Scope: Principles 4–10 form the operational risk-control core of PFMI. They determine whether an FMI — especially CCPs, CSDs, SSSs, and large-value payment systems — can withstand participant failures and market stress without causing contagion.
What this guide adds: concise PFMI excerpts, oversight-focused checklists, concrete regulator practices (EU, UK, SG, AU, CA), typical supervisory findings, stress scenarios regulators use, and the questions supervisors ask during onsite reviews.
4) Principle 4 — Credit Risk
Essence: Ensure participant default does not transmit losses to others.
Regulatory practice (examples)
EU (ECB/ESMA): They require mandatory credit stress testing, daily backtesting of margin models, and regulatory remediation when coverage falls below required levels.
UK (Bank of England): They expect CCPs to meet a Cover 2 standard, to recalibrate models after backtesting breaches, and to provide evidence of model governance.
Singapore (MAS): They require independent validation of credit models and focused reviews of concentration risk among large participants.
Checklist — Credit Risk
- Is the FMI meeting the applicable cover standard (Cover 1/2 as required)?
- Are models independently validated and backtested daily/regularly?
- Is participant creditworthiness monitored and updated?
- Are concentration and intraday exposures measured and mitigated?
- Are margin breach processes escalated and evidenced?
- Backtesting breaches left unaddressed.
- Over-reliance on external ratings without internal assessment.
- Weak handling of concentrated exposures.
5) Principle 5 — Collateral
Essence: Collateral must remain liquid and of high quality during stress.
Regulatory practice (examples)
EU (ESMA — CCP RTS): They enforce conservative collateral eligibility (HQLA), require dynamic haircuts and stress-tested haircut frameworks, and prohibit material wrong-way risk exposure.
Australia (RBA): They require intraday haircut frameworks for volatile asset classes and mandate stress-testing of collateral values under extreme market events.
Checklist — Collateral
- Is collateral eligibility conservative and regularly reviewed?
- Are haircuts calibrated to current volatility and updated frequently?
- Is wrong-way risk identified and prevented?
- Are concentration limits on collateral enforced?
- Can collateral be liquidated in stressed markets?
- Broad eligibility lists including illiquid assets.
- Static haircuts that ignore market volatility.
- No contingency plan if collateral markets seize up.
6) Principle 6 — Margin (for CCPs)
Essence: Margin must cover potential future exposures from the time of default through close-out.
Regulatory practice (examples)
UK (Bank of England): They supervise anti-procyclicality tools, require CCPs to demonstrate margin stability under stress, and assess how margin models behave during volatility spikes.
EU (ESMA): They mandate daily sensitivity analysis of margin models and stress-testing using historical extreme events for calibration and governance.
Singapore (MAS): They focus on transparency, independent validation, and regular backtesting of margin methodologies.
Checklist — Margin
- Are initial margin models independently validated and backtested?
- Is variation margin collected promptly with clear timelines?
- Are anti-procyclicality measures in place and tested?
- Are intraday margin processes effective (where required)?
- Margin cliffs during volatility spikes.
- Delayed margin calls or operational gaps in collection.
- No tested anti-procyclicality buffers.
7) Principle 7 — Liquidity Risk
Essence: Liquidity is the immediate lifeblood — even a well-capitalized FMI can fail without liquid resources.
Regulatory practice (examples)
Australia (RBA): They require scenario-based liquidity stress testing including the default of major participants and market-wide freezes, and they expect pre-arranged committed liquidity facilities.
EU (ECB): They enforce robust liquidity coverage, require identification of currency exposures, and closely monitor intraday positions.
Singapore (MAS): They require pre-funded resources, verified credit lines with rapid drawdown capability, and stress-testing of intraday liquidity shortages.
Checklist — Liquidity
- Are liquid resources pre-funded and available in stress?
- Are committed liquidity lines fully documented and tested?
- Are currency exposures fully identified and hedged where possible?
- Is intraday monitoring operational and supervised?
- Does the FMI have operational access to central bank facilities where needed?
- Reliance on uncommitted or conditional credit lines.
- No contingency funding plan for intraday shortages.
- Failure to stress-test multi-currency liquidity scenarios.
8) Principle 8 — Settlement Finality
Essence: Finality must be legally protected and clearly communicated.
Regulatory practice (examples)
EU (Settlement Finality Directive / CSDR): They provide hard legal protection of finality, require CSDs to define exact timestamps for irrevocability, and enforce clear finality documentation.
Singapore (MAS): They require finality clauses to be legally validated, disclosed, and tested in contingency scenarios.
Checklist — Finality
- Is the moment of finality explicitly defined and documented?
- Is it protected under applicable law (statute or equivalent)?
- Do participant agreements reflect the finality rules?
- Are finality rules tested under contingency scenarios?
- Ambiguous timing or multiple interpretations of finality.
- Finality claimed in rules but not demonstrably enforceable in some jurisdictions.
9) Principle 9 — Money Settlement
Essence: Central bank money eliminates settlement bank credit risk; if commercial banks are used, they must be tightly supervised.
Regulatory practice (examples)
EU/UK/Singapore: They prioritise central bank settlement where feasible; where commercial banks are used, they impose stringent operational and credit standards and require contingency settlement paths.
Checklist — Money Settlement
- Is settlement conducted in central bank money where practical?
- If commercial banks are used, are they monitored for creditworthiness and operational reliability?
- Is intraday settlement risk measured and mitigated?
- Are backup settlement paths available?
- Over-reliance on a single settlement bank without contingency.
- Insufficient checks on the settlement bank’s health.
10) Principle 10 — Physical Delivery
Essence: For CSDs/SSSs and DvP systems, delivery mechanics must be clear, enforceable and supported by fallback arrangements.
Checklist — Physical Delivery
- Are delivery timelines clearly defined and communicated?
- Are procedures and legal remedies for failed delivery documented?
- Are alternative settlement mechanisms specified?
- Are allocation rules and priority transparent?
- Unclear failed-delivery escalation and allocation rules.
- No pre-defined fallback delivery process causing settlement delays.
practical scenarios & supervisor questions
Regulator-style stress scenarios (examples)
- Simultaneous default of two largest participants during a bond market shock.
- Liquidity freeze in government bond repo market causing collateral price collapse.
- Intraday settlement bank outage during peak volume.
- Major cyber incident disabling a critical service provider for 24+ hours.
- Sharp sovereign downgrade reducing HQLA availability.
What supervisors ask on-site (practical checklist)
- Show the last 12 backtesting reports and evidence of remediation actions.
- Provide stress test assumptions and show Board-level discussion minutes.
- Show legal opinions covering all jurisdictions for settlement finality and netting.
- Demonstrate intraday liquidity monitoring dashboards and limit breaches in the last 24 months.
- List top 10 concentration exposures and how they are mitigated.
- Provide evidence that anti-procyclicality tools are operable and tested.
Key takeaways
- Principles 4–10 are the operational risk engine: credit, collateral, margin, liquidity and finality determine FMI resilience.
- Regulators have moved from guidance to enforcement — expect legally-backed remediation, model recalibration, rule rewrites and public assessments.
- Practical preparedness (regular legal opinions, independent model validation, pre-funded liquidity, conservative collateral lists, and tested fallbacks) is what separates compliant FMIs from fragile ones.