Systemic Risk Policy – Internal and External Sources of Risks

CLS Bank’s management of systemic risk is governed by the CLS Risk Appetite Statement (discussed under Principle 2) and the Systemic Risk Policy. These provide tools for managing the systemic impact that the Settlement Service may have on the broader financial system, and include a robust CLS risk design, failure management processes, and on-going bilateral and multilateral communications. CLS Bank has defined systemic risk as the risk of disruptions and breakdowns in financial markets resulting in contagion and financial losses, the risk of an internal breakdown of CLS group infrastructures or processes, and/or the risk that the failure of an entity within the CLS ecosystem to meet its required obligations may spread to other participants or markets through a chain reaction threatening the stability of, or leading to a loss of confidence in, broader financial markets. Systemic risk may be:

introduced by the internal breakdown of the CLS system, processes and/or by human failure; or imposed on the CLS system by external events like Member failure, breakdowns in other key FMIs and critical service providers, central bank policy shifts, RTGS systems issues, and extreme liquidity stress from geopolitical events, financial market upheaval, or widespread bank failures.

CLS Bank seeks to mitigate risks and interdependencies that arise from both internal and external sources through a robust CLS risk design, reliable daily operations, failure management tools, and

ongoing communications with CLS ecosystem constituents. CLS Bank has identified the following potential sources of material risks and defined relevant mitigants in the Systemic Risk Policy:

� Legal Risk - mitigated by the legal framework detailed under Principle 1;

� Settlement Risk - mitigated by the robustness of the CLS risk design (detailed under Principle 7), the operational resilience of the CLS system (detailed under Principle 17), and CLS Bank’s crisis and failure management capabilities, specifically in the event of a participant default (detailed under Principle 19);

� Governance Risk - mitigated by the governance structure detailed under Principle 2;

� Liquidity and Market Risk - mitigated by the liquidity risk management framework detailed under Principle 7;

� Model Risk - mitigated by the model risk management framework detailed under Principle 7;

� Operational Risk - mitigated by the operational risk management framework detailed under Principle 17;

� Credit Risk - mitigated by the credit risk management framework detailed under Principle 4;

� Third Party Risk - mitigated by the tiered participation requirements detailed under Principle 13;

� Nostro Risk - mitigated by the CLS Bank Best Practices for Nostro Agents and Nostro Clients (“Nostro Best Practices”) discussed below, and the liquidity risk management framework detailed under Principle 7;

� Strategic Risk - mitigated by the EMC’s strategic management mandate discussed under Principle 2, and the management of general business risk discussed under Principle 15;

� Capital Considerations - mitigated by the management of custody and investment risks discussed under Principle 16; and

� Interdependencies - as discussed below, CLS Bank recognises the many sources of interdependencies in the CLS ecosystem, including those arising from direct and indirect participants in the Settlement Service and the multiple roles they may play therein, technical and infrastructure considerations, and legal, regulatory and operational elements.

Material risks with respect to systemic risks may be identified via the ORM reporting processes detailed under Principle 17 as well as the enterprise-wide monitoring under the ERM Framework discussed below. The detailed requirements for tracking, monitoring and reporting material risks are discussed below in Section 3.5.1.

3.4.1 Sources of Interdependencies in the CLS Ecosystem

To further manage material risks, as well as the systemic impact that the Settlement Service may have on the broader financial system, CLS Bank identifies the various factors that lead to interdependencies in the CLS ecosystem.

These sources include the following elements:

� Legal and regulatory elements o The global regulatory environment o Individual central bank policies

o CLS Bank’s central bank accounts, maintained with the relevant central bank for each Eligible Currency for CLS Bank to receive Pay-Ins and make Pay-Outs

� Internal and external operational and technical infrastructure

o Connectivity with RTGS systems to process Settlement Service-related payments

o CLS Bank’s internal technical infrastructure as well as ancillary services (i.e., the In/Out Swaps Program and Aggregation Service)

� Direct and indirect participants in the Settlement Service

o Settlement Members, which may also be nostro agents, third party service providers, and/or Liquidity Providers

o Nostro agents contracted⁴³ to fund Settlement Member Pay-In requirements

o Interactions between Settlement Members and their third party customers, subject to the restrictions and notification requirements discussed under Principle 19

o Liquidity Providers contracted to provide liquidity facilities in a specific Eligible Currency which are not Settlement Members

� Reliance on Critical Service Providers

o The SWIFT network to transmit payment instruction information between the CLS system and the CLS ecosystem participants

o IBM to deliver the technology infrastructure that operates the CLS system

o Regional utilities contracted for telecommunications or other infrastructural services o Other critical vendors, including market-wide data providers (i.e., Bloomberg and

Reuters)

� Other FMIs and FMUs - CLS Bank monitors its direct and indirect connectivity to other FMIs and FMUs with the objective of mitigating risk concentrations and contagion from adverse events impacting them (i.e., DTCC and certain CCPs).

CLS Bank identifies the various sources of interdependencies in the CLS ecosystem, analyzes relevant risk implications, assesses associated risk management challenges, and monitors and reports the relevant material risks under the ERM Framework, discussed below.

43As discussed in the Introduction, nostro agents maintain arrangements with Settlement Members and do not have any contractual relationship with CLS Bank.