Jun 63.6; 2009 Dec 64.7; 2010 Jun 64.0; 2010 Dec 66.0
  - Customer deposits to total (non-interbank) loans: 2005 Dec 189.0; 2006 Dec 196.0; 2007 Dec 165.0; 2008 Dec 134.7; 2009 Jun 139.6; 2009 Dec 137.5; 2010 Jun 120.0; 2010 Dec 131.0
  - Foreign currency denominated loans to total loans: 2005 Dec 41.4; 2006 Dec 42.3; 2007 Dec 34.5; 2008 Dec 30.2; 2009 Jun 28.7; 2009 Dec 28.0; 2010 Jun 29.0; 2010 Dec 30.0
  - Net open foreign exchange to capital: 2005 Dec -7.8; 2006 Dec -14.0; 2007 Dec 3.1; 2008 Dec 1.6; 2009 Jun -0.4; 2009 Dec -0.6; 2010 Jun 0.2; 2010 Dec 0.3
- Figure-level assessments:
  - The Luxembourg banking sector appears to be adequately capitalized.
  - In aggregate, the liquidity situation is comfortable.
  - Leverage is comparable with other peers.
  - Non-performing ratios remain low.
  - Foreign exposures are small, as most transactions are euro-denominated.
  - Profitability of Luxembourg banks remains subdued but favorable compared with peers.

### Macro stress testing for banks — scenarios and summary outcomes
- Table 3: Macro assumptions and projections used in stress testing include country-specific baseline and adverse scenario inputs; methodology notes:
  - Adverse scenario generated by applying the difference between baseline and adverse scenario in 2010 CEBS stress testing exercise to October 2010 WEO projection.
  - In terms of 2-year cumulative real GDP growth rate, the shock in adverse scenario roughly corresponds to 1 standard deviation shock (using 1980-2009 history).
  - Using empirical distribution of real GDP growth rate for 1980-2009 period, the baseline scenario puts euro area countries above 20 percentiles, and the adverse scenario puts euro area countries below 10 percentiles on average.
- Table 4 and Figure 6 (summary):
  - Solvency ratio (CAR in percent) entries include: Act. 2010 CAR 19.4; 2011 Act. 18.5; 2011 Adverse 16.7; 2011 Adverse w/o profit 16.8; 2012 Adverse 13.7; 2012 Adverse w/o profit 18.9; 2012 Act. 17.2; 2012 Adverse (All) 15.4; 2012 Adverse (Euro area banks) 17.1; 2012 Adverse (Noneuro area EU) 16.3; 2012 Adverse (Rest of the world) 15.1; 2012 Adverse All banks 26.0; 2012 Adverse All banks 27.6; 2012 Adverse Max 27.8
  - Quantiles of solvency ratio (selected exact values):
    - Max: 482.9, 464.2, 449.4, 462.0, 445.5, 128.2, 126.9, 120.6, 41.4, 39.6, 37.4, 482.9, 464.2, 449.4
    - 75 percentile: 33.9, 32.0, 32.1, 29.6, 28.0, 34.5, 32.3, 34.5, 28.2, 28.3, 28.4, 37.6, 39.6, 41.7
    - median: 21.3, 21.3, 22.1, 19.5, 15.8, 19.7, 19.7, 19.1, 18.0, 19.0, 19.0, 18.9, 23.3, 24.3, 26.5
  - Risk-weighted assets/Exposure at default (proxy for asset quality) average and distribution entries preserved (e.g., Average 29.8, 30.0, 30.2, 32.8, 26.6, 27.0, 28.4, 28.9, 29.1, 30.5).
  - Footnote: The solvency position as of June 2012 includes utilization of the lump-sum provision for those banks where CAR turns negative. The lump sum provision is a regime of countercyclical provisioning that allows banks to set aside capital buffers for unrealized losses. By year end 2009, the total stock outstanding was 1,3bn€ (72 banks). Under the adverse scenario, the use of the lump sum provision allows two banks to avoid falling below the 8 percent minimum CAR.
- Figure 6 methodology notes:
  - Excluding provisions and dividend payment.
  - Gross profit projected implies 10 percent year on year declines overall.
  - Commissions and fees income is projected by applying 0.75 correlation to equity market prices, which are assumed to decline 15% year-on-year for two years.
  - For interest margin, spread is assumed to remain constant, in contrast with beneficial increases Luxembourg banks actually experienced in 2008 during liquidity crisis as net liquidity provider.

### Insurance sector stress testing and resilience
- Table 5: Insurance stress test highlights (exact preserved figures and labels):
  - Life: Market Risk — Pre-shock and shock outcomes:
    - Pre-shock: 56.7 156.2 121.7 149.5 179.4 255.3 -117.7 153.3 (table layout preserved)
    - i) A 25 percent decline in equity prices: 40.7 87.2 106.0 135.9 167.3 253.4 -112.6 142.5
    - ii) A 25 percent increase in interest rate: 40.0 82.3 102.4 133.8 164.0 271.7 177.0 109.8 151.9
    - iii) Combined equity prices and interest rate shocks: 40.0 76.2 107.1 129.5 161.1 271.6 168.5 109.1 146.4
    - iv) Sovereign distress: 52.6 92.1 103.6 127.0 156.6 231.8 -117.7 141.3
  - Nonlife: Market Risk and other shock outcomes preserved (e.g., Pre-shock 115.4 112.4 136.1 173.4 -383.0 -328.9; i) A 25 percent decline in equity prices 96.1 107.0 127.3 165.7 -368.4 -315.9; etc.).
  - Nonlife: Credit Risk — vii) Failure of the largest depository bank: 12.1 -144.8 162.8 234.1 328.0 430.0 262.1
  - Nonlife: Catastrophic Risk — viii) A deterioration in the claims situation: 27.1 79.1 116.6 166.5 265.1 444.2 173.6
  - Methodological notes:
    - Stress tests for equity prices and sovereign distress use data as of the fourth quarter of 2010. Other tests use 2009 data. The tests cover all balance sheets of insurance companies.
    - QIS5 correlation factors, the correlation coefficients for the aggregation of the risk modules, are used.
    - Number of companies corresponding to the distribution of solvency ratio are in the parenthesis.
- Figure-level assessments:
  - Luxembourg's insurance companies mostly comprise subsidiaries of European insurance groups.
  - Life insurance and reinsurance dominate the industry.
  - The industry is highly concentrated for all types of insurers.
  - Life insurance products are mainly investment-linked.
  - Insurance assets are mainly distributed into debt securities and shares.
  - Insurance companies are well-capitalized and solvent.
  - Life insurance manages to reduce some operating costs.
  - The industry's earnings have improved since the financial crisis.

### Policy implications and recommendations extracted from content
- Clarify legal and operational conditions for exercising the BCL's special privilege (lien) over debtor assets in Luxembourg for claims arising from monetary/exchange operations and ELA, including:
  - explicit triggers;
  - defined scope; and
  - clear articulation with bank insolvency and resolution procedures to avoid unintended consequences.
- Consider additional protections for the central bank against ELA-related losses, such as enhanced collateral requirements.
- Recognize need for bank resolution funding architecture:
  - Deposit insurance funds have not been designed to refund insured deposits in very large banks.
  - The EU is proposing to create bank resolution funds, and the BCL has prepared a proposal for a BRF in Luxembourg.

*Source: IMF staff and Luxembourg authorities materials contained in the provided content unit.*

### Appendix I: Observance of Financial Sector Standards and Codes—Summary

### Appendix I: Observance of Financial Sector Standards and Codes—Summary

### Assessment basis and methodology
- Assessment based on: study of the legal and regulatory framework; a self-assessment prepared by the CSSF; detailed discussions with relevant authorities and stakeholders including government representatives, the CSSF, Luxembourg Bankers Association (ABBL), senior management of banks, and auditing firms.
- Focus areas: supervisory challenges in interagency and cross-border (home-host) cooperation and liquidity risk management.
- Assessors: Keith Bell and Jörg Genner.
- Methodology: conducted in accordance with the revised Core Principles (CP) Methodology issued by the Basel Committee on Banking Supervision in October 2006; qualitative assessment of compliance with each CP; ratings for FSAP assessments take into account the essential criteria only.

### Institutional and macroeconomic setting; market structure
- Luxembourg position: a large international financial center specialized in interbank liquidity and asset management activities.
- Key figures and structure:
  - Financial institutions hold assets equivalent to more than 70 times its GDP.
  - Intermediate about 20 percent of total cross-border exposures among euro area banks and money market funds.
  - Banking sector accounts for about 28 percent of total financial sector assets.
  - Interbank positions represent about half of bank assets and liabilities, of which two-thirds are cross-border exposures.
  - Intra-group exposures account for about 40 percent of total bank assets.
- Ownership and business model:
  - Most local banks are foreign-owned (including groups from Germany, France, and other European countries).
  - Core model: pool liquidity and channel it back to international banking groups via intra-group transactions.
  - Limited lending to the local economy excluding small Luxembourg-owned retail banks and placements with parents.
  - Typically, banks do not operate trading books; liquidity generally managed within parent group centralized frameworks.

### Crisis experience and preconditions for effective supervision
- Crisis impact:
  - Luxembourg was severely affected by contagion during the crisis; aggregate bank balance sheets contracted by almost 15 percent in 2009, essentially through interbank deleveraging.
  - Contributed to bailouts of Fortis and Dexia by authorities of France, Belgium, and the Netherlands.
  - Local subsidiaries of three Icelandic banks failed; the investment fund industry endured large redemptions.
  - Domestic credit markets remained resilient in credit volumes and lending spreads.
- Macroeconomic and institutional preconditions:
  - Macroeconomic performance generally satisfactory: unemployment is low; trend growth rate and inflation satisfactory.
  - EU membership and EEA obligations: implementation of European directives on financial services; voluntary adoption of wider international standards such as Basel Committee standards.
  - Implemented IFRS.
  - Sophisticated legal infrastructure; legislative reliance on EU regulations, directives, and decisions.
  - Availability of high-quality accountancy, audit, legal, and ancillary financial services.
- Safety nets and crisis management:
  - 2008 crisis highlighted weaknesses in safety nets, crisis preparedness, and crisis management.
  - Existing private deposit insurance handled Icelandic bank failures but is slated for revamp under European legislation under discussion.
  - Authorities broadly have adequate powers to direct, intervene in, and close a troubled financial institution.

### Main findings—overall
- Overall assessment: high degree of compliance with the Basel Core Principles, but weaknesses remain.
- CSSF developments since 2001 and post-crisis:
  - Increased supervisory capacities and more intrusive ongoing supervision.
  - Intensified cooperation with home and other host supervisors within supervisory colleges.

### Main findings—selected Core Principles (CPs)
- CP1 (Objectives, Independence, Powers, Transparency, Cooperation)
  - Safeguards for CSSF’s independence need to be put in place; mission and corporate governance require revision to grant fully operational independence.
  - Observed reluctance to use corrective measures expeditiously, though no evidence of actual interference.
- CPs 2–5 (Licensing and Structure)
  - Recommendation that CSSF should assume the licensing role (minister currently grants licenses on CSSF advice).
  - CSSF application assessment should include evaluation of proposed directors and senior management for conflicts of interest.
- CPs 6–18 (Prudential Regulation and Requirements)
  - Regulatory minimum capital requirements are often well below actual capital ratios, potentially reducing effectiveness of capital adequacy regime (CP 6).
  - Local subsidiaries remain exposed to failure of foreign parents; many subsidiaries managed as if they were branches, acting as deposit gatherers and channeling funds to parents.
  - CSSF mitigations include limiting maturity transformation and prohibiting lending to peripheral group affiliates.
- CPs 19–21 (Methods of Ongoing Banking Supervision)
  - SRP includes an ICAAP by each bank and CSSF evaluation; current risk profiles produced for each bank.
  - Techniques tailored to system specifics in place but challenges remain on effective application.
  - Formal reporting of on-site findings can be long-delayed due to staff deployment and escalation processes.
  - Frequency, scope and depth of contacts with bank management are good.
- CP22 (Accounting and Disclosure)
  - IAS and IFRS implemented; European-wide harmonized financial and prudential reporting introduced in 2008.
- CP23 (Corrective and Remedial Powers)
  - Noticeable reluctance to use CSSF’s formal remedial and corrective powers in the form of sanctions.
- CPs 24–25 (Consolidated and Cross-Border Supervision)
  - Need to enhance coordination and cooperation with foreign supervisors within college framework.
  - CSSF dedicates significant resources to participation in colleges of supervisors; these colleges are crucial for understanding cross-border banking group risks.

### Summary compliance notes (selected extracts from Table 6)
- CP1: clearer segregation of legal responsibilities and powers between CSSF and BCL required; domestic coordination on early intervention and crisis management needs development.
- CP1.2: statutory structures hold potential for government or industry infringement of CSSF operational independence; potential for dismissal of entire Executive Board noted.
- CP1.6: a formal agreement codifying cooperation between CSSF and BCL is essential.
- CP3: CSSF should assume licensing role and evaluate proposed directors/senior management for conflicts of interest.
- CP6: interbank (intra-group) and sovereign risk may not be appropriately reflected in existing Basel II compliant capital requirements.
- CP11: intra-group and related party transaction risks not explicitly addressed in law or regulation; no explicit obligation on bank executives/boards to prevent more favorable terms to related parties.
- CP12: crisis highlighted sector exposure to country risk; not obvious this risk was appropriately covered before crisis.
- CP18: Luxembourg’s last assessment (2009) against the FATF 40 Recommendations resulted in a poor grading; remedial regime implementation is being closely monitored.
- CP20–21: SRP includes ICAAP; supervisory techniques exist but formal reporting delays persist; harmonized reporting introduced in 2008.
- CP23: formal powers (e.g., sanctions) are rarely used or used with minimum impact; tendency to escalate minor decisions to senior executives causes delay.
- CP24–25: consolidated supervision of minor importance given sector composition; CSSF actively participates in colleges and is comfortable with cooperation though aware of limited influence as a host supervisor.

### Recommended Action Plan (selected items from Table 7)
- CP1 (Objectives, independence, powers, transparency, cooperation)
  - Focus CSSF activities on discharging supervisory responsibilities and exclude role of promoter of the financial centre.
  - Revise legal framework to secure full operational independence for CSSF and revise internal governance to ensure transparent processes and sound governance.
  - Segregate legal responsibilities for CSSF’s micro-prudential role and BCL’s macro-prudential mandate; develop domestic coordination protocols and adopt enforceable regulations.
- CP3 (Licensing criteria)
  - Include CSSF evaluation of proposed directors and senior management for potential conflicts of interest as a standard element of application assessments.
- CP6 (Capital adequacy)
  - Increase regulatory minimum requirements up to a level commensurate with the individual, often atypical, risk profiles of banks operating in Luxembourg.
- CP7 (Risk management process)
  - Reduce number of Circulars dealing with aspects of risk management and condense and update them.
- CP11 (Exposure to related parties)
  - Limit maturity mismatches between intra-group assets and intra-group liabilities.
  - Increase supervisory focus on responsibility and accountability of local bank management for counterparty and liquidity risks from large intra-group exposures.
  - Ensure intra-group lending is done on an arm’s length basis; address related-party lending by specific regulation and use full range of corrective powers.
- CP12 (Country and transfer risks)
  - Continue to use intervention powers to limit country risk including sovereign risk and consider addressing country risk in regulation.
- CP20 (Supervisory techniques)
  - Continue to meet with banks’ internal audit units to leverage their work.
- CP23 (Corrective and remedial powers)
  - Take more effective and timely corrective actions, and hold local authorized managers accountable.

### Authorities’ response (selected points)
- General: CSSF broadly agrees with assessment; two cases of disagreement and one qualification noted (reflecting choice of words rather than substance).
- Disagreement on characterisation of capital add-ons:
  - Assessment statement: capital add-ons described as “symbolic as it does not always have an impact (§17).”
  - CSSF response: while capital add-ons often did not result in increased levels of capital, they are not symbolic; CSSF determines capital add-ons according to a risk-based analysis and factors potential Pillar 1 shortfalls into a bank’s Pillar 1 regime as a capital add-on.
  - Luxembourg banks display high capital adequacy as a result of market expectations regarding capitalization of banks engaging in wealth management activities (“signaling”); these higher levels are often bank-set and not solely reflective of higher-risk profiles.
  - Judicial review of capital add-on decisions requires CSSF to base decisions on objective facts (risk profile).
  - CSSF argues that capital add-ons, even if below actual capital levels, are important backstops and influence banks’ perceived risk profiles and behavior.
- Independence and corrective actions: CSSF response includes discussion on independence and the application of corrective powers in context of capital add-ons and supervisory practice.

*Source: Appendix I: Observance of Financial Sector Standards and Codes—Summary (Assessments).*

### 62. While we agree that the organic law of the CSSF should be amended to remove

### _cr11148 - 62. While we agree that the organic law of the CSSF should be amended to remove

### Independence of the CSSF and related qualifications
- The assessment team "did not find 'evidence of actual [political] interference.'"
- It is not justified to link the " [observed] certain reluctance to use corrective measures expeditiously" to a lack of independence as is done in "§29, second bullet."
- The reference to CP 23 within the comments is described as "unacceptable" for pushing the argument that lack of independence exists.
- The statement that "the lack of independence and the inherent conflict between the CSSF’s prudential duties and inclusion in its mission of a duty to promote the financial sector are likely to have an impact" is challenged:
  - It is "factually incorrect that the CSSF’s mission includes a duty to promote the financial sector."
  - "Promotion" does not appear in its organic law.

### Circulars and Regulations
- "The policy to replace circulars by regulations will be pursued within the CSSF’s general philosophy to have a coherent regulatory body of laws, regulations and circulars."
- Circulars "will thus not completely be abandoned, but their use will comply with the recommended action to CP7."

### Assessment framework and methodology
- The assessment was conducted based on IOSCO objectives and principles of securities regulation and the associated methodology adopted in 2003 and updated in 2008.
- The conclusions are "based on information and findings as of November-2010."
- Important recent reforms include implementation of EU directives/regulations; Luxembourg envisages implementing "the revision of the undertakings for collective investment in transferable securities (UCITS) directive by end-2010."
- The assessor relied on: relevant legislation; self-assessment questionnaires prepared by CSSF staff; the CSSF annual report and website; detailed discussions with CSSF staff, staff from the Luxembourg stock exchange, law firms, representatives of industry and the ministry of finance.
- An assessment of the securities settlement systems under the CPSS/IOSCO recommendations was conducted "setely in early-2011." Thus, "Principle 30 was not assessed here."

### Preconditions for effective securities regulation — key observations
- The UCI(TS) law provides a comprehensive framework for asset management, "largely inspired from EU directives."
- The regulatory framework transposes "also all other relevant EU Directives."
- The regulator has "legally enforceable powers of decision and action," although:
  - "some limits to its independence and one of its mandates (i.e., implementing government initiatives for orderly expansion of the financial sector) may be inconsistent with the IOSCO objectives."
- Judiciary: mechanisms for alternative means of dispute resolution exist.
- Accounting: framework relies on "international financial reporting standards (IFRS) regarding consolidated accounts of listed companies although some accounts may be presented in Luxembourg generally accepted accounting principles (Lux GAAP)."
- Market entry: "there are no indications of barriers of entry to the financial sector. Competition is encouraged and foreign participation is welcomed."
- Taxation: "The taxation framework is supportive to the operations of the industry in the jurisdiction."

### Main findings — structure, risks, and priorities
- "The massive size of the investment fund industry is a key challenge."
- Luxembourg is "the second largest international financial center for investment funds."
- CSSF supervisory approach:
  - Adopted a structure focusing supervision "on the funds themselves but from the central administration perspective and on the regulation of PFS in charge of the fund administration."
  - Predominantly relies on "its review of ex-post regular or specific reports."
  - Has "recently initiated a more pro-active approach by performing routine or specific on-site inspections and/or addressing questions to funds or their operators." These efforts "deserve to be maintained and, above all, accentuated."
- Cross-border reliance and implications:
  - European integration and Luxembourg's position lead other regulators to "rely on the CSSF as the fore regulator, notably regarding investment funds."
  - "Most Luxembourg based financial products and, in particular, Luxembourg UCI(TS) are sold on a cross-border basis to clients who are not resident in Luxembourg."
  - "No EU Member State can be assessed in isolation but instead as part of a wider community and market."
  - Other European countries "may be led to challenge Luxembourg’s approach to regulation of financial products and to impose protective additional rules at the national level, notably with regards to marketing/selling practices on their territory."
- Priority actions: "The system should work toward strengthening the operational independence of the regulator, accentuating the recent efforts to make more effective its enforcement powers, and strengthening the investor protection rules attached to the products and their operators."
- Overall assessment: "Luxembourg has implemented most of the IOSCO Principles in a reasonable way. However, some elements of the Luxembourg regulatory system and CSSF enforcement practices deserve attention (see detailed comments for each Principle)."

### Findings by principle groups (summary)
- Principles 1–5 (regulator):
  - "The CSSF financial independence is correctly ensured by the funding structure in place."
  - Financial accountability, transparency on CSSF decisions and judicial review "are in line with international standards."
  - Potential weakness: "operational independence of the CSSF as it is placed by law under the direct authority of the Minister; its executive board may be dismissed by the Government if any fundamental disagreement arises concerning regulation policy; and one of its mandates is often confused with the expansion of the financial sector."
  - Assessment "could not determine that the current legislative structure has been used so that pressure was exercised on CSSF decision process."
  - Government decisions contrary to CSSF advice "would have to be motivated and could be challenged in a Luxembourg or European court."
- Principles 6–7 (self-regulation):
  - "There are no self-regulatory organizations (SRO) in Luxembourg. These Principles have not been assessed as they are not applicable to Luxembourg regulation structure."
- Principles 8–10 (enforcement):
  - "The CSSF has comprehensive inspection, investigation, and surveillance powers."
  - Anti-money laundering and terrorist financing rules "have not been assessed in detail since they are being modified by the Luxembourg Parliament pursuant to FATF findings."
  - CSSF should "pay more attention to enforce all provisions and should clarify and detail, where needed, notably those relating to the entering into a business relationship with a new customer."
  - In practice, CSSF should "concentrate its efforts and its resources on the market segments which potentially represent more risk for the regulator."
- Principles 11–13 (cooperation):
  - "The CSFF has legal authority to cooperate and exchange information with foreign counterparties."
  - It "is signatory of the IOSCO Multilateral Memorandum of Understanding (MMoU)."
  - At the domestic level, "it is important that a framework for domestic cooperation between the Luxembourg Central Bank and the CSSF be put in place."
- Principles 14–16 (issuers):
  - Issuers "must submit a prospectus to the CSSF, which content is in line with the IOSCO Principles."
  - Issuers are "subject to periodic reporting, including annual and semiannual reports as well as communication of material events (price sensitive information)."
  - CSSF has "implemented supervisory measures (in-house practice) for reviewing securities prospectuses to help assure the sufficiency, accuracy and timeliness of the required disclosures."
  - "Equity issuers are subject to substantial holdings, as well as insider holdings reporting."
  - Authorities should "pay attention to the gaps between IFRS and Luxembourg GAAP."
- Principles 17–20 (collective investment schemes):
  - Operators and marketers of CIS "are subject to registration requirements (in line with the IOSCO Principles) and to CSSF supervision with an emphasis on the products offered to retail investors."
  - Given the "massive size" and cross-border operation of the investment fund industry, other regulators "have in part to rely on enforcement of European rules by the CSSF in Luxembourg."
  - CSSF should "pay a particularly high attention to an effective use of its supervisory and enforcement powers and should, as a matter of priority, increase its ex-ante supervision (e.g. to ensure that disclosures allow all potential investors, including retail investors, to properly evaluate the suitability of the CIS for them)."
  - The assessment "did not evidence that the CSSF had ever sanctioned actors involved in asset management."
  - Rules regarding "segregation and protection of client assets, in particular in the context of delegation of custody functions, should be strengthened."
  - "Potential consequences of a legal practice regarding investor (in funds with the corporate form) ownership rights deserve to be better and more clearly disclosed."
- Principles 21–24 (market intermediaries):
  - There are "minimum entry standards for all market intermediaries that include, inter alia, criteria relating to initial and ongoing capital."
  - The CSSF should "verify whether the capital standards are sufficient to allow investment firms to absorb some losses in the context of the forthcoming Capital Requirements Directive IV."
  - It should "formalize a procedure for dealing with the failure of a market intermediary in order to minimize damage and loss to investors and to contain systemic risk in cooperation with the BCL."

*Source: _cr11148 - 62. While we agree that the organic law of the CSSF should be amended to remove (extracted from provided IMF document).*

### 78. Principles 25–30 refer to the secondary market: There are licensing requirements

### _cr11148 - 78. Principles 25–30 refer to the secondary market: There are licensing requirements

### Secondary market licensing and oversight — key findings
- Principles 25–30 refer to the secondary market: There are licensing requirements on both operators of regulated markets as well as multilateral trading facilities.
- The CSSF does not have the power to license markets and their operators (competence of the minister).
- No evidence of misuse of the current situation has been found and the potential for misuse seems low.
- The proper management of large exposures could be improved by formalizing or publishing default procedures for market intermediaries.
- Principle 30 was not assessed here.

### Summary implementation of the IOSCO Principles — selected findings (Table 8)
- Principle 1: The CSSF responsibility is clearly stated in the law.
- Principle 2: Financial independence ensured by funding structure; financial accountability, transparency on CSSF decisions and judicial review are in line with international standards. Potential weakness in operational independence noted, though no evidence of problems was found.
- Principle 3: Investigative, supervisory and sanctioning powers broadly in line with international standards. Reform of legal provisions concerning sanctions under consideration; opportunity to grant CSSF the power of injunction on investment funds and their operators.
- Principle 4: Rulemaking process involves broad market consultation; in line with IOSCO principles.
- Principle 5: Most CSSF staff are civil servants subject to demanding professional conduct rules; Code of ethics adopted in 2003.
- Principle 6–7: Not applicable.
- Principle 8: CSSF has comprehensive inspection, investigation, and surveillance powers. AML/CFT rules not assessed in detail (being modified pursuant to FATF findings). Customer due diligence requirement not seen by private sector as clear or detailed enough.
- Principle 9: CSSF has broad enforcement powers, including administrative sanctions on regulated entities and third parties.
- Principle 10: Inspections indicate CSSF exercises powers regarding market abuses adequately. Supervision of asset management could be improved: monitoring of UCI(TS) and operators was chiefly based on ex-post reports. CSSF increased on-site inspections recently, but relative to the massive size of the investment fund industry, assessment could not conclude CSSF devotes resources to where most risks reside. No sanctions imposed to operators in this industry despite increasing errors and breaches.
- Principle 11: CSSF has full authority to cooperate and exchange information with domestic and foreign authorities; legal framework does not require independent interest for cooperation.
- Principle 12: CSSF is sole domestic securities supervisor; domestic cooperation framework important for systemic purposes. CSSF signatory of the IOSCO MMOU.
- Principle 13: CSSF can require information from regulated entities to assist foreign counterparties; considered fully cooperative by CESR counterparts.
- Principle 14: Disclosure regime in place: prospectus requirement for public offers/admission; periodic reporting and material events communication; CSSF has supervisory practices to assure sufficiency, accuracy and timeliness of issuer disclosures.
- Principle 15: Company law provides basic protection for minority investors; corporate governance code supplements framework.
- Principle 16: Issuers required to submit financial statements in accordance to IFRS or local GAAP; CSSF authority to enforce compliance; comprehensive oversight regime for external auditors including on-site inspections and sanctions.
- Principle 17: Legal framework establishes fit and proper requirements for CIS operators. Ongoing monitoring of UCI(TS) and operators chiefly based on ex-post reports; CSSF focused on ensuring compensation for investors when losses occur.
- Principle 18: Legal framework requires assets be entrusted to a depository and explicit need for proper segregation of assets. Obligation to properly segregate assets not explicit when custody delegated to a third party (Circular IML 91/75 not stated in writing). Supervisory practice on providing sufficient time to investors for informed decision on fund changes not clearly stated in written regulation. Consequences where investor name not recorded in fund registry may deserve clarification.
- Principle 19: UCI(TS) prospectus content in line with IOSCO Principles. Assessment did not find strong evidence that CSSF practices for prospectus review and intervention allow full implementation.
- Principle 20: Legal framework contains provisions regarding valuation and pricing. Perception of lack of firmness in enforcement; no evidence CSSF has sanctioned a depositary or other actor involved in asset valuation.
- Principle 21: Securities firms subject to minimum and ongoing capital requirements and fit and proper requirements. Licensing power belongs to the Minister of Finance; assessor did not find evidence of misuse.
- Principle 22: Investment firms subject to initial and ongoing capital requirements adjusted by risks; in practice, almost all investment firms are overcapitalized. Recent financial crisis demonstrated several shortcomings.
- Principle 23: Prudential and organizational requirements fully compliant with this Principle and international standards.
- Principle 24: CSSF could extend early warning system for banks to investment firms. CSSF has no power to move client accounts/assets from one intermediary to another but can request court to freeze assets via abbreviated procedure.
- Principle 25: Both regulated markets and multilateral trading facilities are subject to licensing by the MoF and ongoing oversight by the CSSF.
- Principle 26: CSSF subjects Luxembourg Stock Exchange to active oversight; Exchange rules subject to prior CSSF approval; reporting obligations include daily information on all transactions; CSSF conducts regular visits to the Exchange.
- Principle 27: Both RM and MTS that trade equity are subject to pre and post trade transparency requirements.
- Principle 28: Clear provisions sanction market manipulation and other unfair trading practices; evidence CSSF has been relatively active investigating such misconduct.
- Principle 29: Large positions are monitored through means used to supervise credit institutions and investment firms relating to the large exposures regime.
- Principle 30: Assessment of securities settlement systems to be conducted separately in forthcoming weeks; Principle 30 was not assessed here.

### Recommended action plan to improve implementation — selected recommendations (Table 9)
- Principle 2:
  - Broader or firmer independence for the CSSF in the law is desirable. Amend law to:
    - indicate that the CSSF is accountable to the minister not placed under his direct authority (preference to make CSSF accountable to the Parliament);
    - ensure immovability of the executive board with a potential corollary that the mandate of the directors would not be renewable or would be renewable for a limited number of times; and
    - clarify that one of the broad competences of CSSF is to ensure an orderly functioning of securities market rather than an orderly expansion.
  - Use forthcoming amendment on sanctions powers to overhaul law establishing the CSSF. A draft revision should be proposed to the Parliament in the medium term (one year).
- Principle 3:
  - Given the massive size of the fund industry and attached service providers and the relatively limited size of the securities market in Europe, the CSSF should concentrate resources and powers on sectors where risk of misconduct might be more pregnant. Maintain and intensify training and education for staff.
- Principle 4:
  - Strengthen investor education beyond investor protection given Luxembourg domiciled UCITS are largely offered cross-border to retail investors nonresident in Luxembourg.
- Principle 5:
  - Assign monitoring of compliance with civil servant declarations of personal interest to the Internal Audit Department. Formalize the declaration.
- Principle 8:
  - Clarify provisions imposing customer due diligence and identification by means of reliable and independent source. Amend relevant regulation or issue new one to impose detailed and clear procedures on market intermediaries. Implement changes at short term and issue new CSSF Regulation within one year.
- Principle 10:
  - Develop a more aggressive strategy of routine and surprise on-site inspections for UCI(TS) and their operators to earlier detect errors and breaches and sanction abuses more often. To be implemented at short term.
- Principle 12:
  - Banque Centrale du Luxembourg and the CSSF should sign a MoU regarding cooperation and put it into practice. Implement at short term.
- Principle 16:
  - CSSF could promote voluntary shift from Luxembourg GAAP to IFRS among companies based in Luxembourg.
- Principle 17:
  - Strengthen ongoing and surprise on-site inspections to ensure operators adopt adequate ex-ante procedures to detect and sanction breaches. May warrant increased CSSF resources. Address weaknesses at short term.
- Principle 18:
  - Clarify Circular on role and responsibility of UCI(TS) depositary, notably concerning duty of surveillance where custody is delegated abroad. Amend Circular IML 91/75 to clarify and align segregation and protection requirements with international standards. Address at short term.
  - Disclose consequences of use of a nominee more clearly and prominently. Address at short term.
- Principle 19:
  - Use enforcement powers more frequently where a CIS prospectus does not allow investors, notably retail investors, to evaluate suitability. Strengthen ongoing and surprise on-site inspections to ensure timely prospectus updates.
- Principle 20:
  - Maintain and strengthen routine and surprise on-site inspections to ensure operators adopt adequate ex-ante procedures for UCI(TS) valuation.
- Principle 21:
  - Ideally transfer authorization and withdrawal power to the CSSF, though this is not a priority.
- Principle 22:
  - Pay specific attention to whether capital standards suffice for intermediaries to absorb losses and wind down without customer loss or market disruption. Address at medium term (3 years) in cooperation with the Banque Centrale du Luxembourg.
- Principle 24:
  - Improve investor protection by granting CSSF power to move client accounts/assets from one defaulting intermediary to another in exceptional circumstances. Address at medium term (three years).
  - Implement early warning systems and resolution plans as part of supervision on market intermediaries. Address at short term (one year).
  - Reiterate need for domestic cooperation (see Principle 12) due to importance for financial stability.
- Principle 26:
  - Although no misuse found, consider granting CSSF power to confer and withdraw market operator licenses where legal and regulatory conditions are met. Address at medium term (three to four years).

*Source: _cr11148 - 78. Principles 25–30 refer to the secondary market: There are licensing requirements*

### 79. The Luxembourg authorities appreciate the work performed by the IMF to

### _cr11148 - 79. The Luxembourg authorities appreciate the work performed by the IMF to

### CSSF comments on FSAP findings related to Collective Investment Schemes (CIS)
- Paragraph 79: The Luxembourg authorities appreciate the work performed by the IMF to prepare this FSAP and are grateful for being given the opportunity to comment on the findings of the IMF. The Luxembourg authorities essentially agree with the assessment made by the IMF, but would like to add the clarifications and comments made below, which are exclusively in relation to CIS related aspects of the FSAP. The CSSF would like to stress its commitment to further strengthen, as this has already been the case, its resources, including in the division in charge of the supervision of CIS and their operators, on a short and medium term basis.
- Paragraph 80 (general): The CSSF provides specific comments on different comments, findings and Principles in relation to collective investment schemes.

Key CSSF positions and actions (as stated)
- On absence of sanctions and reporting of valuation/pricing errors (Principle 17 and 20):
  - The CSSF considers that the absence of sanctions against actors in the CIS value chain (administrators or valuation agents and depositaries) and the specific focus of the CSSF practice, which has been to ensure systematic compensation of all investors in cases of losses to CIS investors due to errors in relation to the asset valuation/pricing of units in collective investment schemes (Principle 17 and 20), is justified due to the absence, in relative terms, of any concentration of acts and omission with defined actors in the CIS value chain.
  - Reporting of errors of asset valuation/pricing of units in collective investment schemes is mandatory in only very few jurisdictions at European and non-European level; nothing has come to the attention of the CSSF that would indicate any disproportionate concentration of errors with certain specific actors in the CIS value chain subject to the prudential supervision of the CSSF.
  - The CSSF has conducted on-site inspections and looked more closely at actors with above-average reporting of the number of errors, without considering that imposing sanctions was necessary.
- On segregation and protection of client assets (Principle 18):
  - Recommended action stated Circular IML 91/75 shall be amended to clarify CIS asset segregation requirements and align UCI(TS) asset segregation and protection with applicable IOSCO standards.
  - The CSSF considers that local CIS laws and regulations correctly implement segregation and protection of client assets Principles as provided for under applicable European Union and IOSCO Principles.
  - The mandate principle preventing the depositary from being given the core function of investment management has been extended generally to all UCITS and non-UCITS funds under Luxembourg law regarding collective investment schemes end of 2010 (Law dated 17.12.2010 concerning undertakings for collective investment).
  - Depositary duties and liabilities are being revised at European level; the CSSF supports and contributes to these discussions and will implement resulting changes in due course.
- On supervisory review of CIS prospectuses under IOSCO principles:
  - The CSSF considers that evidence in the assessment demonstrates that its supervisory practice is fully in line with applicable IOSCO principles, both in the criteria used for review and the diligence applied, including review of changes to prospectuses.
- On clarification of investor rights and investor ownership rights:
  - Recommended action: embed current regulatory practice regarding protection of investor rights (major changes and situations where investor name is not registered in the fund registrar) in local regulations.
  - The CSSF agrees with the proposed recommendations and will ensure rapid implementation.

### CPSS/IOSCO assessment of Clearstream Banking S.A. (CBL) — scope and context
- Paragraph 81: Assessment against the Recommendations for Securities Settlement Systems (RSSS) was undertaken in February 2011 as a follow-up of the November 2010 IMF FSAP mission to Luxembourg; it covers Clearstream Banking S.A. (CBL), a Luxembourg based ICSD licensed as a general purpose bank under Luxembourg law. CBL is a subsidiary of Clearstream International S.A., which belongs to Deutsche Börse Group AG.
- Paragraph 82: CBL is a key international financial market infrastructure; as one of the two largest ICSD in the world, it has developed a strong position in the international fixed income market over a period of 40 years. CBL manages securities for over 1,200 financial institutions in 110 countries and has a global network of domestic settlement links including 50 countries. Core services include settlement of global and international securities, domestic securities traded across borders, and value added services in collateral management as a third party service provider.
- Paragraph 83–84: Assessment used CPSS/IOSCO RSSS methodology issued November 2002. BCL and CSSF completed a formal assessment of CBL’s observance of ESCB-CESR Recommendations in 2010 and provided documents and meetings to the Fund; discussions included CBL and representatives of participants, clients, settlement banks, and the Luxembourg Stock Exchange.

### Institutional and market structure—key facts
- Paragraph 85: Luxembourg Stock Exchange (LSE) is prominent for listing international bonds and investment funds; equity listings are small relative to global stock market capitalization but large relative to the economy. Activity is driven by primary issuance; secondary trading plays a limited role. No CCP is registered in Luxembourg; market participants may use CCPs located outside Luxembourg (Eurex Clearing, LCH Clearnet Limited, LCH Clearnet SA).
- Paragraph 86: Two Luxembourg-based securities settlement systems currently: CBL (main) and VP Lux (fully owned subsidiary of VP SECURITIES, established in 2008 to enable Danish issuers to issue securities eligible as collateral in Eurosystem credit operations). A third system, LuxCSD, is being constituted as a joint venture between Clearstream International S.A. and BCL to settle euro transactions in central bank money and to connect to Target2 Securities.
- Paragraph 87 (statistics):
  - In December 2010, the value of assets under custody in CBL was around €5 trillion.
  - About 20 million settlement transactions were processed in 2010, for a value of around €63 trillion.

### Regulatory framework and oversight
- Paragraph 88: As a licensed credit institution, CBL is supervised by the CSSF and must comply with banking requirements. As an operator of a system, CBL is overseen by BCL.

### Main findings and recommended actions (paragraph 89 and Table summary)
- Overall assessment (paragraph 89):
  - The system is reliable and effective in providing delivery versus payment settlement on a real time gross basis.
  - The ICSD benefits from large amounts of liquid resources and can access euro central bank liquidity by providing eligible collateral.
  - Given CBL’s global systemic importance, more systematic liquidity and credit risk stress-testing of different kinds of disruptions should be implemented.
  - Authorities should finalize a contingency plan to face a potential CBL default, including pre-defined arrangements to move participants’ positions to a solvent intermediary and continue core functions.
  - The role and responsibilities of relevant public authorities with respect to securities settlement activities are statute-based and transparent.
  - Supervision and oversight are undertaken by dedicated teams at the central bank and the banking supervisor, on the basis of clear and comprehensive procedures, but they need to increase resources and skills to perform more risk-focused inspections and shorten assessment completion times.

Selected items from the Table 10 summary observance (legal, risk, operational and governance highlights)
- Legal risk:
  - There is a consistent set of laws, regulations, and contractual arrangements forming a sound and clear legal foundation for settlement and custody activities.
  - Luxembourg’s implementation of European directives provides statutory foundation for netting, set-off and securities lending consistent with other member states.
  - A draft law on immobilization and dematerialization is currently being worked out by the authorities.
  - 2009 amendments to the Settlement Finality Directive are in the process of being transposed in Luxembourg law.
- Pre-settlement risk:
  - Most trades between direct market participants are confirmed the same day; all DvP transactions must be matched before being settled in CBL. Regulatory authorities do not monitor trade confirmation performance.
  - Most trades are settled on a continuous basis: rolling settlement cycle three days after trade execution for equities, and between zero and three days for debt instruments. Values and average duration of failed settlements are not available and not monitored.
  - Luxembourg has not introduced a CCP mechanism or guarantee arrangement; CBL customers may centrally clear transactions using CCPs located outside Luxembourg.
  - CBL offers well-developed securities lending and collateral management services; these are supported by law, regulation, tax and accounting systems.
- Settlement risk:
  - CBL uses a model 1 DvP system, ensuring simultaneous final settlement of securities and funds transfers on a gross (trade-by-trade) basis.
  - CBL settles in quasi real-time throughout the day (more than 300 settlement cycles) complemented by a multi-batch settlement processing overnight.
  - CBL allows unilateral revocation of non-settled transactions, even matched and late in the settlement day, which may create liquidity risk for participants.
  - CBL offers credit lines (mostly secured) and securities lending; it invests funds held by its participants in its books, creating credit and liquidity risks that need close monitoring and mitigation.
  - CBL conducts monthly and quarterly stress tests; these should be complemented by tests including multiple participant failures and the liquidity impact of the participant with the largest exposure.
  - CBL settles securities transactions in commercial bank money and is its own settlement agent; it has access to Target2, allowing customers to use central bank money. Cash is deposited with cash correspondent banks that may provide free and mostly unsecured intra-day liquidity facilities and overnight credit.
- Operational risk:
  - Operational risk is significant but well-controlled; the system is reliable, secure, and has adequate, scalable capacity.
  - Contingency plans and back-up facilities are in place; however, there is no compulsory contingency testing for the largest participants, no third IT site (three sites architecture), and no disaster recovery test simulating operational disruptions at the level of the whole Luxembourg financial sector.
- Custody risk:
  - Assets safekeeping is regulated by the CSSF. In the event of a custodian’s bankruptcy, clients would be entitled to claim their securities or equivalent securities deposited with CBL up to the amount not reserved by CBL to cover ongoing transactions of the defaulting custodian’s clients.
  - There are no pre-defined arrangements to move clients’ positions to a solvent custodian.
  - Most securities held by CBL are sub-deposited with sub-custodians, mainly outside Luxembourg; legally CBL holds depositors’ accounts in Luxembourg and ICSD rules select Luxembourg law as applicable. Continuous reconciliation is performed and forms part of internal and external audit activities.
  - Authorities are working on a contingency plan or resolution process to face a potential CBL default, in particular to design pre-defined arrangements to move participants’ positions to a solvent intermediary and continue core functions.
- Governance and access:
  - CBL governance arrangements are not primarily designed to fulfill public interest requirements but to make a profit for the benefit of Deutsche Börse stakeholders; in practice this is not currently contradictory with system efficiency, safety, and user satisfaction.
  - As a bank, CBL does not publish access criteria and access to CBL services is at CBL’s discretion. Procedures for participant exit (initiated by participant or ICSD) are clearly stated in the participant rules.

*Source: IMF country report text provided in content unit _cr11148 - 79.*

### 15. While maintaining safe and secure

### 15. While maintaining safe and secure

### Observance of CPSS-IOSCO Recommendations: cost-effectiveness and user satisfaction
- Securities settlement systems should be cost-effective while maintaining safe and secure operations.
- The ICSD routinely reviews its pricing levels against its costs of operation.
- The Clearstream group has undertaken a cost reduction programme since the financial crisis.
- Ad-hoc surveys are used to assess user satisfaction with the system and the service it provides.

### Communication procedures and cross-border settlement
- Securities settlement systems should use or accommodate the relevant international communication procedures and standards to facilitate efficient settlement of cross-border transactions.
- CBL uses the relevant international communication procedures and standards to facilitate efficient settlement of cross-border transactions.

### Disclosure of risks and costs to market participants
- CSDs and central counterparties should provide market participants with sufficient information to accurately identify the risks and costs of using the CSD or central counterparty services.
- CBL provides a number of information on its website, but could provide market participants with more information for them to accurately identify the risks and costs associated with using the ICSD.

### Regulation, oversight, and institutional cooperation
- Securities settlement systems should be subject to regulation and oversight; responsibilities and objectives of the securities regulator and the central bank with respect to SSSs should be clearly defined and publicly disclosed.
- The role and responsibilities of relevant public authorities with respect to securities settlement activities are statute-based and transparent.
- There is no formal framework for cooperation between BCL and CSSF, or a working document detailing their respective roles and tasks, to reduce uncertainty and potential overlapping between the two authorities and facilitate crisis management.
- There is no formal supervisory framework with Belgium authorities, even though CBL’s activities are highly relevant for both Luxembourg and Belgium (through the Bridge with Euroclear Bank).
- The ICSD’s supervision and oversight are undertaken by dedicated teams at the CSSF and BCL, on the basis of written procedures.
- Given the global systemic importance of CBL, BCL and the CSSF need to increase resources and skills in order to perform more risk-focused inspections and shorten the period needed to complete assessments.

### Cross-border links and stress testing
- CSDs that establish links to settle cross-border trades should design and operate such links to reduce effectively the risks associated with cross-border settlement.
- The ICDS has established a bilateral direct link via the Bridge to Euroclear Bank and several unilateral direct links with domestic settlement systems.
- Credit exposures stemming from the Bridge are collateralized.
- Until now only one stress test has been performed to assess the level of liquidity in various currencies that is needed by CBL under extreme but plausible scenarios affecting the Bridge, and none for the other links.

### Recommended Action Plan (summary of Table 11: Luxembourg)
- RSSS8: CBL should not allow unilateral revocation of non-settled matched transactions late in the settlement day so as to avoid the liquidity risks that such actions can create. CBL’s Handbook should more clearly explain when unilateral or bilateral revocation of a transfer order is possible, and CBL should check if the definition of the moment of entry in the system is consistent with the Settlement Finality Directive requirements.
- RSSS9: CBL should regularly evaluate the probability and impact of multiple participant failures.
- RSSS13: CBL should publish more updated information on its governance arrangements (for example CBL’s board composition, and the process by which major decisions are taken and management made accountable). Independent members should be included on CBL’s board.
- RSSS14: Access criteria should be objective, clearly stated, and publicly disclosed.
- RSSS17: The fee structure should allow participants to easily calculate the cost of their participation in CBL. CBL should publish regularly updated activity statistics on its website. The CPSS/IOSCO questionnaire published on CBL’s website should be up to date.
- RSSS18: BCL and CSSF should establish a formal framework or a working document, detailing their respective roles and tasks. A formal supervisory framework with Belgium authorities should be established. BCL and the CSSF need to increase resources and skills for the oversight/supervision of CBL in order to perform more risk-focused inspections and shorten the period to complete assessments.
- RSSS19: CBL should perform regular stress tests to assess the level of liquidity in various currencies that is needed by CBL under extreme but plausible scenarios affecting the Bridge and CBL’s exposure on Euroclear Bank, as well as the other links.

### Authorities’ response to the assessment
- The authorities welcome the IMF assessment of the securities settlement system (SSS) operated by Clearstream Banking S.A. against the CPSS-IOSCO Recommendations for SSSs and take note of its conclusions and observations.
- They are of the opinion that the IMF has performed a thorough and comprehensive assessment in a dynamic and interactive way.

*Source: _cr11148 - 15. While maintaining safe and secure*

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_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2011/_cr11148.pdf_