Latin American Capital Markets

ENHANCING MARKET INFRASTRUCTURE IN EMERGING ECONOMIES 241Framework for Enhancing Financial Sector InfrastttttttttructureIn the past, policymakers tended to view financial sector infrastructure as a minorissue that could be left to technicians, but this is no longer the case.The growing relationshipsand linkages among capital markets worldwide mean that national policymakersmust consider and define a public sector role in financial sector infrastructureand that they must recognize and address the strong competitive forces affecting marketsand infrastructure. International financial institutions and organizations, such asthe International Organization of Securities Commissions (IOSCO), the Bank for InternationalSettlements (BIS), the International Monetary Fund (IMF), and the WorldBank, as well as private sector entities, are developing standards and best practices forclearing and settlement that cannot be ignored. Infrastructure is now one crucial elementin a capital market's overall competitiveness, and weaknesses in clearing and settlementcan jeopardize the successful development of a capital market.This sectionintroduces some of the key policy issues relevant for market infrastructure.EfficiencyA fundamental challenge for market infrastructure is to ensure proper managementof risks in the process of trading and settlement There are several types of risk in thisprocess, including principal risk, replacement cost risk, and liquidity risk, which arisefrom the possibility that the counterpart to a trade fails. Operational risk and legal riskmay also give rise to principal risk, replacement cost risk, and liquidity risk Operationalrisks arise from deficiencies in systems, human error, and management processes.Legal risk arises when the legal or regulatory regime does not fully support a clearanceand settlement system, its rules, or the application of the rules designed to enforcethe rights of system operators, participants, and their customers. Systemic riskis the risk that one participant that fails to meet its settlement obligations can causeother participants to subsequently default on their obligations.Financial sector infrastructure is important because all participants in capitalmarkets depend on its smooth and efficient functioning. It represents the intersectionof the diverse and heterogeneous participants. It is composed of the institutions,mechanisms, rules, and laws that govern the clearing, settlement, and custody of capitalmarket trades. Without a well-functioning infrastructure, capital markets could notflourish. Functions covered include registry of ownership, custody, communication ofinformation, and instructions concerning changes in the status of securities.The infrastructurebrings together participants in the capital markets to differing degrees. ForCopyright © by the Inter-American Development Bank. All rights reserved.For more information visit our website: www.iadb.org/pub