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While the European Community has made progress toward establishing a single European capital market, the institutional arrangements for trading and settling securities remain predominantly national rather than cross-border, according to authors Linda Goldberg, John Kambhu, James M. Mahoney, Lawrence Radecki, and Asani Sarkar.
The authors explain that the introduction of the euro has laid the groundwork for a single capital market by reducing intra-European currency risk and simplifying cross-country comparisons of investment returns. Also, the lifting of restrictions on some pension fund portfolios has given institutional investors more freedom to invest in foreign financial assets across Europe. Despite these advances, securities trading and settlement systems in Europe are still fragmented along national lines. Accordingly, full market integration is impeded by high cross-border transaction costs, due largely to the existence of redundant settlement service providers.
Some securities trading and settlement systems are evolving to address the problem of national fragmentation, observe the authors. For example, recent cross-border mergers of stock exchanges and the associated clearing and settlement agencies have given rise to three major market centers, in France, Germany, and the United Kingdom.
The study also describes cost savings from other types of trading and settlement system consolidations that may develop. These include the introduction of one central counterparty to clear all interdealer trades on European exchanges, the establishment of links between local and foreign central securities depositories, mergers of central securities depositories, and mergers of exchanges.
The study includes an analysis of the corporate governance issues involving demutualization: the transformation of exchanges and settlement agencies from user-owned institutions to shareholder-owned, profit-driven corporations. The authors note that while demutualization is leading to more consolidated trading and settlement systems, it creates the potential for increased operational risk and monopoly pricing.
The authors conclude that as Europe moves closer to a more unified capital market, regulatory authorities there "will face the challenge of securing the benefits of eliminating redundant service providers while promoting innovation and carefully overseeing the resulting concentration of risks and market power."
Linda Goldberg is a vice president in the Federal Reserve Bank of New Yorks international research area; John Kambhu is a vice president and James M. Mahoney a senior economist in the capital markets area; Lawrence Radecki is a vice president in the payments studies area; Asani Sarkar is an economist in the capital markets area.