Journal of Financial Market Infrastructures

In this letter, in the second issue of The Journal of Financial Market Infrastructures, I would like to focus on the so-called interdependencies between financial market infrastructures (FMIs). Such interdependencies can be viewed as links between FMIs. An infrastructure may itself already be fairly complicated, but when these mutual links are also taken into account, one can truly say that the whole ensemble is complex. To visualize this complexity, to some extent we first need to find a way to present multiple FMIs in a single picture. Given the complexity it is useful to a metaphor for the purposes of explanation, and here I use the metaphor of a warehouse (see the figure in the full PDF attached) to represent the complete set of FMIs (and more: a point to which I return later).

The concept of an FMI is formally defined in the Principles for Financial Market Infrastructures.(*) The following set of financial infrastructures are colored lighter gray in the figure: the systemically important payment system (SIPS), the trade repository (TR), the central counterparty (CCP), the securities settlement system (SSS) and the central securities depository (CSD). It is also clear that FMIs are located on the upper floors of the warehouse as they perform the function of processing large-value payments (on the first floor) or form a stage in the post-trade process of a securities transaction (on the second floor) or a derivative transaction (also on the second floor but lifted somewhat for the sake of presentation). The lower floors of the warehouse perform the crucial function of cash retail payments (located in the basement of the warehouse) and noncash retail payments (located on the ground floor); these do not usually have FMIs but are, nonetheless, important. Now I come to the "and more" mentioned earlier: the boxes in the figure that are darker gray in color. They are also relevant infrastructures and platforms in the warehouse, such as the exchange, multilateral trading facility (MTF) and the automated clearing house (ACH). The distinction between the two types of blocks is whether a given infrastructure is systemically important (and is hence an FMI in lighter gray) or not (darker gray).

Having identified the nodes of the total network (warehouse), we can now turn to the links, formally addressed by the term interdependency. Although the events surrounding the September 2008 Lehman Brothers bankruptcy showed the potential systemic risks, it was already known that FMIs could influence each other through these links. In early 2008 the CPSS published a report on "interdependencies" (see Three types of interdependencies were recognized, and these are also shown in the warehouse diagram.

The first type is internal to the warehouse and is called "system-based". These links are, in most cases, a necessary consequence of either the structure of the industry (a vertically integrated post-trade securities chain) or the adherence to one of the principles for FMIs. Examples are the link shown between the SIPS and SSS boxes ("delivery versus payment", which is part of Principle 12 on exchange-of-value settlement systems), and the link between the CCP and SIPS boxes (the requirement to settle in central bank money where practicable and available, which is part of Principle 9 on money settlements).

The second type of interdependency follows from a bank's membership in multiple FMIs: the "institution-based" interdependency. In practice, most banks, particularly large ones, are connected to a number of FMIs. A failure of such a bank or a connected FMI could propagate systemic risk via the institution-based links.

The third type of interdependency is external to the warehouse and is related to services provided to more than one FMI by a service provider. In such circumstances the service provider becomes critical for (part of) the warehouse. Such criticality is termed "environmental" interdependency. A prime example is SWIFT, which provides worldwide messaging services.

With this short overview of the warehouse I hope that the relative positioning of the five types of FMIs and the links between them are clear. It should also be noted that there is a principle related to links (Principle 20) in order to mitigate the risks associated with them, and FMIs on both sides of the link should fully observe the principle.

In this second issue of The Journal of Financial Market Infrastructures we have four papers, all of which fit into the warehouse, of course.

The first paper, "Intraday patterns and timing of TARGET2 interbank payments" by Marco Massarenti, Silvio Petriconi and Johannes Lindner, provides a descriptive analysis of daily patterns of settlement of payments inTARGET2 (which is a SIPS and is therefore located on the first floor of the warehouse) using a unique transaction-level data set.

The second paper in the issue, "The impact of microchips on payment card fraud" by Guerino Ardizzi, provides an empirical analysis of the impact on fraud losses of the migration from payment cards with a magnetic stripe to cards containing a microchip. The results show that chip technology has had a positive effect on the safety of retail payments. In terms of the warehouse this paper is located on the ground floor.

The same is true for the third paper in this issue, "A dual consent approach for payments" by Ron Berndsen and Daaf van Oudheusden. This paper looks at payments where, due to a lack of trust between buyer and seller, it is beneficial to involve a guarantor for payments. This guarantor should obtain consent for access to the buyer's bank account from both the buyer and the bank of the buyer. The authors argue that this approach should become a minimal regulatory requirement for a large variety of payment methods.

The fourth paper in the issue is presented in a new section of the journal: the forum. The aim of the forum is to stimulate policy debate and discussion on new trends, incidents and regulatory developments. From now on, therefore, we also invite policy-oriented papers to be submitted to the journal.

The paper in the forum in this issue is "A central bank perspective on liquidity management" by J. J. Spaanderman. The paper addresses the topical issue of liquidity management throughout FMIs, corresponding to the upper floors of the warehouse in our metaphor. The paper proposes improvements with an eye on liquidity management in areas as diverse as tri-party collateral services, tiering in SIPSs and secure lending.

It is with great pleasure that I invite you to explore this second issue of The Journal of Financial Market Infrastructures wherever you are affiliated: inside or outside the warehouse.

(*)These principles are formulated by the two standard setting bodies: the Committee of Payment and Settlement Systems (CPSS) and the International Organization of Securities Commissions (IOSCO)

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