Market Infrastructures – Making it work for both the big and the beautiful

Operating in an environment of unprecedented change, market infrastructures provide mission-critical functionality and lie at the heart of the financial services ecosystem. Day-in and day-out, they can settle 100M U.S. trades a day, or manage the expanse of segregated retail accounts for large populous countries with mobile front-ends, in countries such as India.

But, market infrastructures are not impregnable castles that can escape the winds of change.

Having firmly delivered on their fiduciary promise to manage risk throughout the financial crisis – the core infrastructure did not fall over, despite unpreceded market turmoil - now they face pressures to manage costs, ensure transparency and bring new products and services to the market.

Now more than ever, market infrastructures are at a cross-roads impacted by many forces - they are still grappling with the impact of regulation, the need to be resilient and the need to meet ever-changing customer needs - all whilst trying to reduce their cost basis. And now the threat of disruptive technologies looms large on the horizon.

Technologies such as Blockchain and Distributed Ledgers with Smart Contracts were the buzz of this year’s Sibos. Market infrastructures believe that these might augment and supplement what they do, but won’t disintermediate.

As one panellist said, “The existing plumbing can’t be allowed to leak. Ever. For market infrastructures the impact from these new technologies is over exaggerated. Core infrastructure can't be easily knocked of its perch. Yes, these technologies are interesting, but they can’t easily replace 80 years of rules, regulation, market practice, tax laws, resiliency and triple-site redundancy. We’re much more worried about the deep dark ‘unknowns’, such as cyber-attacks.”. And then added “only the paranoid survive …”

But how does one manage these seemingly contradictive drivers?

As one major practitioner said, “going forward, market infrastructures will have to cater for the big and the beautiful. Meaning, they will need to ensure the market gets huge economies of scale, but also ensure that specialist, niche players survive and thrive.”

Either way, as a market infrastructure, you need to constantly strive for continuous improvement and innovation.

But are market infrastructures really geared up to deliver innovation? As one panellist said “west-coast free thinkers and serial entrepreneurs aren’t generally attracted to work at market infrastructures. Plus, our ownership structure and formal procedures aren’t exactly conducive to innovation.”

This does not mean that innovation doesn't happen. On the contrary, some have established internal ‘skunk works’ that foster creative thinking from employees – everything from continuous improvement of existing processes, through to dreaming up new products and services for customers. Aside from just generating new ideas, employees are also encouraged to select, filter and refine ideas, rather than leaving that role to senior management.

“From 100 ideas, 95 will end up being dismissed, 5 might be developed and perhaps 1 will go into production” said one senior manager.

Arguably, it’s a perfect time for innovative thinking, as the market infrastructure landscape is changing. “Now we are seeing active, public policy to get the infrastructures ‘open-up’ and allow downstream competition”, said one session moderator.

But how do you provide a ‘level playing field’ where anybody can play, but not upset core settlement? It’s time to get creative.

For market infrastructure, innovation is manifesting itself as a strong demarcation of roles.

On one hand, create a ‘backbone’ by stripping the core engine down to its fundamental components allowing commoditised settlement – make it efficient, simple and compliant with global standards.

And on the other hand, allow imagination, innovation and competition to take place, on top of the infrastructure – with access to the backbone through open source APIs that allow new services to be created. Some of these commercial services can be created by the market infrastructures themselves (with governance and management outside of the core functions), and some can be created by customers.

“This creative new approach provides a level playing field to all players, be they traditional banks or upstart new entrants, and also one that promotes collaboration and competition” summarised one panellist. “This elegant framework allows the ‘big and plain’ to live alongside the ‘small and beautiful’, all using the same core functions.”

But for banks, this may start to change the dynamics. Since banks have been the traditional gateway into the market infrastructure, things may start to get uncomfortable. “This sea change could allow both influential corporates and FinTech upstarts to join the party - I’m not sure I’m totally comfortable with this yet”, said one banker.

Market infrastructures are embracing the difficult juxtaposition of building a framework that both encourages competition and allows new services to be created in its (not so) simple quest to join investors to investments.

As concrete examples, various panels discussed TARGET2-Securities and the new NPP real-time payments system in Australia. Both have commoditised settlement, living hand-in-hand with the provision for value-added services on top of the infrastructure.

Ultimately, differentiation and market forces will decide the winners and losers of these new creative services. Whether they are provided by new entrants or by established players the end user will be the ultimate beneficiary of the competition.