Oversight of financial market infrastructures

The Central Bank’s oversight of financial market infrastructure centres on fostering stability by promoting security, efficiency, and efficacy of core infrastructure in the Icelandic financial system. Payment and securities settlement systems are an important element of the financial system; therefore, it is important to ensure that they function effectively and reliably. The Central Bank performs a variety of roles in payment intermediation.

The term financial market infrastructure refers to systems that play an important role in intermediating funds in support of trading in the market, transfers of funds between credit institutions, and settlement of business transactions. Because of this important role, financial market infrastructure is often referred to as the plumbing system of the financial markets. As with other plumbing systems, it is important that these systems function in a predetermined way, that stringent security requirements are in place, and that the systems are monitored closely.

The Bank for International Settlements (BIS) and the International Organization of Securities Commissions (IOSCO) define the concept as follows:

The term systemically important financial market infrastructure refers in particular to payment systems that could catalyse or spread system-wide disruption. Inadequate security and efficacy in the operation of systemically important financial market infrastructure could cause a chain reaction between participants and markets. Effective and reliable risk management of such financial market infrastructure is extremely important, as shocks to infrastructure operations or related activities could have severe economic and societal repercussions. In modern economies and financial markets, it is therefore considered appropriate to subject systemically important financial market infrastructure to stringent requirements as regards professional work habits and operational set-up, and to entrust the authorities with an active supervisory role, with the particular aim of minimising potential systemic risk.

Two of Iceland’s systems are designated as systemically important: the Central Bank’s interbank payment system and the Nasdaq CSD SE securities settlement system. Securities depositories that own and operate securities registration and settlement systems are supervised entities.

The Central Bank’s oversight role vis-à-vis systemically important financial market infrastructure involves the following:

1. Monitoring infrastructure developments, efficacy, and operational security.
2. Assessing the security and efficacy of systemically important infrastructure based on international standards.
3. If warranted, recommending changes to the framework for financial market infrastructure, including the regulatory framework.

The Central Bank’s Financial Stability Committee decides which supervised entities, infrastructure, and markets shall be considered systemically important and of such a nature that their activities could affect financial stability.

Systemically important financial market infrastructure is generally recognised as such and is duly notified to the EFTA Surveillance Authority (ESA) pursuant to the Act on the Security of Transfer Orders in Payment Systems and Securities Settlement Systems, no. 90/1999. On the website of the European Securities and Market Authority is a list of all financial market infrastructure in the European Economic Area that is recognised under the Settlement Finality Directive 98/26/EC, which was incorporated into Icelandic law with Act no. 90/1999.

The aim is for systemically important payment and settlement systems to comply with both international and domestic requirements. Chief among these are the Core Principles of below, European Union law and directives on payment intermediation and securities settlement, and the Icelandic regulatory framework. The systems in question must be transparent, efficient, and secure, and their structure shall take account of the fact that they are intended to promote financial stability. In accordance with foreign models, the Central Bank of Iceland has important roles to play in promoting this:

• Policy-making role – the formulation of policy related to system development;
• Regulatory role – preparation and adoption of rules for the systems;
• Catalyst role – the promotion of market solutions and the assumption of initiative in matters related to payment and settlement systems;
• Operational role – the operation of the RTGS system and the execution of settlement in the netting and securities settlement systems;
• Oversight role – oversight of the systems in accordance with international standards.

The Central Bank has decided to use the Core Principles issued by the Committee on Payment and Market Infrastructure at the Bank for International Settlements (CPMI/BIS) and the International Organization of Securities Commissions (IOSCO) as a foundation for its operation and oversight of the interbank payment system. Furthermore, the CPMI/IOSCO Guidance on Cyber Resilience for Financial Market Infrastructures shall be observed in connection with the interbank system. In this way, the Bank aims to foster the operational security of the interbank system to the maximum extent possible, thereby bolstering financial stability.

The Core Principles are internationally accepted as criteria for best practice in the field, and the Central Bank’s Financial Stability Committee has decided that the interbank system shall be designated as systemically important financial market infrastructure. According to the Core Principles, the interbank and securities settlement systems should be classified as systemically important financial market infrastructure. The systems satisfy the general requirements for systemic importance in terms of Icelandic law, turnover, transaction volume, substitutability, and other factors.

Further information can be found here: Principles for Financial Market Infrastructures (PFMI) (bis.org)

Operators of systemically important systems assess their systems’ adherence to the Core Principles. The Bank’s Financial Market Infrastructure Oversight unit then reviews this self-assessment and evaluates the interbank systems’ compliance with the Core Principles that apply in each case. There are a total of 24 Core Principles, and not all of them apply, for instance, to an appraisal of the interbank system. The degree to which the Principles are satisfied at any given time may vary, and even if they are not satisfied in all respects, there can be rational explanations for this.

The assessment may reveal that the Principles are:

• Observed
• Broadly observed
• Partly observed
• Not observed
• Not applicable

The interbank payment system is an independent system owned by the Central Bank. It is subject to the Rules on the Central Bank of Iceland Interbank Payment System, no. 1030/2020, dated 22 October 2020. The interbank system is divided into two components, the gross settlement component (RTGS) and the retail component (EXP). Large-value payments of 10 m.kr. or more between customers of two different financial institutions are routed through the RTGS component of the system, which also handles the settlement of transactions between the Central Bank and deposit institutions, as well as transactions in the interbank foreign exchange market. All final settlement in Icelandic krónur takes place in the interbank system, including the monetary component of securities settlement.

Further information on the operation of the Central Bank’s payment systems

Two securities depositories are licensed to operate in Iceland: a branch of the Nasdaq CSD SE (NCDSI), which operates on the basis of a licence from the Latvian financial supervisory authority; and Verðbréfamiðstöð Íslands hf. (VBM), which is licensed by the Central Bank of Iceland. Both are privately operated, and Nasdaq is foreign-owned.

The role of securities depositories is to handle issuance of and registration of title to electronic financial instruments – including equity securities, bonds, funds, rights, subscription rights, and options in securities accounts – and to settle securities transactions by delivering the securities against secure payment (delivery versus payment, or DvP). Final settlement of securities transactions takes place in the Central Bank’s interbank system.

The Financial Stability Committee decided in December 2020 to designate the Nasdaq CSD SE securities settlement system as a systemically important infrastructure component. The system is also recognised pursuant to Act no 90/1999 and has been notified as systemically important to ESA and ESMA; cf. Article 3, Paragraph 2 of the Act.

Verðbréfamiðstöð Íslands (VBM) received its first operating licence from the Financial Supervisory Authority. The licence was re-issued in 2022, following the passage of Act no. 7/2020. Even though VBM has been licensed for over six years, its activities have thus far been limited in scope.