Introduction
To provide the right answers, it is vital to ask the right questions. This has become particularly relevant when considering the governance of infrastructure institutions in the financial markets. The manner in which exchanges, central counter-parties and central securities depositories are governed has now become a focus of great commercial, regulatory, legislative and even political attention.
Such widespread concern has not meant, however, that there is agreement on what needs to be done. On the contrary, the more that interest has grown in how market infrastructure institutions should be governed, the less consensus there appears to be on what governance models should be adopted. A central reason for this is that there is great uncertainty and confusion about what governance actually means, and about what problems different governance mechanisms can actually solve. The simple aim here, therefore, is to identify some key questions that need to be addressed regarding the governance of market infrastructure institutions, and also very briefly to discuss the nature and importance of these questions.
The questions
What does governance mean in the context of a market infrastructure institution?
Central to the notion of what governance means in the context of a market infrastructure institution are the issues of who has what power at the institution, how and why they obtain it, and how and why they exercise it. Such power may be determined both by the formal, legal and regulatory constructs within which the institution operates, including its constitution and relevant contractual arrangements, and also by a range of informal, non-constitutional and non-contractual factors.
As important as determining what governance means in the context of a market infrastructure institution is the need to identify which institutions are important when considering whether their governance structures are appropriate or not. This is not a trivial exercise. The blurring of activities undertaken by various institutions in the financial markets now means that many different types of organisation are undertaking activities that were previously thought the sole domain of exchanges, central counter-parties and central securities depositories. Furthermore, while some such institutions provide services that are believed to be fundamental to the operations of various financial markets, other institutions providing the same services are believed to be marginal to the ongoing functioning of the markets.
How are market infrastructure institutions actually governed in practice?
There is great uncertainty about how market infrastructure institutions are governed in practice, even amongst the major participants trading directly in the markets. The factors leading to such uncertainty include the diversity of voting and governance models employed by different market infrastructure institutions, the complexity of some of their corporate and holding structures, the multiplicity of their stated objectives, a lack of clarity about the role of some of their boards and of any relevant market advisory committees that have been established, and a lack of transparency about some of their governance structures and practices whether they are for-profit or not.
What lessons can be learned from an analysis of corporate governance for the governance of market infrastructure institutions?
The widespread and intense focus on corporate governance around the world is bringing to the fore questions concerning the governance of market infrastructure institutions. In particular, there is debate about what lessons, if any, can be drawn from the analysis of corporate governance for the governance of market infrastructure institutions. Important issues being raised include appropriate levels of disclosure, the role of boards and non-executive directors, and the role of shareholders and other forms of stakeholders in influencing governance. A further issue that needs to be addressed is whether there are any substantive differences between market infrastructure institutions and other types of corporation which mean that particular types of governance models might be appropriate specifically for market infrastructure institutions.
Is there a best form of governance for market infrastructure institutions?
There is great debate about what is the most effective way of governing market infrastructure institutions. Changes in the recent structure of many such organisations, and particularly the trend to demutualise and adopt the for-profit motive, have challenged the traditional non-profit and mutual approaches. The relative costs and benefits of different governance models have become extremely contentious. Three central questions need to be addressed: Are there sufficient similarities across market infrastructure institutions that any general conclusions can usefully be drawn about how they should be governed? Is there a best governance model for market infrastructure institutions, or is a diversity of governance structures more appropriate? If there is a best governance model for market infrastructure institutions, what is it?
Is any regulatory intervention in the governance of market infrastructure institutions desirable, and if so, what regulatory actions are appropriate?
Despite widespread agreement that something needs to be done to enhance the governance of market infrastructure institutions, there is controversy both about whether regulatory intervention in the governance of market infrastructure institutions is justified, and if so, what regulatory actions would be appropriate.
Why are these important?
These concerns are not simply theoretical in nature. A range of legislative and regulatory developments concerning market infrastructure institutions and their governance structures are currently being considered. In the EU the European Commission is evaluating whether to propose a Directive on Clearing and Settlement in which the governance of clearing and settlement infrastructure institutions may be addressed, and in the USA both the Commodity Futures Trading Commission and the Securities and Exchange Commission are examining the governance of exchanges in the markets under their respective jurisdictions.
There are many reasons why legislative and regulatory intervention in the governance of market infrastructure institutions has been proposed. Each one of them implies the need for different types of regulatory action. Three of the primary reasons are noted here.
First, consolidation amongst market infrastructures, and their perceived growing market power, has lead to debate about whether there should be greater legislative or regulatory intervention in their governance structures to mitigate some of the potentially adverse effects of any perceived market power they may have. The trend towards demutualisation and the adoption of the for-profit motive is thought to heighten the problems associated with market power. At the same time, however, there has been debate about whether any problems that might arise as a result of market power are best dealt with by standard competition policy, rather than relying on any particular governance mechanisms.
Second, 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. Conflicts of interest typically occur when market infrastructure institutions are simultaneously commercial organisations and have regulatory duties. They may arise as a result of self-regulation – namely when the people taking regulatory decisions, or the firms they represent, are affected directly or indirectly by such decisions. They may also arise when a market infrastructure institution regulates its users, customers, suppliers or competitors.
Third, 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. Whether such short-term concerns should provide the basis for fundamental reform of the governance models of market infrastructure institutions is an open issue.
Conclusion
Of course, answers are what we need. But to attempt to provide them, without first ensuring that the correct problems are being addressed, is merely to cement our ignorance about the world into our actions. A few important questions about the governance of market infrastructure institutions are noted here.
Ruben Lee is the Founder and Managing Director of the Oxford Finance Group, a private research and consulting firm. From 1989-1992, he was a Fellow of Nuffield College, Oxford University, where he specialised in financial economics and law, and from 1980-1984 he worked in the capital markets in New York and London for Salomon Brothers International. Dr Lee is on the Advisory Panel of Financial Services Experts, established by the Economics and Monetary Affairs Committee, European Parliament, and the Conseil Scientifique of the Autorité des Marchés Financiers in France.
