FMIs: how market infrastructures are transforming the future

Posted: 5 February 2017 | Juliette Kennel, Head of Market Infrastructures, SWIFT | No comments yet

Digitally empowered financial market infrastructures (FMIs) can enable established businesses and new entrants to compete to sell financial transfer and intermediation services says Juliette Kennel, Head of Market Infrastructures at SWIFT…

Juliette Kennel, Head of Market Infrastructures at SWIFT

Juliette Kennel, Head of Market Infrastructures, SWIFT

The term infrastructure was once synonymous with the very foundations of an economy. The character of infrastructures means that they have always had a profound effect on the behaviour of the participants that make up the industries that use them and they are expected to be unfailing and unimpeachable.

Yet one of the many effects of the increasing power and falling price of digital technology is to transform the potential of FMIs. As recently as a decade ago, our thinking about FMIs was conditioned by the costs of technology. Given these high costs, the building of an FMI had to be funded collectively, and the only way to mitigate the concern of users that infrastructural monopolies would exploit their position was for FMIs to be owned by a public authority or by their users.

The digital opportunity for FMIs

The cheap, powerful and widely available digital technology of today has fundamentally altered the terms of that equation. By reducing the marginal cost of processing a transaction effectively to zero, digital technology creates an opportunity for FMIs to break with their past. Instead of being regulated as monopolies, they can become competitors themselves. Just as the internet has enabled more companies to compete to sell goods all over the world, so can digitally empowered FMIs enable established businesses and new entrants to compete to sell financial transfer and intermediation services.

Digitisation is giving FMIs the power not simply to transform the landscape but to terraform entirely new planets which can support unprecedented forms of financial and commercial life. In this transformed financial universe, FMIs will become the shared means to many ends. In the payments and securities industries, multiple transactions which entail the delivery of an asset against cash payment in digital form are already being supported by FMIs. In future, the range of transactions they support will broaden enormously.

The systemic constraint on FMIs

The evolution of this new, digital eco-system will be driven by interactions between FMIs and their users. FMI’s are already experimenting with distributed ledger technology (DLT) to test whether it can make interactions cheaper and more efficient in, for example, the fields of payments and corporate actions processing, settlement and proxy voting. However, FMIs will only be able to embrace the digital future if it does not jeopardise their business-as-usual activity. The speed of adoption of new technology by FMIs is therefore bound to be tempered by the systemic importance of the services they supply.

How will digitalisation of FMIs affect real-time payments and settlement?

How will digitalisation affect market infrastructure?

This dilemma is at an acute stage in real-time retail payments (RTP), where instantaneous payments systems are now being developed, which banks will be able to ‘overlay’ with innovative payment services. The banks, clearing and settlement mechanisms (CSMs) and regulators that are driving progress towards RTP are debating whether it is safer to adapt existing infrastructures, or to build new systems, and whether it is more prudent to aim for a single platform or to maintain multiple payment systems.

As part of the ongoing payments modernisation efforts, Canada’s long term aspiration is to obtain a single platform for all forms of payments. They are convinced that a single, open utility can promote competition in the payments industry more effectively than multiple platforms, each with their own rules and guidelines, governance and access models, and each charging a separate membership fee. In the United Kingdom, an expert body created by the Payment Systems Regulator (PSR) has called for consolidation of three existing CSMs: Bacs; the Cheque and Credit Clearing Company; and Faster Payments, as the foundation of a new payments platform that will create a safer environment for market infrastructures to provide established and innovative services to their customers.

Standards underpin inter-operability

In digital interactions, the inability to exchange information in a common language is a significant source of avoidable operational cost, so the widening use of the ISO 20022 standard will ensure that the cost of market interactions will continue to fall. Soon, close to 200 FMIs – including the Federal Reserve, CIPS, EBA, T2S and TARGET2 – will communicate with their users via ISO 20022 messages which will also reduce the cost of connecting to multiple different market infrastructures.

But there is another sense in which ISO 20022 will make an even greater contribution. This is interactions between FMIs. The ability to exchange information through a common standard is essential if domestic payments systems are to interoperate efficiently, especially across borders. But the remaining obstacles to such harmonisation are multiple and far from negligible, and FMIs must address them if they are to remain relevant in a world being turned upside down by economic and regulatory pressures, as well as the cost reducing powers of digital communication and computation.

FMIs can still cut costs by creating synergies

The rising cost of capital and liquidity is tightening the links between asset classes. The ECB has announced that it will merge its high value payments system (TARGET2) with its securities settlement system (T2S) in 2020 and it also has plans to offer clearing and real-time settlement. There could be no clearer signal of the synergies between cash, securities and collateral. The closer integration of the various components of the financial market infrastructure of the Eurosystem will help to enhance the safety and efficiency of payments, securities and derivatives by making it cheaper and easier to access liquidity, credit and collateral.

In a global marketplace in which virtually every equity or bond is potentially eligible collateral to secure central or commercial bank money, FMIs must find ways to globally cut the costs of moving assets between their account-holders. Inevitably, the business case for infrastructural transformations of this kind is complicated by the current diversion of technology budgets into projects to comply with regulatory demands. But this is poised to change, and not just because the long list of post-crisis regulations affecting the industry may now be coming to an end.

FMIs can help defeat cybercrime

One barrier to progress in integration is cybercrime. The negative potential of cyber-threats is destructive enough to overwhelm all of the benefits of the digital revolution. In facing up to that peril, FMIs understand that they are particularly at risk, not least because failure really is not an option, given their responsibility to ensure secure settlement of critical transactions. FMIs must now consider investing in a third level of resiliency and security as they are natural inheritors of prime responsibility for cyber-security, since they came into existence to reduce operational risks and costs. It is work to which FMIs, with their long history of neutrality and mutual ownership and governance, are well suited. They are instinctive collaborators as well as competitors, who share experience and information naturally.

That collegial spirit is now being put to the ultimate test by the tempting opportunities created by the digital revolution. Each FMI will strike its own balance between the need to innovate to remain relevant and the obligation to provide a reliable underpinning to the work of others. FMIs are used to doing the hard and unglamorous work of translating strategic visions into services that actually work. In this sense, FMIs are the real agents of transformation in our industry.

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