FMIs – Knights in Shining Armour?

FMIs – Knights in Shining Armour?

Christian Goerlach (Deutsche Bank AG, Germany), Anne-Katrin Brehm (Deutsche Bank AG, Germany) and Bradley Lonnen (Deutsche Bank AG, Germany)
Copyright: © 2016 |Pages: 19
DOI: 10.4018/978-1-4666-8745-5.ch004
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Abstract

Great hope is being pinned on FMIs. They lie at the heart of the financial system and enable the post-trading business by successfully completing trades and concentrating as well as mitigating risks. This end of the payment and securities settlement business does not usually attract much attention: It is expected to be there and function. In this respect, it is comparable to oxygen in the air – most people do not think about it, however, if something is wrong with it, things can turn bad extremely quickly. Such was the case with the Lehman crisis of 2008, playing a major role in the unfolding of the global crisis of the late 2000s. It became apparent just how vital these FMIs were in enabling the continuation of the globe's securities & derivatives exchanges. In particular, CCPs played a major role in keeping transaction processing ticking over. It became evident which knock on effects the downturn of one institution can have on the global financial landscape. As such, we all depend on those markets and on the performance of what can only be described as ‘knights in shining armour'.
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Introduction To Financial Market Infrastructures

Types of Financial Market Infrastructures

FMIs are essentially the core of the financial payment and settlement ecosystem, either enabling the movement of cash and securities needed to settle transactions and/or intermediating exposures between market participants, thereby ensuring financial obligations are met. The fact that they help reduce and allocate inherent risks arising from transactions between market participants means they are an essential component in the functioning of the financial markets and wider economy (Rehlon, 2013).

In the past, clearing and settlement services were carried out through physical exchanges. Today it is a high-tech IT driven business. FMIs have had to adapt to those developments. To understand their increasing initial function within the financial market landscape globally, we need to have a look at each of them individually. The CPSS and IOSCO differentiate five types of FMIs: Payment Systems (PS), Securities Settlement Systems (SSS), Central Security Depositories (CSD), Central Counterparties (CCP) and Trade Repositories (TR).

Payment Systems

Concept. The PSs are of paramount importance for the smooth functioning of financial markets. A well-developed PS improves the interaction of markets and contributes to eliminating ’frictions in trade’ (ECB, 2010). PSs are not accessible to everybody. Membership is governed by access criteria including minimum requirements to secure their robustness. Therefore, two basic access options exist: direct participation referring to full membership, or indirect participation making use of intermediaries (ECB, 2010).

Developments. Since the introduction of the PS there have been a multitude of developments. While in the early years these developments were more in the area of formats accepted and how the PSs could be accessed (including front ends), in recent years most large PSs have developed mechanisms and procedures that allow a more efficient payment processing. Such mechanisms include liquidity saving mechanisms, such as multilateral netting cycles.

Securities Settlement Systems

Concept. SSSs are just as important as PSs for the smooth functioning of financial markets. According to the Principles for Financial Market Infrastructures (PFMIs) published by the CPSS & IOSCO, “a securities settlement system enables securities to be transferred and settled by book entry according to a set of predetermined multilateral rules” (CPSS, 2012, p. 8). The CPSS and IOSCO are more precise in the classification and definition of SSSs. They exclude CSDs and CCPs from their SSS definition and narrow it to the primary function of providing security, clearing and settlement functions, such as the confirmation of trade and settlement instructions. CCPs and CSDs are treated as individual types of FMIs and explained in more detail below (CPSS, 2012).

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