OSFI Releases Updated Liquidity Principles
December 17, 2019
On December 5, 2019, the Office of the Superintendent of Financial Institutions (OSFI) released the final version of the updated Guideline B-6: Liquidity Principles (Guideline). The Guideline applies to banks and federally regulated trust and loan companies (Institutions). It outlines a set of updated liquidity risk management principles that supplement the quantitative liquidity metrics set out in OSFI’s Liquidity Adequacy Requirements (LAR Guideline). The revised Guideline takes effect on January 1, 2020, replacing the current version, which was last updated in 2012, before the implementation of the LAR Guideline.
The updated Guideline confirms that foreign bank branches are not subject to OSFI’s liquidity guidelines and are expected to follow the Basel-compliant liquidity risk management policies of their head office. However, the Guideline notes that OSFI may require a foreign bank branch to provide quantitative reports on their operations in Canada as they relate to the liquidity of the Canadian branch and the degree of ongoing reliance on the head office.
The updated Guideline sets out thirteen liquidity risk management principles, which are built on the Basel Committee on Banking Supervision’s 2008 Principles for Sound Liquidity Risk Management and Supervision, and are supplemented with additional guidance by OSFI. Specifically, the OSFI principles provide as follows:
- An Institution should establish a robust liquidity risk management framework that ensures it maintains sufficient liquidity, including a cushion of unencumbered, high-quality liquid assets, to withstand a range of stress events, including those involving the loss or impairment of both unsecured and secured funding sources.
- An Institution should clearly articulate a liquidity risk tolerance that is appropriate for its business strategy and, as the updated Guideline notes, its role in the financial system. The updates to the Guideline note that the liquidity risk tolerance should define the level of liquidity risk that the Institution is willing to assume and should ensure that it prudently manages its liquidity in normal times, such that it is able to withstand a prolonged period of stress. The risk tolerance is expected to be articulated in such a way that all levels of management clearly understand the trade-off between risks and profits. This can be expressed both qualitatively and quantitatively, and OSFI will assess the appropriateness of an Institution’s risk tolerance framework in the context of its business strategy and role in the financial system.
- Senior management should develop strategies, policies and practices to manage liquidity risk in accordance with the risk tolerance and to ensure that the Institution maintains sufficient liquidity. Senior management should continuously review information on liquidity developments and report to the board, as appropriate. The updates to the Guideline stress the importance of adequate separation of responsibilities in key elements of the liquidity risk management process. Specifically, OSFI expects that the Chief Risk Officer (CRO), or an equivalent independent second-line risk management function, will provide sufficient independent oversight of the first line activities. OSFI recognizes, however, that for small, less complex Institutions, the CRO role can be held by another executive, provided that such dual role does not compromise the independence required of the CRO. The updated Guideline also notes that OSFI expects large Institutions to establish a liquidity and funding risk management committee (or an equivalent cross-functional forum) responsible for the strategic direction of liquidity and funding risk. A separate committee or forum is not required for small, less complex Institutions, but senior management should be satisfied that it has the collective skills, time and appropriate reporting to effectively manage liquidity and funding risk.
- An Institution should actively monitor and control liquidity risk exposures and funding needs within and across legal entities, business lines and currencies, considering legal, regulatory and operational limitations to the transferability of liquidity.
- An Institution should have a sound process for identifying, measuring, monitoring and controlling liquidity risk. This process should include a robust framework for comprehensively projecting cash flows arising from assets, liabilities and off-balance sheet items over an appropriate set of time horizons. The revised Guideline has updated the list of elements that a liquidity measurement program must address.
- An Institution should conduct stress tests on a regular basis for a variety of short-term and protracted Institution-specific and market-wide stress scenarios, individually and in combination, to identify sources of potential liquidity strain and to ensure that current exposures remain within the established liquidity risk tolerance. An Institution should use stress test outcomes to adjust its liquidity risk management strategies, policies and positions and to develop effective contingency plans. The revised Guideline notes that Institutions should explore stressors based on severe but plausible events that may differ from the Institution’s own historical experience or from market observations. Reliance on models for measuring or mitigating liquidity and funding risk must be consistent with OSFI’s 2017 Guideline E-23: Enterprise-Wide Model Risk Management for Deposit-Taking Institutions. Any stress testing should also comply with the requirements of OSFI’s Guideline E-18: Stress Testing.
- An Institution should maintain a cushion of unencumbered, high-quality liquid assets to be held as insurance against a range of liquidity stress scenarios. There should be no legal, regulatory or operational impediment to using these assets to obtain funding.
- An Institution should actively manage its collateral positions, differentiating between encumbered and unencumbered assets. An Institution should monitor the legal entity and physical location where collateral is held and how it may be mobilised in a timely manner.
- An Institution should have a formal contingency funding plan that clearly sets out the strategies for addressing liquidity shortfalls in emergency situations. The plan should outline policies to manage a range of stress environments, establish clear lines of responsibility, include clear invocation and escalation procedures, and be regularly tested and updated. The revised Guideline elaborates on the components of an effective contingency funding plan, including the design and monitoring of early warning indicators.
- An Institution should consider liquidity costs, benefits and risks in the internal pricing, performance measurement and new product approval process for all significant business activities to align the risk-taking incentives of individual business lines with the liquidity risk exposures their activities create for the Institution as a whole.
- An Institution should establish a funding strategy that provides effective diversification in the sources and tenor of funding. It should maintain an ongoing presence in its chosen funding markets and strong relationships with funds providers to promote effective diversification of funding sources. An Institution should regularly gauge its capacity to raise funds quickly from each source. It should identify the main factors that affect its ability to raise funds and monitor those factors closely to ensure that estimates of fund-raising capacity remain valid.
- An Institution should actively manage its intraday liquidity positions and risks to meet payment and settlement obligations on a timely basis, under both normal and stressed conditions, and thus contribute to the smooth functioning of payment and settlement systems. The updated Guideline makes clear that all Institutions are expected to comply with this principle on intraday liquidity risk monitoring, even if they are not subject to the application LAR Guideline’s intraday liquidity monitoring tools that are set out in Chapter 6 and apply only to direct clearers.
- An Institution should publicly disclose information on a regular basis that enables market participants to make an informed judgment about the soundness of its liquidity risk management framework and liquidity position.
A blackline showing all of the changes made to the original Guideline is available here.
For further information, please contact:
Paul Belanger 416-863-4284
Katie Patterson 416-863-2659
Vladimir Shatiryan 416-863-4154
or any other member of our Financial Services Regulatory group.
Posted in: Financial Services Regulatory
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