Financial Market Infrastructures

In the paper Financial Market Infrastructures, recently made publicly available on SSRN and forthcoming as a chapter of The Oxford Handbook on Financial Regulation, edited by Eilís Ferran, Niamh Moloney, and Jennifer Payne (Oxford University Press), we study the impact of the post-crisis reforms on financial market infrastructures in the securities and derivatives markets.

The 2007-2009 financial crisis led to large-scale reforms to the regulation of securities and derivatives markets. Regulators around the world acknowledged the need for structural reforms to the financial system and to market infrastructures in particular. Due to the global dimension of the crisis and the extent to which financial markets had been revealed to be closely interconnected, national regulators moved the related policy debate to the supranational level. This approach led to the international regulatory guidelines and principles adopted by the G20 and then developed by the Financial Stability Board (FSB). The new global regulatory framework which has followed has institutionalized financial market infrastructures (FMIs) as key supports for financial stability and as cornerstones of the crisis-era regulatory reform agenda for financial markets.

This paper focuses on the impact of FMIs and of their regulation on the post-crisis transformation of securities and derivatives markets. It examines, in particular, FMIs’ role in the expansion of “public” securities and derivatives markets, and the progressive shrinkage of “private” markets (which broadly coincide with the “unregulated” or “less regulated” over-the-counter (OTC) markets.

The crisis had a profound impact on the policy/regulatory discussion on FMI regulation, leading to direct public intervention and a restructuring of securities and derivatives markets, and to a withdrawal from self-regulation, particularly in the derivatives segment. The paper provides an overview of the policy approaches underlying the international crisis-era reforms to FMIs, and adopts a “public interest” perspective, which focuses on the dichotomy between the “systemic risk” and “transaction costs” approaches to financial markets and FMIs regulation. Crisis-era reforms to FMIs have followed two main paths: the micro-level, transaction costs approach, which focuses on transactions and intermediaries; and the macro-level, systemic risk approach, which focuses on market structures and other mechanisms to address systemic risk and transparency.

By reviewing the current move from “private” markets to “public” markets internationally, and with respect to the EU and US regimes, we analyze the role of trading infrastructures as liquidity providers, both in the securities markets and in the derivatives markets. And, shifting the focus to post-trading infrastructures—central clearing houses (CCPs), central securities depositories (CSDs), and trade repositories (TRs)—we address their role in supporting financial stability and market transparency.

The guiding principles for these reforms were set at international level, while implementation of these principles has occurred at national level. The four pillars set by the FSB—standardization, mandatory trading, mandatory clearing, and mandatory reporting—were the common bases for the national regulatory initiatives, which, although sharing the same principles and aiming at the same results, adopted similar, but different solutions. For instance, both the EU and US regulation focuses the new derivative scenario on the role of CCPs: standardized derivatives must be centrally cleared; CCPs must be authorized by the competent regulatory authorities; CCPs must have sound risk management practices, they must have a solid capital structure, etc. However analyzing the single norms, there are differences and nuances in the final solutions adopted. For instance, the EU regulation does not provide for any ownership limits on CCP’s members, while, as described in the paper, both the CFTC and the SEC have set up stringent limits for CCP members’ ownership and voting powers. On the other, the approach adopted on structuring the risk management committee, despite differing in small details, share the same spirit of having a committee composed both by a third of independent directors and also representatives of customers.

The analysis in this paper starts with developments in the trading venues FMI segment and moved on to FMIs in the post-trading segment (CCPs, CSDs, and TRs), and shows that regulators are now more deeply involved in FMIs’ governance and operation. Regulators acknowledged the importance of FMS as systemic mechanisms to ensure stability and to foster efficiency in the financial market. This resulted in regulatory initiatives, either in the form of recommendations for FMIs or as strict rules, which move in the direction of increasing the systemic scope of FMIs, introducing elements of publicity in private markets, and calling for higher public supervision. The new regulatory regime and the related move towards making FMIs more public in nature reflects the current characterization of FMIs as potential sources of liquidity and as transparency providers to the markets, and as mechanisms to mitigate systemic risk. The crisis-era regulation of FMIs is supporting the current trends from private to public markets, through intermediate and hybrid forms of semi-public markets. Regulators, by operating on trading infrastructures and focusing on transactions and intermediaries, intervene at a micro-level. They promote trades concentration on formal trading venues with appropriate level of pre and post trade transparency with the aim of increasing market efficiency, reducing transaction costs, and enhancing liquidity in the market. On the other hand, at a macro-level, regulators reshaped the FMI’s scenario institutionalizing the role of CCPs, TRs, and CSDs as mechanisms to mitigate systemic risk, foster transparency vis-à-vis regulators, and promoting stability.

This market and regulatory trends have a global dimension: the review in this paper of the EU and US implementation of international guidelines with respect to FMIs, and the related global market reaction reveals that regulators are moving uniformly in setting-up the new regulatory framework for FMIs, and that the FMIs’ phenomenon is becoming really transnational with respect to regulation and to its participants.

The full paper is available for download here.