1: Overview

1.1 This consultation paper (CP) outlines the Bank of England’s (the Bank’s) proposals to introduce a set of Fundamental Rules for financial market infrastructures (FMIs) incorporated in the UK. The aim of the proposed rules is to increase the resilience of FMIs through providing a clear and transparent articulation of the desired outcomes of the Bank’s policy framework. This will support FMIs’ compliance with the relevant regulatory regime and their supervisory engagement with the Bank, and so UK financial stability. The proposed Fundamental Rules are complementary to the existing relevant regulatory frameworks for FMIs, set out in paragraph 1.8.

1.2 Fundamental Rules will contribute toward the Bank achieving a nimble, effective and forward-looking regulatory regime. The Bank’s primary objective is to protect and enhance the stability of the UK financial system (the Financial Stability Objective). The Bank also has a secondary objective to, where possible, facilitate innovation in the provision of central counterparty (CCP) and central securities depositories (CSDs) services when advancing the primary financial stability objective.

1.3 For CCPs and CSDs the Fundamental Rules will take the form of rules made under Financial Services and Markets Act 2000 (FSMA 2000).^{footnote [1]} For recognised payment service operators (RPSOs) and specified service providers (SSPs) they will take the form of a binding Code of Practice (CoP), pursuant to the powers given to the Bank under Part 5 of Banking Act 2009. The Bank is continuing to develop its approach to a systemic stablecoin regime, having published a discussion paper in November 2023. The Bank intends to apply the Fundamental Rules to systemic stablecoins, alongside the existing payments CoPs, in due course.^{footnote [2]}

1.4 This new rulemaking power for CCPs and CSDs is accompanied by certain obligations in respect of oversight and accountability.^{footnote [3]} These include a new secondary objective to facilitate innovation when advancing the Bank’s primary Financial Stability Objective. It also includes consideration against certain regulatory principles and the introduction of new accountability mechanisms that are more aligned with those that already exist for the Financial Conduct Authority (FCA) and Prudential Regulation Authority (PRA), as well as a requirement to carry out cost-benefit analysis (CBA) on the proposed rules.^{footnote [4]}

1.5 These obligations are reflected in this consultation paper in respect of the proposed rules for CCPs and CSDs.

1.6 Although the CBA requirement does not apply to the Bank’s power to publish binding Codes of Practice for RPSOs and SSPs, the Bank has carried out a proportionate CBA in respect of the proposed Fundamental Rules for payment systems and specified service providers.

1.7 FMIs are crucial components of the UK’s financial system and play a significant role in supporting the UK economy. They support the safe operation of financial markets and financial stability by reducing counterparty credit risk and settlement risk and enabling safe and reliable payments. In the UK, in a single day CCPs clear trillions of pounds worth of notional outstanding of financial contracts, the CSD settles around £800 billion of securities transactions and £5.4 trillion of payments are made using recognised payments systems.^{footnote [5]} The Bank’s regulation and supervision of FMIs seeks to ensure that they are resilient, predictable, and able to recover effectively from incidents should they occur. This ensures that they can achieve their role of reducing risks to financial stability rather than transmitting or amplifying them, particularly in times of stress.

1.8 As noted above, the Fundamental Rules are intended to underpin this resilience through clearly and transparently establishing the high-level outcomes for all FMI types, consistent with the Bank’s objectives, that are being sought by more detailed aspects of the regulatory framework. The Bank regulates FMIs in accordance with a domestic statutory framework which includes the Banking Act 2009, Bank of England Act 1998, the Financial Services and Markets Act 2000 (FSMA 2000), binding Codes of Practice for payments systems and specified service providers, and EU law which was onshored into UK law at the end of the transition period following the UK’s exit from the EU (UK EMIR and UK CSDR).^{footnote [6]} These are complemented by certain supervisory statements and expectations published by the Bank. The regulatory framework is based on internationally agreed principles. The Principles for Financial Market Infrastructures (PFMI) developed by the Committee on Payment and Settlement Systems (CPSS – subsequently renamed the Committee on Payments and Market Infrastructures, or CPMI) and the International Organization of Securities Commissions (IOSCO) set international standards for FMI regulation with which the current UK regulatory framework is consistent.^{footnote [7]} Annex F of the PFMIs specifically sets out considerations relevant for SSPs, as critical service providers to FMIs.

Statutory Obligations

1.9 In carrying out policymaking functions the Bank is required to comply with several statutory obligations. Section 3 explains how the Bank has had regard to the obligations applicable to the Bank’s policy development process, including an explanation of how this is reflected in the proposals. The Bank has a statutory duty to consult when introducing new rules and changing existing rules for CCPs and CSDs made under the Financial Services and Markets Act (FSMA) 2000 as amended by FSMA 2023. While there is not the same statutory duty to consult when introducing new codes of practice under the Banking Act 2009 or amending existing codes of practice, the Bank decided to do so in this instance to gather feedback on the proposals.

Statutory objectives analysis

1.10 The Bank has developed the proposals for Fundamental Rules for CCPs and CSDs in accordance with the relevant statutory obligations in the Bank of England Act 1998 and FSMA 2000 (as amended by FSMA 2023). This includes considering the proposals against the Bank’s Financial Stability Objective, its secondary objective to facilitate innovation in the provision of FMI services^{footnote [8]} (the Secondary Innovation Objective), the requirement to ‘have regard’ to certain policy considerations and to carry out a cost benefit analysis.

1.11 The Bank has developed the proposals for Fundamental Rules for RPSOs and SSPs under the legislative framework set out in Part 5 of the Banking Act 2009. While these require considering the proposals against the financial stability objective, it does not include a requirement to consider them against the secondary innovation objective, to expressly ‘have regard’ to certain policy considerations or to carry out a CBA in the same manner as the accountability framework for CCPs and CSDs. However, the Bank has included a non-statutory CBA for these proposals.

1.12 This section outlines the analysis of the Fundamental Rules against these frameworks, making clear where it applies to all FMIs, or only to CCPs and CSDs, or only RPSOs and SSPs.

Financial Stability Objective – All FMIs

1.13 The Bank considers that these proposals would advance the financial stability objective. The key benefit of introducing the Fundamental Rules for FMIs is enhanced financial stability, both through enhanced supervisory effectiveness and through addressing potential underlaps in the existing regulatory framework. The rules are designed to clearly and transparently set out the outcomes that the Bank seeks to achieve through its regulation of FMIs. In doing so, they cover the outcomes that the Bank is seeking across a full range of policy areas, from the way FMIs should organise their financial resources, risk management and operational resilience, to how FMIs engage with the regulator, and how FMIs consider their impact on the stability of the financial system. This is expected to support FMIs’ understanding of the rules, and also their engagement with the Bank, leading to improved compliance with detailed regulation and therefore enhanced effectiveness of FMI supervision. In addressing regulatory underlap the rules aim to ensure that FMIs have a full appreciation for their interconnected nature within the financial system with an understanding of the impact they may have through this interconnection. These outcomes, taken together, are intended to ensure financial stability by reducing the likelihood of a financial crisis stemming from or transmitting through FMI operations.

Secondary Innovation Objective – CCPs and CSDs

1.14 The Bank considers that these proposals are consistent with the Secondary Innovation Objective for CCPs and CSDs. They will provide clarity on the high-level outcomes that the Bank is seeking, supporting their understanding of the regulatory framework in which they operate. This will support their ability to consider how they might innovate to achieve these outcomes within the regulatory framework in order to achieve better outcomes and also better resilience within the system. There is analysis and academic literature to support the notion that a stable and transparent regulatory regime fosters an environment where financial institutions are able to safely and effectively innovate.^{footnote [9]} This is particularly important for new or prospective entrants, ensuring they have a clear understanding of the focus of the Bank’s regulatory framework and the rationale behind more granular rules.

Have regards – CCPs and CSDs

1.15 When making policy for CCPs and CSDs, the Bank must ‘have regard’ to certain public policy considerations set out in the Bank of England Act 1998 as amended by FSMA 2023.^{footnote [10]} The Bank has had regard to these considerations and identified the following ‘have regards’ which it considers significant to the proposed Fundamental Rules. Where analysis has not been provided against a ‘have regard’, it is because the Bank considers that ‘have regard’ to not be a significant factor for the proposals in this CP.

Equality and diversity – all FMIs

1.16 In developing its proposals, the Bank has had due regard to the equality objectives under s.149 of the Equality Act 2010. The Bank considers that the proposals do not give rise to equality and diversity implications.

Cost-benefit analysis

1.17 In respect of rulemaking for CCPs and CSDs, the Bank is required to publish a CBA alongside any proposed rules, defined as an analysis of the costs, together with an analysis of the benefits that would arise if the proposed rules were made and an estimate of those costs and of those benefits, where reasonably practicable to do so.

1.18 The Bank assesses that the benefits of the Fundamental Rules outweigh the associated costs. The Bank considers that the benefits these rules provide to financial stability, through addressing any potential underlaps in the regulatory framework, as well as enhanced supervisory effectiveness, through transparent and clear articulation of the regulatory outcomes the Bank seeks to achieve, outweigh the initial and ongoing costs to FMIs of implementing the proposed policy. The full CBA for the proposed rules is set out in Section 3.

1.19 In line with our statutory requirements, the Cost Benefit Analysis Panel^{footnote [11]} were consulted on the areas of the CBA relating to CCPs and CSDs, an overview of which is set out in paragraphs 3.25–3.26.

Implementation

1.20 The Bank proposes that the final policy will be published (and take effect) following consideration of feedback received as a result of this consultation. The Bank intends for there to be a six-month implementation period between the publication of the final rules and the application of the Fundamental Rules to FMIs. The Bank welcomes views on what an appropriate implementation period would be.

1.21 The Fundamental Rules will form the foundation of a broader Bank rulebook for FMIs, which will be developed in due course, as the Bank uses its new rulemaking power over UK CCPs and CSDs to replace detailed firm-facing requirements currently in UK primary legislation.

Responses and next steps

1.22 This consultation closes on the 19 February 2025. The Bank invites feedback on the proposals set out in this consultation. Please address any comments or enquiries to FMIfundamentalrulesCP1124@bankofengland.co.uk. Please indicate in your response if you believe any of the proposals in this CP are likely to impact persons who share protected characteristics under the Equality Act 2010, and if so, please explain which groups and what the impact on such groups might be.

1.23 The CP will explain if responses will be shared with other organisations (for example, the FCA). If this is the case, the other organisation will also review the responses and may also contact you to clarify aspects of your response.

2: Our proposals

2.1 The Fundamental Rules collectively set out the Bank’s overall requirements of FMIs. They are intended to be comprehensive and transparent in covering the various types of FMIs and reflect the high standards that the Bank is seeking across financial and operational resilience, governance and engaging with the Bank. This is in order to support the resilience of the FMIs themselves and of the financial system more broadly. They are consistent with, complement and underpin the relevant underlying detailed rules and international standards for FMIs.

2.2 The Bank’s Fundamental Rules will apply through the Bank’s general rulemaking power over CCPs and CSDs and to RPSOs and SSPs through binding codes of practice. The rules will apply to recognised UK CCPs, recognised UK CSDs, UK RPSOs and UK SSPs. Third-country CSDs and ‘systemic third-country CCPs’ are not in scope, but should HM Treasury (HMT) make regulations in future that allow for the application of these rules to third-country CSDs, or set criteria of general application in respect of a 'systemic third-country CCP', the Bank may look to expand the Fundamental Rules to these entities. Although non-UK RPSOs and SSPs also fall outside of the scope of these proposals, the Bank may also look to extend the Fundamental Rules to these entities in due course.

2.3 The rules will make it clear to FMIs and the users of their services what the Bank is seeking to achieve through its regulation and what the Bank’s requirements are of FMIs. Through introducing these proposed rules, the Bank intends to influence FMIs’ approaches to thinking about regulation and ensure they exhibit behaviours and take action that contribute toward achieving the Bank’s objective of financial stability.

2.4 Fundamental Rules will apply to all FMIs at all times, including in times of stress. In general, the application of the Fundamental Rules will be considered alongside the underlying regulation that is in place through Bank rules and legislation for each FMI and any supervisory interactions between the Bank and FMIs. The rules are designed to be consistent with this underlying regulation, meaning that where FMIs are compliant with the underlying regulation they can expect to be compliant against the Fundamental Rules. Where the Fundamental Rules set requirements that are not specifically outlined in the underlying regulation the Bank has expanded on their interpretation in the accompanying supervisory statement in order to make their interpretation clear to FMIs (see Appendix 1).

2.5 The Fundamental Rules are applicable to all UK CCPs and UK CSDs, subject to a set of restrictions. These restrictions apply across three categories:

• Unregulated and regulated activities.
• Group activities.
• Extraterritorial activities.

2.6 The Fundamental Rules will apply to CCPs and CSDs across all regulated and unregulated activities, In practice the application of these rules in this way will be in so far as those activities are relevant for the Bank to advance its financial stability objective. This ensures that any activity whether regulated or unregulated will be in scope of the Fundamental Rules in instances where there is a financial stability implication.

2.7 Fundamental Rules 3, 4, 5, 6, 8, 9, 10 and (in so far as it relates to disclosing to the Bank) 7 will apply to CCP/CSD group activities.^{footnote [12]} For these rules the activities of the wider group can have a relevant bearing on an CCP/CSDs ability to comply with the Fundamental Rule. An example of this is for instance Fundamental Rule 4: financial resources. The activities of the group an FMI is part of can have a material impact on the ability for an FMI to ensure it is in compliance with this Fundamental Rule. This restriction does not apply to Fundamental Rule 1 and 2 as the ability for a CCP/CSD to behave with integrity, due skill care and diligence is internal to the CCP or CSD, and so there is less scope for the group to influence the regulated FMI to comply with this rule. The Fundamental Rules will apply extraterritorially to all activities whether in the UK or another jurisdiction, reflecting the global nature of the services FMIs provide.

2.8 The rules will apply to RPSOs and SSPs in line with the scope of the code of practice power as set out in section 189 of the Banking Act 2009. The scope of the application of codes of practice to payment systems is different in its legal basis from the general rule making power the Bank has over CCPs and CSDs, whereby the application of the codes of practice relates to the system operated by the RPSO and services provided by SSPs. Given the scope of the rulemaking power in relation to RPSOs and SSPs the Bank does not deem it necessary to include restrictions in relation to regulated and unregulated activities. The Fundamental Rules will apply extraterritorially to RPSOs and SSPs whether services and activities are provided in the UK or in another jurisdiction, reflecting the global nature of the services FMIs provide. In line with the scope of the code of practice power the Fundamental Rules will not apply to group activities of RPSOs and SSPs.

The proposed Fundamental Rules

Fundamental Rule 1 (FR1) – An FMI must conduct its business with integrity.

2.9 This Fundamental Rule aims to ensure that FMIs behave in a way which is honest. This is foundational to the other Fundamental Rules. The proposed rule requires that FMIs are acting in good faith when conducting their business given their systemic importance. FMIs must show adherence to this standard in the everyday course of business and when making business-related decisions.

2.10 Everyday use of the term ‘integrity’ will be applied by the Bank.

Fundamental Rule 2 (FR2) – An FMI must conduct its business with due skill, care and diligence.

2.11 This Fundamental Rule aims to ensure that FMIs are well-run, with decisions being appropriately informed and well executed. This is in order to establish the importance of competence in how FMIs conduct themselves. An FMI must discharge the obligations required by the Fundamental Rule during the everyday course of its activities and when making decisions, including strategic decisions, and the rule is not limited to the formal governance arrangements of an FMI.

2.12 Everyday use of the terms ‘skill’, ‘care’ and ‘diligence’ will be applied by the Bank.

Fundamental Rule 3 (FR3) – An FMI must act in a prudent manner.

2.13 This Fundamental Rule aims to ensure that FMIs demonstrate sound judgement and exercise caution when making decisions that involve risk. This is particularly important given FMIs’ roles in managing risk in the financial system. FMIs must take due account of the risks and possible consequences for the FMI as part of their normal operations. This requirement interacts with Fundamental Rule 10 which proposes an explicit requirement of FMIs to have a consideration for the risk their business operations may pose to the stability of the financial system.

2.14 Everyday use of the term ‘prudence’ will be applied by the Bank.

Fundamental Rule 4 (FR4) – An FMI must maintain sufficient financial resources.

2.15 This rule aims to ensure that FMIs’ financial resources (including capital and, for CCPs, margin contributions and default funds) are sufficient with regard to their business. This is particularly critical where an FMI accepts financial resources from its participants to manage risks from their activity. Where relevant, an FMI in a group will need to consider its financial resources by taking into account demands from the consolidated level of the group. It does not impose an additional requirement for any FMI beyond that which is already required by applicable rules, legislation and expectations that have been clearly communicated to FMIs by the Bank.

2.16 Use of the term ‘sufficient’ is intended to align with the wording of the relevant international standards for FMIs, set out within the PFMIs, including in PFMIs 4 (credit risk) and 7 (liquidity risk). What is sufficient may vary by FMI type and the relevant underlying regulatory framework.

Fundamental Rule 5 (FR5) – An FMI must have effective risk strategies and risk management systems.

2.17 This rule aims to ensure that FMIs place sufficient emphasis on risk management, reflecting their role in managing risk in the financial system.

2.18 It reflects the need for FMIs to accurately identify and understand the risks inherent in their businesses and ensure there are robust structures for managing and reporting on these risks. FMIs should clearly define the degree of risk they are prepared to assume in pursuing their strategic and business objectives. A vaguely expressed risk appetite could suggest a breach of this rule. The Bank considers the references to ‘risk strategies’ and ‘risk management systems’ as having a wider application than just financial soundness; the rule is designed to cover risks material to an FMI’s activities including, for example, legal and strategic risk. In addition to complying with this rule, an FMI will also be required to meet specific rules related to risk management that are applicable based on the relevant underlying rules and legislation. An FMI must also be able to demonstrate clear strategies to identify risks, to provide a holistic view of the risk exposures to an FMI’s board and define measures to respond to risks appropriately.

2.19 The requirement interacts with the language of Fundamental Rule 10 in relation to systemic risk, in that it requires FMIs to have risk strategies that provide a structured and coherent approach to identifying, assessing and managing risk.

Fundamental Rule 6 (FR6) – An FMI must organise and control its affairs responsibly and effectively.

2.20 This rule is primarily focused on good internal governance, which plays a critical role in an FMI meeting the standards set in the other rules. In complying with this rule, an FMI is required to have directors and senior managers who are fit and proper for their roles and adequate arrangements for securing the suitability of persons who carry out functions on its behalf. This will include apportioning responsibilities among senior managers and directors so that their individual responsibilities are clear. This will assist the business of the FMI to be adequately monitored and controlled at senior level and will help the Bank understand the governance structures of the FMI.

Fundamental Rule 7 (FR7) – An FMI must deal with its regulators in an open and co-operative way and must disclose to the Bank appropriately anything relating to the FMI of which the Bank would reasonably expect notice.

2.21 This rule requires an FMI to maintain relationships with its regulators that are characterised by timely co-operation and candour. This is essential to the Bank ensuring the FMI’s compliance with the regulatory framework in pursuit of its financial stability objective.

2.22 FMIs’ compliance with this rule will be relevant to mitigation or aggravation when the Bank is considering appropriate action for breaches of other Fundamental Rules and Bank rules.

2.23 The rule extends to the provision of information and notification of events concerning non-regulated activities and other members of a group, where appropriate. What constitutes reasonable is dependent on the particular circumstances facing the FMI.

2.24 Where this rule refers to regulators, this means, in addition to the Bank, other regulators with recognised jurisdiction in relation to regulated activities, in the United Kingdom. The introduction of this Fundamental Rule will support increased efficiency and effectiveness of supervisory interactions between the Bank and FMIs.

Fundamental Rule 8 – An FMI must prepare for resolution or administration so, if the need arises, it can be resolved or placed into administration in an orderly manner with a minimum disruption to critical services.

2.25 This Fundamental Rule reflects the importance the Bank places on an FMI’s ability to be prepared for resolution or administration. This is to ensure that an FMI in difficulties can be addressed in a way that maintains its critical functions and has minimal impact on financial stability and public finances.

2.26 The Bank is proposing one rule to cover all FMI types, while acknowledging that there are different, underlying resolution or administration regimes for different FMI types. The UK has a resolution regime for CCPs in place,^{footnote [13]} by which the Bank can intervene should a CCP’s failure poses a threat to financial stability. The UK has a special administration regime for payments and settlement systems,^{footnote [14]} which focuses on the facilitation of continuity of critical services. This rule should therefore be read in conjunction with the guidance in the accompanying supervisory statement, and FMIs should prepare for eventualities that are relevant for their respective businesses.

2.27 How an FMI is expected to show compliance with this rule will be determined by the type of business it carries on. What constitutes a critical service is context and firm specific. This rule will ensure that there is minimum disruption in the event an FMI approaches or does fail and therefore has the most limited possible impact on financial stability through the continuation of FMIs’ critical services.

Fundamental Rule 9 (FR9) – An FMI must maintain sufficient operational resilience.

2.28 This rule aims to ensure FMIs place a high priority on maintaining their operational resilience. The increased complexity and interconnectedness within the financial system has made it even more critical that FMIs understand, test and address possible risks to their operations, which may have an impact on financial stability. The rule is consistent with and complements the PFMI in respect of operational risk, relevant articles of UK EMIR and UK CSDR, and also the Bank’s supervisory statements on Operational Resilience for CCPs and CSDs, and Code of Practice for Payments Systems and Specified Service Providers. By placing operational resilience within the Fundamental Rules, the Bank is emphasising the importance it places on FMIs ensuring their operational resilience to maintain financial stability.

Fundamental Rule 10 (FR10) – An FMI must identify, assess, and manage the risks that its operations could pose to the stability of the financial system.

2.29 This rule aims to ensure that FMIs have a knowledge of, understanding of and ability to deal with, risks that their operations may pose to the stability of the financial system. It reflects the central role that FMIs play within the financial system, in managing counterparty credit risk and settlement risk, and in ensuring that payments are made safely and securely. This means that they may both introduce and amplify risks through their operations and interactions with financial market participants. For this reason, it emphasises the need for FMIs to consider the impact of their operations beyond their immediate participants to the broader market. In doing this, they will support both broader financial stability and also their own resilience.

2.30 The rule is consistent with and complements other Fundamental Rules, including Fundamental Rule 3 (acting in a prudent manner) and 5 (having effective risk strategies and risk management). While these rules require FMIs to consider the impact of risks to themselves and the risks that that FMIs might pose to others, this rule places greater emphasis and clarity on the Bank’s expectations of FMIs taking a broader view given their central roles in the financial system.

Draft supervisory statement

2.43 FMIs should refer to the accompanying draft supervisory statement (see Appendix 1), for additional information on how they should interpret the proposed Fundamental Rules.

3: Cost-benefit analysis

Overview and counterfactual – all FMIs

3.1 The Bank assesses that the benefits of Fundamental Rules outweigh the associated costs. The Bank considers that the benefits these rules provide to financial stability, through addressing any potential underlaps in the regulatory framework, as well as enhanced supervisory effectiveness, through transparent and clear regulatory outcomes that the Bank seeks to achieve outweighs the initial and ongoing costs to FMIs of implementing the proposed policy. This assessment is outlined in more detail below.

3.2 This consultation provides a largely qualitative approach to assessing the impacts of the introduction of FMI Fundamental Rules, particularly when assessing benefits, given their high-level and outcomes-focussed nature. The Bank has outlined its estimation of costs using standardised industry data for staff costs and estimates of staff time needed to implement proposals through supervisory data.

3.3 The baseline for comparing the costs and benefits of the introduction of the Fundamental Rules would be the existing current requirements on FMIs across the areas of policy that the Fundamental Rules relate to. As set out in paragraph 1.8, these requirements sit across binding Codes of Practice for payments systems and specified service providers, and EU law which was onshored into UK law at the end of the transition period following the UK’s exit from the EU (UK EMIR and UK CSDR) for CCPs and CSDs.

3.4 Table B below also provides an overview as to how the Fundamental Rules map to the PFMIs for FMIs. Annex F of the PFMIs is relevant for SSPs. While not requirements, these should be familiar to FMIs and mapping them may help FMIs familiarise themselves with the intended outcomes of the Fundamental Rules.

Table B: Relationship between Fundamental Rules and PFMIs ^(a)

Case for action – all FMIs

3.5 FMIs are critically important to the financial stability of the UK and play a crucial role in global financial markets; they are often described as the plumbing of the financial system. This vital role is played throughout benign market conditions and during times of market crisis and instability. FMIs offer vital services to members and customers in order to facilitate payments, clearing and settlement. FMI regulation seeks to ensure that in carrying out their vital functions, FMIs are financially and operationally resilient, run with sufficient skill and care and have an appropriate appreciation for the risks they face and the risk that their actions may pose to the financial system.

3.6 While the Bank believes that the current regulatory framework for FMIs is effective, the Bank is confident that the addition of the Fundamental Rules will offer a further tool to protect against market failures which can occur in the FMI space. These include information asymmetry between FMIs and the Bank, as well as between FMIs and the broader financial system, and possible negative externalities from FMI operations. In order to have effective regulation it is essential that FMIs have an understanding of what the regulator expects to achieve through its actions. The Fundamental Rules increase the clarity through which those high-level outcomes are communicated. This helps ensure that FMIs and the Bank have a shared understanding of what the regulations and supervisory decisions taken by the Bank are trying to achieve.

3.7 As well as outlining the outcomes sought by the underlying regulatory frameworks, Fundamental Rules also protect against potential regulatory underlap, with some of the Fundamental Rules addressing known gaps where there are no existing formal requirements set out for FMIs. This is particularly the case for Fundamental Rule 10, which the Bank considers will reduce the negative externalities that FMIs may cause without proper identification, assessment and management of the risks they can cause to the broader financial system.

3.8 For RPSOs and SSPs, it is important for the Bank to formally set out minimum requirements in a new CoP on Fundamental Rules. This will support the requirements set out in the existing CoPs on Governance, Operational Resilience and Outsourcing and Third-party Risk Management for RPSOs and SSPs, but importantly it will also formalise expectations in areas where there are no existing CoPs. Addressing this underlap in the policy framework for FMIs would help the Bank to further its financial stability objective by clearly setting out minimum standards and what is expected of RPSOs and SSPs.

3.9 Recently there have been legislative changes to the regulatory perimeter relevant to payment systems. FSMA 2023 expanded the scope of the Banking Act 2009 to capture payment systems that use digital settlement assets (DSA) and DSA service providers like wallets and exchanges. As set out in the discussion paper on the Bank’s approach to innovation and money,^{footnote [15]} the Bank expects the payments landscape will continue to evolve and innovate. This innovation may affect the regulatory landscape and the UK may need to respond to this changing environment with an agile regulatory framework. In response to the innovation and unbundling of payments, in 2023 HMT set out its intention^{footnote [16]} to further amend the Banking Act 2009 so that the Bank could capture a broader set of payments entities. With this possible future expansion of the Bank’s systemic payments perimeter, it is helpful for the Bank to be forward looking to identify and prevent any underlap in our regime.

CBA – CCPs and CSDs

Benefits

3.10 The key benefit of introducing the Fundamental Rules for FMIs is enhanced financial stability, both through enhanced supervisory effectiveness and through addressing potential underlaps in the existing regulatory framework.

3.11 The Fundamental Rules will increase supervisory effectiveness, and accountability of adherence to the regulatory framework at FMIs through increased transparency of the outcomes of the Bank’s regulatory framework. By increasing transparency, FMIs will better understand what the Bank aims to achieve through its regulatory framework, allowing for more structured conversations at board and executive level at FMIs. It will also help supervisors communicate their supervisory priorities more effectively. The introduction of these rules will therefore improve supervisory engagement between the Bank and FMIs on key priorities. This brings benefits to financial stability by reducing the probability that emerging and existing risks go unnoticed by the CCP/CSD and supervisor, leading to a reduction in the likelihood of crisis, or a faster, more informed response if one does occur.

3.12 The Fundamental Rules also bring financial stability benefits through addressing any potential underlaps in the existing regulatory framework, including known gaps. For example, Fundamental Rule 10 focuses particularly on encouraging FMIs to think more broadly about the risks they may pose or transmit to the financial system. This rule aims to ensure that FMIs look beyond risks that might materialise for the FMI and to how risks to the FMI and risks from the FMIs operations might cascade into the financial system. The aim of this rule is to ensure that FMIs understand and appreciate how their interconnectedness with other financial institutions heightens contagion risk. By ensuring FMIs are making a judgement on the negative externalities that can arise through their own operations FMIs will make the financial system more resilient, ensuring FMIs can play their role as absorbers of systemic risk, rather than amplifiers.

3.13 Fundamental Rule 7 specifically focusses on the relationship between the FMI and regulators. This rule aims to ensure that FMIs deal with regulators in an open and co-operative way. The rule looks to mitigate the risk that FMIs do not share information with regulators which may have a material impact on the resilience of the FMI itself or have an impact on financial stability. Through the introduction of this rule FMIs will ensure that regulators have access to as complete information as possible when supervising a firm.

3.14 Taken together, increased adherence to the desired outcomes of the FMI regulatory framework, enhanced supervisory effectiveness of monitoring this adherence and addressing any potential underlaps in regulatory requirements will enhance financial stability through reducing the likelihood of a financial crisis stemming from or transmitting through FMI operations. The financial crisis of 2007/08, while not attributable to FMIs, was an example of the consequences of regulatory underlap and risks manifesting in regulated bodies, but which supervisors were not aware of and did not have the tools to monitor. The cost of a financial crisis, should it happen today are huge,^{footnote [17]} and so through reducing this likelihood, even if by a small degree the Bank considers that the introduction of the Fundamental Rules will bring material benefits.

3.15 Fundamental Rules will also increase confidence in the financial system. Given the clear nature of the 10 outcomes-focused rules, users of FMI services will have increased confidence in FMIs. Many users of FMI services, and particularly FCA and PRA-regulated firms, are familiar with operating within an outcomes-focused regulatory framework. The introduction of Fundamental Rules for FMIs will therefore reinforce confidence FMI service users have in the robustness of the FMI regulatory framework and FMI resilience. At a macro-economic level this may lead to an increase in the use of FMI services. Through increased use of clearing, the network effects of increased benefit of multilateral netting, through gross risk reduction and efficiency gains would have a net positive impact on financial stability. Furthermore, the enhanced confidence that wider market participants will have in FMIs contributes toward broader economic benefits through increasing the attractiveness of the UK as a financial centre.

3.16 The Fundamental Rules will also be broadly facilitative of innovation. Outcomes-focussed regulatory frameworks support CCPs’ and CSDs’ ability to consider how they might innovate to achieve these outcomes within the regulatory framework in order to provide better, more efficient and more economic FMI services which support resilience within the system. There is significant analysis and academic literature to support the notion that a stable and transparent outcomes-based regulatory regime fosters an environment where CCPs and CSDs are able to safely and effectively innovate.^{footnote [18]} This is particularly important for new or prospective entrants, ensuring they have a clear understanding of the focus of the Bank’s regulatory framework and the rationale behind more granular rules. Through increased innovation there are tangible economic benefits, new products and new entrants to a market can increase the economy or quality of existing FMI services, or increase competition within FMI services, by providing services in new and novel ways. This may lead to lower prices for FMI services or services which operate with greater efficiency and therefore promote effective improvements in the financial system. These efficiencies may eventually filter through to the real economy through services that clearing members and clients provide to broader society.

Costs

3.17 The Bank has given consideration to potential costs. These potential costs include costs to the market of any unintended consequences which may foreseeably arise as a result of the introduction of these rules. Fundamental Rule 3 (acting in a prudent manner) could have an unintended negative consequence if FMIs were so cautious in their operations that it deterred innovation. However, taken with the other Fundamental Rules, as well as the underlying framework and supporting guidance in the supervisory statement, the Bank believes the risk of this is low.

3.18 Similarly, Fundamental Rule 10 could have the unintended consequence of FMIs spending too much time identifying and assessing potential risks they could cause the financial system, leading them to reduce their broader operations, ultimately reducing the efficiency and effectiveness of FMI services, which could have a knock-on negative effect on the broader economy. However, the Bank has sought to reduce this risk through guidance outlined in the supervisory statement, and encourages FMIs to work with their usual supervisory contact in complying with this rule in a proportionate manner.

3.19 However, the Bank judges that the majority of the costs will be in the form of initial familiarisation costs and ongoing compliance costs, though we expect these to be minimal given that the Fundamental Rules are consistent with the existing regulatory framework. Initial familiarisation costs could include an assessment for FMIs of whether they are already complying with the underlying framework, and identification of any gaps in compliance that are now caught by the Fundamental Rules. It may also include any investment into new technology or processes that might be needed to comply.

3.20 Examples of how the Bank has considered inputs to implementation and compliance costs include Fundamental Rule 10, which the Bank considers could feasibly require a change to CCPs’ and CSDs’ internal processes to ensure that there is effective consideration of wider risks. In addition, FR7 might require FMIs to consider on an ongoing basis which information is provided to regulators and how this is collected and transferred from across the FMIs business. The Bank has produced a supervisory statement alongside this consultation which aims to provide FMIs with further information and greater clarity to support FMIs’ implementation. In general, it is expected that the implementation cost of ensuring compliance with the Fundamental Rules will be low for FMIs that currently comply with other relevant existing regulatory requirements.

3.21 The Bank estimates familiarisation with the rules will take roughly 30 working days, and that changing internal policies and process will take a further 60 working days, with associated staff training and communication another 30 working days. Ongoing compliance cost in staff days estimated as 10 working days per year. The Bank has used industry benchmark data on staff costs, and assumed the time spent for familiarisation and compliance will be split by seniority of staff.^{footnote [19]} Using these inputs, it has been estimated that across all CCPs and CSDs the initial costs will be £340,000 and ongoing costs will be £28,000 a year. This will therefore represent £588,000 in present value over 10 years.

Table C: Estimated direct costs to individual CCPs and CSDs ^(a)

3.22 It is expected that there will be minimal, if any short-term additional costs to the Bank itself, through enhanced supervisory or regulatory remit as FMIs are familiarising themselves with the Fundamental Rules. However, the Bank expects in the longer term the Fundamental Rules will improve the efficiency and effectiveness of supervisory engagement through improved transparency of supervisory expectations.

3.23 Overall, the Bank considers that the proposals contained within this consultation paper have a large net benefit and will support the effective and efficient regulation of FMIs.

Engagement with the CBA Panel – CCPs and CSDs

3.24 The Bank consulted the CBA Panel on the CBA for CCPs and CSDs ahead of publication. The Panel was not consulted on the CBA for RPSOs and SSPs, which was conducted on a non-statutory basis.

3.25 The Panel provided feedback on the way the draft CBA addressed: the proposal’s impact on financial stability, both through addressing potential underlaps in the regulatory framework, and increased supervisory effectiveness; the scale of potential benefits of increased financial stability; and the break down of the familiarisation and compliance costs.

• The Panel recommended the CBA bring out the benefits of the Fundamental Rules filling potential gaps in the regulatory framework, particularly the underlaps that can exist in regulatory frameworks without overarching high level rules. Paragraphs 3.12–3.14 explain this key benefit in more detail.
• The Panel recommended that while increased transparency of regulatory outcomes was a benefit, the resulting increased supervisory effectiveness of monitoring compliance and holding FMIs accountable was the key mechanism through which this resulted in changing incentives at FMIs, and so increased adherence to regulatory requirements, supporting financial stability. This has been brought out in greater detail in paragraph 3.14.
• The Panel noted that it is very difficult to precisely quantify the financial stability benefits of the introduction of the Fundamental Rules, but even so advised it would be helpful to give a sense of the benefit through reference to the cost of financial crises should they occur, especially as a result of regulatory underlap. They advised that even though it wasn’t FMI specific, the 2007/8 crisis would be a helpful reference. The Bank has addressed this in paragraph 3.14.
• The Panel recommended the Bank explain further what we meant by familiarisation and compliance costs, including:
  • How the time spent by FMIs was split by different levels of the organisation. This detail was added in 3.21 and Table C, but these costs are uncertain, and the Bank welcomes FMIs’ feedback on our estimates.
  • A consideration of whether there would be the need for enhancements to CCPs’ and CSDs’ internal process and technology. This has been addressed in 3.19.

CBA – RPSOs and SSPs

3.26 As set out at in Section 1, the Bank does not have a statutory obligation to prepare a CBA when discharging its powers in relation to RPSOs and SSPs. Nonetheless, we have set out below some specific costs and benefits of introducing Fundamental Rules for RPSOs and SSPs. It follows a similar approach to the CBA for CCPs and CSDs, with many of the costs and benefits for those entities being broadly similar to those for RPSOs and SSPs. In preparing this analysis, consideration has been given to the Bank’s primary financial stability objective and public law obligations.

Benefits

3.27 As noted in the analysis for CCPs and CSDs, the Fundamental Rules would provide increased transparency on the outcomes the Bank is expecting to achieve through its regulation. The Bank considers that increased transparency would be particularly beneficial in supporting the Bank’s objectives for RPSOs and SSPs in areas where the Fundamental Rules are less directly linked to the existing regulatory regime, for example Fundamental Rule 4 (an FMI must have sufficient financial resources).

3.28 Similarly to CCPs and CSDs, applying the Fundamental Rules to RPSOs and SSPs would provide consistency in our outcomes-based approach to supervision. The proposed Fundamental Rules would take the form of a new code of practice which would support our existing approach to regulation. This, in turn, would create certainty and predictability for RPSOs and SSPs supervised by the Bank, while also not representing a change in how we approach the regulation and supervision of these entities.

3.29 The high-level nature of the Fundamental Rules would continue to allow flexibility in how regulatory outcomes are achieved for RPSOs and SSPs. Having flexibility in how the outcomes are achieved allows RPSOs and SSPs to propose new ways in which they can meet the outcomes we are seeking. This supports FMIs to innovate how they meet our requirements, which in turn supports our broader financial stability objective. Given the high-level nature of the rules, they would also support RPSO/SSP-specific decisions and guidance provided by supervisors where needed. Furthermore, a stable and transparent regulatory regime creates conditions which are beneficial to innovation.

3.30 As discussed above in relation to CCP/CSDs, other benefits of introducing Fundamental Rules would include increasing the confidence of participants in the services provided by RPSOs and SPPs and increasing the confidence in their resiliency and ability to withstand periods of market stress.

3.31 For new payment systems, the proposals would provide a clear set of expectations that they would be expected to meet when entering the Bank’s supervisory remit. If the scope of the Bank’s regulatory remit for systemic payments is reformed, there may be payment systems entering into the Bank’s supervisory remit that may not be familiar with regulation, or that are currently out-of-scope of regulation. It would also provide a set of minimum expectations for payment systems that are considered systemic at launch. The Fundamental Rules would allow those payment systems to understand what is expected of them and frame their understanding of what it means to be regulated from the outset.

3.32 Adding a CoP on Fundamental Rules to the existing toolkit is a proportionate approach to regulating the RPSOs and SSPs in the Bank’s remit at this point in time, without creating a more detailed and prescriptive regime. The Bank considers this is proportionate both because of the small population in the Bank’s systemic payments regime at this time, and because it considers it to be the most effective way for the Bank to set out minimum requirements in anticipation of a future reformed perimeter.

3.33 Fundamental Rules may benefit the Bank by creating more efficient supervisory relationships. Similar to the CBA for CCPs and CSDs, the Bank anticipates that there may be direct benefits to itself, where supervisory costs may be reduced in line with Fundamental Rule 7 (engagement with regulators). In general, we anticipate Fundamental Rules will support better understanding of supervisory expectations which may create a more efficient supervisory relationship between RPSOs/SSPs and the Bank.

Costs

3.34 The Bank anticipates costs to RPSOs and SSPs to be minimal as the proposed Fundamental Rules should not represent a significant shift in their approach if they are already in compliance with the Bank’s expectations. The Fundamental Rules have been drafted, where practical, to align with the PFMIs (which RPSOs and SSPs are already expected to comply with) and the requirements set out in existing regulatory frameworks. Therefore, it is not expected that RPSOs/SSPs will have to change their approach if already meeting the Bank’s regulatory expectations.

3.35 However, we anticipate that there may be some costs for RPSOs/SSPs to engage with regulators and familiarise themselves with the Fundamental Rules, especially to understand the rules and whether there are any implications for the payment system’s operations. Fundamental Rule 4, while linked to the PFMIs, does not have a direct link to any of the Bank’s existing CoPs, and may require more familiarisation. Similarly, Fundamental Rule 7 does not have a direct link to the existing regulatory framework and for which we have provided some guidance in the draft supervisory statement.

3.36 The Bank judges that the majority of the costs will be borne through initial familiarisation costs and ongoing compliance costs, though we expect these to be minimal given that the Fundamental Rules are consistent with the existing regulatory framework. The Bank has outlined its estimation of costs using a standardised cost model where feasible to map the costs to FMIs using standardised industry data for staff costs and estimates of staff time needed to implement proposals through supervisory data.

3.37 As with the estimations above for CCPs and CSDs, the Bank has estimated that familiarisation with the rules for RPSOs and SSPs will take roughly 30 working days, and that changing internal policies and process will take a further 60 working days, with associated staff training and communication another 30 working days. Ongoing compliance cost in staff days estimated as 10 working days per year. Using these inputs, it has been estimated that across all RPSOs and SSPs the initial costs will be £510,000, ongoing costs will be £42,000 a year, representing £882,000 in present value over 10 years.

Table D: Estimated direct costs to individual RPSOs and SSPs

3.38 As outlined for CCPs and CSDs above, the Bank recognises that there may be some additional costs for RPSOs and SSPs beyond normal familiarisation and implementation. However, where RPSOs and SSPs are already in compliance with PFMIs and existing requirements, and meeting our supervisory expectations, we do not anticipate RPSOs/SSPs would have to change their behaviour or approach. Therefore, the introduction of Fundamental Rules should not result in significant costs to the RPSOs/SSPs or a reduction in revenue or loss or profit.

3.39 Similar to the analysis provided above for CCPs and CSDs, we anticipate that costs to the Bank would be limited save for any supervisory resource costs to engage with RPSOs/SSPs while they are implementing the Fundamental Rules. This may be in the form of providing guidance and additional supervisory engagement while RPSOs/SSPs are familiarising themselves with the rules. However, as the rules are based on existing supervisory practices, we do not anticipate there should be any ongoing additional or enhanced supervision to ensure compliance with the rules.

3.40 The Bank does not expect that the introduction of Fundamental Rules for RPSOs and SSPs would lead to costs to economic outputs to the RPSOs/SSPs and therefore there should not be any indirect costs to participants.

Appendices