We often hear that financial market infrastructures, or FMIs, are crucial parts of the financial system, not just nationally but with global implications as well. But what are these FMIs exactly and why are they so critical to the world’s economy? To answer that, it’s first important to take a step back and take a brief look at financial markets and their significance. Then we can reflect on financial market infrastructure as such.
There is one thing financial markets cannot do without – financial market infrastructure. Even so, a lot of people take this infrastructure for granted.
Financial market infrastructure
Financial market infrastructure is the critical network that enables financial transactions. It’s frequently referred to as the ‘plumbing of the financial system’. FMIs are in use every hour of every single day, with some being simpler and more common among the general public than others. The use of an ATM or online payments are good examples.
FMIs are basically where all transactions are handled – cleared, recorded etc. Essentially, they enable all financial dealings between people, institutions, businesses and other types of participants.
What categories of FMIs are there?
To shed a little more light on FMIs, let’s look at the different kinds you can find.
1. Payment system
This type of FMI is used for the transfer of funds between or among participants – consumers, businesses, institutions, etc. By ‘payment system’, we are referring to all the people, standards, procedures, tools and technology that make this transfer possible.
2. Central securities depositories – CSDs
The function of CSDs is the keeping and transfer of fungible securities. Typically, the CSD only has contact with banks and not with the end investors. CSDs register and track all issued securities and the identities of their owners and issuers, making sure the integrity of these issues remains untouched.
3. Securities settlement systems/facilities – SSS/SSF
As the name suggests, SSSs/SSFs are responsible for the settlement of securities. This is done through book entry and based on a number of pre-set rules. Transfer of securities can be done free of payment, against payment or against another asset.
4. Central counterparties – CCP
Central counterparties, or CCPs, are placed between participants (counterparties) of a transaction done in one or more financial markets, whether it’s trade of securities, goods, derivatives or another financial instrument.
In that way, a CCP creates separate transactions with each counterparty and assumes the settlement risk on both ends. Normally participants are required to cover the value of potential risks by providing collateral/margins. Other measures can also be in place to limit potential risks.
5. Trade repositories – TR
Trade repositories or TRs are responsible for collecting, storing and maintaining data related to financial transactions. This data is kept in a centralised electronic database and is of incredible importance to the financial market, especially in the case over-the-counter derivatives.
Financial market infrastructure – importance
FMIs essentially act as a backbone to the global financial system. Without them, this system would lack the efficiency, stability and seamlessness that we expect and perhaps take for granted every day.
Want to understand FMIs better, and how they impact markets?
Be sure to start off right. Reach out to Aitken Advisors to learn more.