What are Financial Market Infrastructures:
- Financial Market Infrastructure are Multilateral systems among participating institutions, including the operator of the system, used for the purposes of clearing, settling, or recording payments, securities, derivatives, or other financial transactions.
In today’s blog, I will share meanings into the different types of financial market infrastructures.
- PAYMENT SYSTEMS
A payment system is a set of instruments, procedures and rules for the transfer of funds between or among participants; the system includes the participants and the entity operating the arrangement. Payment systems are typically based on an agreement between or among participants and the operator, and the transfer of funds is effected using an agreed-upon operational infrastructure.
A payment system is generally categorised as either a retail payment system or a LVPS. A retail payment system is a funds transfer system that typically handles a large volume of relatively low-value payments in such forms as cheques, credit transfers, direct debits, and debit card transactions.
Many retail payment systems are operated either by the private sector or the public sector, using a multilateral DNS or a RTGS mechanism. An LVPS is a funds transfer system that typically handles large-value and high-priority payments. Many LVPSs are operated by central banks, using an RTGS or equivalent mechanism.
2. CENTRAL SECURITIES DEPOSITORIES
A securities depository holds securities accounts and, in many countries, operates a securities settlement system. A CSD also provides central safekeeping and asset services, which may include the administration of corporate actions and redemptions, and plays an important role in helping to ensure the integrity of securities issues (that is, securities are not accidentally or fraudulently created or destroyed or their details changed)
A CSD can hold securities either in physical form (but immobilised) or in dematerialised form (that is, they exist only as electronic records). The precise activities of a CSD vary based on jurisdiction and market practices. For example, the activities of a CSD may vary depending on whether it operates in a jurisdiction with a direct or indirect holding arrangement or a combination of both. A CSD may maintain the definitive record of legal ownership for a security; in some cases, however, a separate securities registrar will serve this notary function.
3. SECURITIES SETTLEMENT SYSTEMS – A securities settlement system enables securities to be transferred and settled by book entry according to a set of predetermined multilateral rules. Such systems allow transfers of securities either free of payment or against payment. When transfer is against payment, many systems provide delivery versus payment (DvP), where delivery of the security occurs if and only if payment occurs. An SSS may be organised to provide additional securities clearing functions, such as the confirmation of trade and settlement functions.
4. CENTRAL COUNTERPARTIES – A central counterparty is an entity that interposes itself between counterparties in derivatives contracts traded in one or more financial markets, becoming the buyer to every seller and the seller to every buyer and thereby ensuring the performance of open contracts. A CCP becomes counterparty to trades with market participants through novation, an open-offer system, or through an analogous legally binding arrangement. CCPs have the potential to reduce risks significantly to participants through the multilateral netting of trades and by imposing more effective risk controls on all participants. For example, CCPS typically require the posting of margin (collateral) by participants to cover current and future exposures, as well as the sharing of residual risk by direct participants.
As a result of their potential to reduce risks to participants, CCPs also can reduce systemic risk in the markets they serve. The effectiveness of a CCP’s risk controls and the adequacy of its financial resources are critical to achieving this risk-reduction benefits.
*Note – CCPs are generally referred to as clearing houses. However, there are clearing houses that do not take up counterparty risk. They provide adequate risk management tools to reduce default risk. However if one party defaults, the counterparty will have to bear the losses.
5. TRADE REPOSITORIES – A trade repository is an entity that maintains a centralised electronic record (database) of transaction data. TRs have emerged as a new type of FMI and have recently grown in importance, particularly in the OTC derivatives market. By centralising the collection, storage, and dissemination of data, a well-designed TR that operates with effective risk controls can serve an important role in enhancing the transparency of information to relevant authorities and the public, promoting financial stability, and supporting the detection and prevention of market abuse. An important function is to provide information that supports risk reduction, operational efficiency, and cost savings for both individual entities and the market as a whole.
Such entities may include the principals to a trade, their agents, CCPs, and other service providers offering complementary services, including central settlement of payment obligations, electronic novation and affirmation, portfolio compression and reconciliation, and collateral management.
I will share my knowledge of the Nigerian Financial Market Ecosystem in my next blog.
My Gratitude.