Reforming the Securities Holding Infrastructures: A Pluralistic Assessment and Promising Next Steps
Charles W Mooney, Jr, University of Pennsylvania School of Law
-- Publicly traded securities generally are held by investors in securities accounts with intermediaries such as stockbrokers and banks—intermediated securities. For many investors this is the only practical means of holding and dealing with securities. These intermediated holding systems impose a variety of risks and costs, some of which are visited directly on securities markets and their participants (internal costs). For example, investors are exposed to intermediary risk (default or insolvency of an intermediary holding securities for investors) and the costs of protecting against these risks as well as impediments to the exercise of investor rights such as voting and asserting claims against securities issuers. The nontransparency of many deeply intermediated holding systems impose other social costs, such as obstacles to enforcement of anti-money laundering and anti-terrorist financing regulations and other regulatory compliance and enforcement (external costs). The emergence of FinTech and the potentially disruptive effects of distributed ledger technology (including blockchain technology) now present realistic opportunities for reforms of securities holding infrastructures that would increase transparency and allow investors to hold securities directly on the books of their issuers.
In a recent article "Beyond Intermediation: A New (Fintech) Model for Securities Holding Infrastructures," I proposed a “New Platform System” (NPS) for the direct holding of securities that would connect issuers and investors and also connect both constituencies with trading and settlement systems (which I suggest could remain intact, at least for now). Unlike some other recent transparency and direct holding proposals, the NPS would cover both equity and debt securities and would flexibly accommodate beneficial aspects of current intermediated holding systems, such as margin lending, securities lending, and rehypothecation. The article also presents a broader menu of problems that the NPS could resolve. The NPS addresses the probable objections that the intermediaries who benefit from the status quo would make to any transparency or direct holding proposals. Disintermediation likely would require regulatory intervention by the SEC in the United States. By offering reforms that would minimize the disruption of current market practices, the NPS could encourage intervention and blunt opposition. It also could provide a “primordial soup” for future, more extensive reforms of trading and settlement systems.
I build on Beyond Intermediation in a forthcoming new book chapter, "An Essay on Pluralism in Financial Market Infrastructure Design: The Case of Securities Holding in the United States." Legacy infrastructures such as the United States holding system reflect a monopoly for the intermediaries (stockbrokers and banks) who benefit from the infrastructure, sustained by the path dependence resulting from the influence of the relevant intermediaries and the entrenched, sticky characteristics of the infrastructure and the regulatory environment. Essay on Pluralism explores the external costs imposed by the incumbent infrastructure on constituencies outside the securities markets, and argues that its beneficiaries, the intermediaries, do not internalize these costs. This represents a classic negative externality and a fundamental regulatory failure.
Essay on Pluralism explains the broad societal impact of financial market infrastructures, which are very understudied aspects of financial markets. It emphasizes the failures in the regulation of financial markets and in regulation more generally. It challenges regulators (primarily the SEC in the United States) to establish more ambitious goals for the securities holding infrastructures and the Fintech community to meet those goals. And it further illuminates the roadmap and framework for a cost-benefit analysis of the prevailing infrastructure and the reforms that are outlined in Beyond Intermediation.
In a promising new development within the American Bar Association Section of Business Law, a new Task Force on Securities Holding infrastructure is being organized. The Task Force will examine the current infrastructure in the United States, identify, analyze, and assess significant problems, and consider potential means of addressing the problems. It aspires to produce an in-depth report that may form a sound basis for more formal regulatory action in cooperation with the many and varied stakeholders.