Every day, trillions of dollars, euros, yen and many other currencies flow among participants in markets for foreign currency, securities and derivatives contracts. This vast flow of payments happens largely below the radar screen of most people, thanks to a collection of institutions known as financial market utilities (FMUs). The basic function FMUs perform is simple. After a financial trade has been agreed upon, a mechanism must exist to convey the financial asset from seller to buyer and reciprocally to convey compensation from buyer to seller. FMUs provide this mechanism. In particular, FMUs mitigate settlement risk (the risk that trades will not be settled or completed as expected) and the particular form of settlement risk known as counterparty credit risk (the risk that a party involved in a transaction might fail to deliver funds or securities as promised).
Financial market utilities ensure that clearing, settlement and payments operations go smoothly. This article explores how these systems mitigate settlement risk, using precisely targeted "just-in-time" liquidity, and discusses the risks for financial stability implied by the increasing role of just-in-time liquidity in our financial markets.