Principles of Financial Market infrastructures - The foundation of a successful financial market

Principles of financial market infrastructure (PFMI),TLDR;

I wanted to make an attempt to summarise these Principles of financial market infrastructure for those like me who prefer mostly TLDR :) !!! 

Also,I am writing this in the wake of weak global economy this year. I am by no means an experts in economics, however , I am just sharing my understanding for other readers to know the importance of set guidelines.

Financial markets can also fail in several ways. A series of failures can lead to financial crisis and not only affect banks, mortgage brokers, credit rating agencies, and asset managers, but will also have wide-ranging effects across the global economy.

Having a stronger FMI might be a key towards a sustainable economy, hence compiling the set principles published by the CPSS-IOSCO.

I will also attach the link to the elaborate original PDF from CPSS-IOSCO at the end for those who wish to get complete understanding of the same.So lets dive in!!

Let us understand few of the important foundations before getting to the PFMI

What are Financial Market infrastructures?

Financial Market Infrastructures (FMIs) are key components of the financial system, delivering services critical to the smooth functioning of financial markets.These FMI’s if well designed ensure smooth solutions to any kind of settlements, manage risks and obligations along with financial stability in case of adverse situations.

These Principles of financial market infrastructure provide guidance to FMI’s who deal with facilitating clearing, settlement, and recording of monetary and other financial transactions in large number which are always prone to many adverse situations.

What are Principles of Financial Market Infrastructure?

It is defined like "A Multilateral system of standards among participating institutions including the operator of the system that is used for the purposes of clearing, settling or recording payments securities, derivatives or other financial transactions”.The Principles also set out responsibilities for central banks, market regulators and other relevant authorities in their supervision of financial market infrastructures, including arrangements for cooperation between the relevant authorities.

So,Essentially these are the minimum standards to be followed to be safe ( probably a wrong choice of word !) in bad situations.Lets now summarise the PFMI…

There are 24 Principles as part of PFMI which are classified into 9 segments.There are two main actors to note

• Market Operator
• Participant

1.General organisation

Principle 1: Legal basis

The operations of the system must have a clear basis and adhere to the law of     

         the land .

Principle 2:Governance 

  Governance arrangements of the Market must be clear and transparent

Principle 3 :Risks framework assigned by local government

The market operator must have a proper risk management framework

2.Credit and liquidity risk management 

Principle 4:Credit risk

The market operator must carefully manage its credit risk sufficient resources 

 Principle 5:Collateral

If the market requires collateral it must choose collateral with low credit, liquidity and market risks.

Principle 6: Margin

Central counterparties must have an effective margin system.

Principle 7:Liquidity risk

The market operator must monitor and manage liquidity risk and cannot traded  quickly

3.Settlement

Principle 8 :Settlement finality

Liabilities incurred must be settled with finality, at the very least at the end of the day where value is credited (at least at the end of value date), but ideally in real-time.

Principle 9 : Money settlements

Credit risk and liquidity risk must be minimised by settling in central bank when possible

Principle 10 :Physical deliveries

If the market deals with securities or commodities, there must be clear rules about their physical delivery.Risks relating to the storage and delivery of physical securities and commodities must be managed.

4.central securities depositories & exchange of value settlement systems

Principle 11 :central securities depositories

Where a securities depository holds the underlying securities of a market it must manage this 'safeguarding' risk, and ensure the securities are held separately from its own assets.

Principle 12: exchange of value settlement systems

Where two linked obligations are exchanged in a transaction (for example, foreign exchange), the settlement of one must be conditional on the settlement of the other.

5.default management

Principle 13:Participant-default rules & procedures

The market needs to have rules to cope with the default of a market participant, ensuring the losses are contained and liquidity preserved to allow the market to continue to operate.

Principle 14 :Segregation & portability

For a central counterparty, it must be possible to segregate and move the positions of the participants' customers

6.General business and operation risk management

Principle 15:General business risk

The market operator must manage its own business risks to ensure it can continue as a going concern. It must maintain a reserve to ensure orderly wind down

Principle 16:Custody & investment risks

Assets, whether belonging to the market operator or market participants, must be safeguarded against losses. Any investments must be chosen for minimal credit, liquidity and market risks

Principle 17:Operational risk

A financial market must identify operational risks: both internally and across the market and its participants. Where appropriate, they should mitigate the risks through controls.

7.Access 

Principle 18:Access & participation requirements (central counter party)

Participation in the market must be objective and transparent, ensuring fair and open access.

Principle 19 :Tiered participation Arrangements (direct, indirect - participants)

Where the financial market has participants at different tiers (i.e. direct participants, and indirect participants who are themselves serviced by the direct participants) then the market operator needs to monitor and manage the risks that such indirect relationships could cause

Principle 20 :FMI links

If a financial market infrastructure (FMI) is interlinked to another FMI then it needs to monitor and manage the risks relating to that relationship

8.Efficiency 

Principle 21:Efficiency & effectiveness

Financial markets should be structured to efficiently and effectively meet the needs they were created to serve

Principle 22:Communication procedures & standards

The market should use relevant and internationally accepted methods of communicating transactions

9.Transparency 

Principle 23:Disclosure of rules, key procedures & market data

The rules and procedures of the financial market must be clear. Rules and key procedures must be disclosed publicly.

Principle 24 :Disclosure of market data by trade repositories

A trade repository must disclose relevant market information to the public and government authorities that is timely and accurate

• For full Official PDF : https://www.bis.org/cpmi/publ/d101a.pdf
• For Additional info :https://www.bis.org/cpmi/info_pfmi.htm

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