There is great controversy about how to define an infrastructure; about how to characterise an exchange, a central-counterparty (CCP), and a central securities depository (CSD); and also about the implications of identifying such institutions as infrastructure. Nevertheless, it is widely accepted that exchanges, CCPs, and CSDs, do form the infrastructure underlying the operation of financial markets throughout the world, not least because of their importance to the functioning of the markets. As a result, how these institutions are governed matters, as it affects their behaviour and performance. Brief comments on the definitions of an infrastructure, an exchange, a CCP, and a CSD, and on why the governance of market infrastructure institutions is now thought crucial, are provided here.
An examination of a broad range of definitions and uses of the term ?infrastructure? highlights eight key factors and attributes that are commonly believed to contribute towards identifying an institution as an infrastructure. In particular, an infrastructure often:
- is, or provides, the basic framework that supports or underlies a system, defined quite broadly;
- is essential to support commerce, economic activity and development, or whatever other activities are facilitated by the system it operates;
- is, or operates, a network, which in the economic sphere facilitates the delivery of goods and services;
- exhibits economies of scale;
- requires large, long-term, and sunk investments;
- is, or operates, a natural monopoly;
- provides beneficial public goods or services, in addition to the specific goods and services it delivers directly; and
- has some form of government or public sector involvement.
The central element in almost all definitions of an exchange is that such an institution operates a trading system, and through this provides a market. Two core functions delivered by a trading system are data dissemination and order execution. Data dissemination is the publication of pre- and post-trade data, about quotes and trades respectively, to market participants. Order execution is the process whereby orders can be transformed into trades. The widely accepted definition of a CCP is that it is an entity that interposes itself between counterparties to contracts in one or more financial markets, becoming the seller to every buyer and the buyer to every seller. Although there is significant variation in the definition of a CSD, two aspects are commonly believed critical. First, a CSD is an entity that holds securities either in certificated or dematerialised form. Second, it is an entity that enables the transfer of ownership of securities, typically by means of book entry transfer usually on an electronic accounting system.
Notwithstanding the perceived simplicity of these definitions, however, a wide range of factors have led to disagreement and uncertainty about the definitions of an ?exchange?, a ?CCP?, and a ?CSD?, and also to some confusion about which organisations should be classified as which of these types of institutions. Three relevant factors are notable.
First, historically, the identification of whether an institution was an exchange, a CCP, or a CSD was based on an assumption that an institution could be identified by what it does. The functions that an organisation undertakes were therefore thought critical in assessing what it was. There has, however, been growing confusion about the terms used to refer to different functions. If there is disagreement about how to define key functions in the financial markets, and the definitions of an exchange, a CCP, or a CSD, are dependent on such definitions, there will be disagreement about what constitutes each of these types of institutions. Second, another problem with using functional definitions is that there is less and less commonality in the functions undertaken by institutions previously thought of as exchanges, CCPs, and CSDs. If different institutions do different things, then it becomes less feasible to classify them according to what they do. Third, technological changes and market developments have meant that institutions which were historically not thought to be exchanges, CCPs or CSDs, have begun to undertake functions previously thought the sole domain of these types of institutions.
Central to the notion of governance at market infrastructure institutions are the issues of who has what power at such an institution, how and why they obtain it, and how and why they exercise it. Governance is not important per se, but for what it can deliver. Two critical questions arise in the context of market infrastructure institutions: What interests do the governance arrangements at such institutions seek to deliver? and What interests should the governance arrangements at such institutions seek to deliver?
The interests of many key constituencies may be identified as particularly relevant: users; owners; management; the institution itself; the public; a financial centre; the national interest; the regional interest; and the global interest. While some of these interests are relatively easy to specify, others are much more controversial.
Consider, for example, the interests of users. A market requires the interaction of many different types of user, so by definition it is difficult to identify a single common user interest. One difficult conflict that may arise is between the direct users of an exchange, which are typically financial intermediaries of one form or another, and the so-called ?end-users? which are typically the customers of these financial intermediaries, often the investors or issuers in a market. Direct users of an exchange may actually benefit from inefficiencies in the operation of an exchange, while the costs of such inefficiencies are typically borne by end-users.
There are seven key reasons why the governance of market infrastructure institutions has progressively become a matter of great commercial, regulatory, legislative and political concern:
- There is controversy about what is the most effective way of governing market infrastructure institutions.
- There is uncertainty about how market infrastructure institutions are in fact governed in practice, even amongst participants trading directly in the markets.
- There is mounting concern about the presence of conflicts of interests at market infrastructure institutions, and about whether governance mechanisms should be put in place to minimise the occurrence of such conflicts, or to facilitate the management of them when they do arise.
- A range of legislative and regulatory developments concerning market infrastructure institutions and their governance structures are currently being considered.
- Various scandals connected with the governance of specific market infrastructure institutions have brought the issue of how these organisations are governed to the attention of the wider public, and this in turn has engendered political interest in the topic.
- The widespread and intense focus on corporate governance around the world is bringing to the fore questions concerning the governance of market infrastructure institutions.
- Consolidation amongst market infrastructures, and their perceived growing market power, has lead to controversy about whether there should be greater legislative or regulatory intervention in their governance structures.
So, it is hard to define an infrastructure. It is difficult to characterise an exchange, a CCP, and a CSD. Governance is a complex notion, with the interests of many key constituencies being relevant. Many of these interests are controversial in nature. And on top of all of this, a multitude of factors have progressively meant that the governance of market infrastructure institutions has become a matter of great commercial, regulatory, legislative and political concern. Time for a major research project?
