Exchanges

This chapter presents a series of case studies illustrating how specific exchanges have actually been governed in particular contexts. The following institutions and contexts are described in turn: the proposed iX merger between Deutsche Börse and the London Stock Exchange (LSE), and its subsequent collapse, in 2000; the “Penny Stocks Incident” at Hong Kong Exchanges and Clearing Ltd. in 2002; the attempted takeover of the LSE by NASDAQ over the period 2006–8; Euronext's purchase of London International Financial Futures and Options Exchange in 2001; the resignation of the chairman/CEO of the New York Stock Exchange in 2003; and the purchase by the “Murakami Fund” of a major block of shares in the Osaka Securities Exchange in 2005. A few brief general lessons from each case study are also identified.

Regulation and Governance of Market Infrastructure: Global Perspective

This chapter examines a unique set of assessments of securities markets and their regulation, from countries around the world, in order to provide a global perspective on policymakers' viewpoints about the regulation and governance of market infrastructure institutions. The assessments were undertaken as part of an initiative called the Financial Sector Assessment Program (FSAP), implemented jointly by the International Monetary Fund and the World Bank. Each assessment evaluates the extent to which a country's securities markets regulatory regime reflects internationally recognized standards. The assessments prepared for the FSAP since its inception in 1999 up until 2006 are analyzed. Together they provide insights on three topics: how exchanges, central counterparties, and central securities depositories are regulated and governed globally; official perceptions on the optimal way of regulating markets and market infrastructure institutions; and the assumptions that are often made when examining the governance and regulation of market infrastructure institutions.

CCPs and CSDs

This chapter presents a series of case studies illustrating how some specific central counterparties (CCPs), and central securities depositories (CSDs) have been governed in particular contexts. The following institutions and contexts are described in turn: the relationship between the Canadian Depository for Securities' owners, its users, and board directors from the company's inception to 2008; the establishment of European Central Counterparty Limited by Depository Trust and Clearing Corporation over the period 2000–2002; the creation of Clearstream International by Deutsche Börse over the period 1999–2002; some aspects of how Euroclear was governed regarding its creation, ownership, and board structure up until 2006; and the creation of LCH.Clearnet and some difficulties it faced over the period 2003–6. A few brief general lessons from each case study are also identified.

Governance of Market Infrastructure Institutions: A Snapshot

The chapter provides an overview of how market infrastructure institutions in the cash equity markets around the world were governed as of September 2006. The 90 member exchanges of the World Federation of Exchanges, and their associated clearing and settlement entities, were examined. For exchanges, the dominant control model, at 40 percent of the population, was that of a private company; 27.8 percent of the population were under mutual control, 16.7 percent were listed, and 15.6 percent were government controlled. For clearing institutions, the dominant control models were exchange control at 37.9 percent of the population and user control at 40.2 percent. Government control was low at 13.8 percent, as was control by independent entities at 7.8 percent. For settlement entities, user control was the dominant model at 45.1 percent of the population, with exchange control still common at 28.1 percent, although less important than for clearing entities.

How Should Market Infrastructure Institution Governance Be Regulated?

This chapter explores what regulatory intervention in the governance of market infrastructure institutions is optimal. Attention is focused on how such intervention can enhance the realization of the three core objectives of securities markets regulation identified by International Organization of Securities Commissions (IOSCO), namely the protection of investors, ensuring that markets are fair, efficient, and transparent, and the reduction of systemic risk. The chapter is divided into five sections. In the first, some preliminary comments are presented. In the next three sections, the manner in which regulatory intervention in the governance of market infrastructure institutions may promote each of the IOSCO core objectives in turn is examined. The last section encapsulates these discussions and presents key lessons about how best to regulate the governance of market infrastructure institutions. In order to do so, 16 general propositions are articulated.

Who Should Regulate What?

The question of what regulatory authority over securities markets should be assigned to exchanges, central counterparties, and central securities depositories has long been controversial. This chapter explores this issue in the broader context of examining how regulatory powers should be allocated between government regulators, self-regulatory organizations, and other types of regulatory institutions. The chapter is composed of three sections. In the first, the complexity of the decision as to how to allocate regulatory powers in a jurisdiction is discussed. The second section lists and analyzes crucial factors and constraints that affect the relative merits of allocating regulatory powers to different types of institutions. The last section encapsulates these discussions and presents in a simple and accessible manner key lessons about how best to allocate regulatory powers in the securities markets. In order to do so, nine general propositions are articulated.

Definitions

For many people, the “infrastructure institutions” in financial markets are the exchanges, central counterparties (CCPs), and central securities depositories (CSDs) that provide the trading, clearing, settlement, and sometimes other core functions for cash and derivative markets. There are, however, also many reasons why the definitions of an infrastructure, an exchange, a CCP, and CSD are all quite opaque. This is important, as the identification of a particular organization as one of these types of institutions can have significant commercial, regulatory, and policy consequences. This chapter aims to provide some basic insights into the definitions and nature of an infrastructure, an exchange, a CCP, and a CSD; and explores the reasons why these concepts are sometimes ambiguous and controversial. The first section considers the meaning and nature of what is an infrastructure. The second provides some comments on the definitions and nature of exchanges, CCPs, and CSDs, and on the functions they deliver. Brief conclusions are offered in the last section.

What Is the Most Efficient Governance Structure?

This chapter analyzes what is the optimal governance model for market infrastructure institutions using the broad goal of efficiency as the main yardstick to compare different models. Three fundamental elements of governance are examined: an organization's ownership structure, its profit mandate, and its board composition. The chapter is composed of four sections. The first section outlines the archetypal ownership and mandate models that may be adopted by a market infrastructure institution. The second section identifies and discusses the pivotal factors that affect the relative efficiency of the different ownership and mandate models. The third section discusses two issues of fundamental importance to market infrastructure institutions' boards: the roles such boards should undertake, and the merits and difficulties of having independent directors or user directors on these boards. The last section encapsulates these discussions and presents key lessons about how to choose the optimal ownership structure and mandate for a market infrastructure institution.

The Allocation of Regulatory Powers Over Securities Markets

This chapter seeks to compare how different jurisdictions allocate regulatory powers over their securities markets. Rather than seek to present detailed descriptions of how any specific jurisdictions allocate such regulatory responsibilities, three surveys on the topic, covering various jurisdictions and institutions, are described and evaluated. The chapter is composed of four sections. The first two summarize key results from two surveys that examine the regulation of securities markets, and how regulatory powers over such markets are allocated—one prepared by the World Federation of Exchanges in 2004, and the other by the International Council of Securities Associations in 2006. The third section presents the results of a survey undertaken in 2006 for this book on how regulatory authority is allocated in eight jurisdictions with large securities markets. Conclusions are presented in the last section.

Market Power

A critical determinant of whether exchanges, central counterparties, and central securities depositories should be considered infrastructure institutions is whether they have market power. This chapter explores whether they do, specifically in the provision of trading, clearing, central register, and settlement services. It examines four general issues and provides some broad comments on the nature of market power. It discusses the key factors that lead towards consolidation of market power in each industry sector, and those that tend to promote competition and reduce market power. It then presents brief comments on the industry structure in practice in each of the three sectors. Finally, a range of generic propositions about the industry structure in each of the three sectors are articulated.