1 Introduction

What is the role of exchanges in capital markets? In public perception, the terms ‘stock exchange’ and ‘stock market’ are often used interchangeably, mostly referring to the latter. As central hubs, exchanges facilitate the circulation of financial information and the concentration of financial services firms, thereby serving as ‘anchors’ for financial centres (Wójcik, Reference Wójcik2012). Therefore, exchanges are often depicted as marketplaces, neutral spaces where borrowers and investors meet to buy and sell ownership stakes in companies or trade commodities, derivatives, or other securities.

Traditionally, exchanges were merely such national marketplaces, mutual non-profit organizations owned and controlled by their members, which is reflected in earlier analyses of exchanges that rather focused on those members (Baker, Reference Baker1984; Abolafia, Reference Abolafia1996). Academic debates have often mirrored this perception of exchanges: while they facilitate financial market transactions, exchanges themselves are often not perceived and analysed as (powerful) actors, but rather as marketplaces or sites dominated by other actors (for a literature review, see Petry, Reference Petry2021a).

But more than mere marketplaces, exchanges are powerful actors in their own right. Over time, they have become complex organizations whose task is the provision of financial infrastructures that enable the functioning of capital markets in the first place. While financial markets are used by investors to allocate financial assets, provide corporate financing, and facilitate economic growth, certain infrastructural arrangements must exist to enable these transactions (Bowker and Star, Reference Star1999): from market data, indices, financial products, trading platforms to clearing, exchanges shape the infrastructural arrangements of capital markets. Exchanges are the providers of these financial infrastructures (Petry, Reference Petry2021a), thereby shaping capital markets, their development, characteristics, and dynamics.

As this chapter illustrates, exchanges exhibit both commonalities and differences. Section 2 examines commonalities across exchanges – notably their role in the provision of financial infrastructures. However, not all exchanges (and capital markets) are equal with respect to both how they organize markets as well as their relative importance within the global financial system. Section 3 thus discusses how exchanges are embedded within specific institutional environments which informs how they organize markets differently, while Section 4 illustrates the hierarchical nature of exchanges within the global financial system. However, we can also observe tectonic shifts within global capital markets. Section 5 therefore examines potential contestations through the rise of exchanges in emerging markets. Section 6 concludes by discussing exchanges within the context of an increasingly fractured global economy.

2 Commonalities: Organizing Financial Infrastructures

Exchanges are one of the institutional foundations of contemporary capitalism. The early history of stock exchanges dates back to ancient China during the Tang and Song dynasties where, in the seventh century, the first ‘joint stock’ companies were created. In Europe, pre-modern forms of stock exchanges have existed in Venice, Florence, and Genoa at least since the fourteenth century. This was followed by the founding of the Amsterdam Stock Exchange through the Dutch East India Company in 1602, which – while not the first exchange as such – was the first embodiment of what we today perceive as modern stock markets. As Braudel (Reference Braudel1983, p. 101) noted, ‘what was new in Amsterdam was the volume, the fluidity of the market and publicity it received, and the speculative freedom of transactions’. Thus, the modern stock exchange was born. While exchanges can be created for virtually anything – from bonds, to bitcoins and carbon emissions – stock and derivatives exchanges have historically emerged as their most prominent forms (see Chapter 10, this volume).

From the 1980s onwards, however, exchanges underwent important changes (Petry, Reference Petry2021a). While there is variation in exchanges’ transformation (see Section 3), we can observe important commonalities with respect to their core activities, that is, is the provision of financial infrastructures for capital markets. Exchanges have diversified their activities horizontally – by adding new asset classes, time zones, and countries to their market portfolio – and vertically – by buying/merging with other financial service providers such as clearing houses or index and data providers. You can now buy market data and analytics tools from exchanges; license their indices; trade various financial products and asset classes on their platforms, not only equities but also bonds, foreign exchange, commodities; or derivatives (e.g., index derivatives based on indices which the exchange might calculate itself in turn based on its proprietary market data); co-locate your servers next to theirs to enhance trading speed; and use their clearing house, settlement, collateral management, custodian services, and regulatory reporting tools. What exchanges do has changed significantly. This has endowed them with considerable power to shape capital markets (see Swartz, this volume).

While financial markets are used by investors as sites of exchange, financial infrastructures need to be in place to enable these transactions in the first place (Bowker and Star, Reference Star1999) – existing and newly emerging systems through which ‘payments are settled, risks are assessed, and prices agreed’ (Bernards and Campbell-Verduyn, Reference Bernards and Campbell-Verduyn2019, p. 777). Crucially, financial infrastructures are ‘the social, cultural, and technical conditions that make [financial markets] possible’ (MacKenzie, Reference MacKenzie2006, p. 13) – socio-technical systems that enable the functioning of financial markets but tend to be taken for granted and assumed (Star, Reference Star1999; Edwards, Reference Edwards, Misa, Bray and Feenberg2003; see also Pinzur, this volume).

Providing these infrastructures is more than a mere technical exercise. Financial infrastructures are inherently political as infrastructural arrangements modify the distribution of power and capabilities within marketplaces (Riles, Reference Riles2011; Pardo-Guerra, Reference Pardo-Guerra2013). As Bernards and Campbell-Verduyn (Reference Bernards and Campbell-Verduyn2019, p. 783) note, financial infrastructures ‘can confer, extend and enable new forms of governance’. Drawing on Mann’s (Reference Mann1984) work on the infrastructural power of the state, Braun (Reference Braun2020) for instance demonstrates how states’ attempts to govern through markets provide financial actors with infrastructural power due to states’ increasing entanglement with financial markets on which they rely for governance purposes (see also Coombs, this volume). Infrastructure is thereby conceptualized relationally (Bernards and Campbell-Verduyn, Reference Bernards and Campbell-Verduyn2019), and it is this entanglement that provides financial actors with infrastructural power (Gabor, Reference Gabor2016; Sgambati, Reference Sgambati2019), as state–market interactions take place ‘on the turf and according to the rules of financial markets’ (Braun and Gabor, Reference Braun, Gabor, Mader, Mertens and Van Der Zwan2020, p. 241). Crucially, as Bernards and Campbell-Verduyn (Reference Bernards and Campbell-Verduyn2019, p. 783) emphasize, ‘power often depend[s] on control over key financial infrastructures’. Financial infrastructures ‘sediment’ power relations and ‘shape, enable, constrain that power in specific ways’ (de Goede, Reference de Goede2020, p. 355).

This chapter argues that the implications of this ‘control over key financial infrastructures’ (Bernards and Campbell-Verduyn, Reference Bernards and Campbell-Verduyn2019, p. 783), and who sets ‘the rules of financial markets’ (Braun and Gabor, Reference Braun, Gabor, Mader, Mertens and Van Der Zwan2020, p. 241), require closer examination in the emerging literature on infrastructures and power. While SSF/STS (Social Studies of Finance/Science and Technology Studies) perspectives in infrastructure usually focus more on the micro level (Pinzur, this volume), international political economy literature on infrastructural power focuses on the macro level of the state (Coombs, this volume). While both of these perspectives are helpful to understand the politics of financial infrastructures, this chapter emphasizes the meso level – concentrating specifically on those actors that provide, create, and control financial market infrastructures, thereby connecting the micro and macro levels (see also Campbell-Verduyn and Hütten, Reference Campbell-Verduyn and Hütten2023). In other words, how and by whom markets are organized matters.

Through their transformation, exchanges have turned into exactly such providers of financial infrastructures. They are important actors whose power derives from their ability to define the features of the infrastructures for financial markets. Exchanges do not derive power through participation in financial markets, but from their role in organizing their underlying infrastructural arrangements. Rather than instrumental or relational, their power is more architectural in nature – from market data, indices, and products to trading platforms – they enable the operation of capital markets.

Through their role as providers of financial infrastructures, exchanges have therefore become constitutive for how capital markets function. First, by deciding which companies can list on their market or which products (stocks, bonds, derivatives, indices, etc.) can be traded, exchanges define investment opportunities. Secondly, exchanges exercise influence over who gets to participate in these markets and who is able to invest into – and own – these listed assets, thereby influencing investor structures. Thirdly, whoever wants to participate in these markets can only do this through the systems implemented by exchanges. Through these systems, exchanges set investment rules of how trading/investing is conducted, monitored, and sanctioned. Fourthly, because of their role of organizing markets exchanges have historically had close relationships with regulators and governments. Exchanges therefore also have a certain degree of political influence beyond capital markets.¹

By organizing infrastructures exchanges constrain and influence the actions of those actors entangled within their markets. Exchanges decide the ‘rules of the game’ – acting as gatekeepers, deciding who gets in, what is traded, and how trading is conducted.² Thereby, they are crucial actors that shape capital markets. Developing an understanding of exchanges as actors rather than marketplaces as well as exploring the provision of financial infrastructures as the source of their power helps to place them and their activities within the political economy of global finance.

While this section discussed the provision of financial infrastructure as an important commonality, there are important differences between exchanges. As the next sections illustrate, not all exchanges organize markets equally, nor are all exchanges equals.

3 Differences: Differing Institutional Logics

In contrast to the premise that markets are uniform, both capital markets and exchanges are ‘embedded in distinct sets of social and political institutions’ (Ebner and Beck, Reference Ebner and Beck2008, p. 4; see also Vogel, Reference Vogel2018). As Deeg and Jackson (Reference Deeg and Jackson2006, p. 152) highlight, ‘these institutional configurations create a particular contextual “logic” or rationality of economic action’. Every economy consists of a set of institutions which create distinct patterns of constraints and incentives that shape and channel actors’ behaviours (Zysman, Reference Zysman1994, pp. 245–246). By making some forms of action more likely or reasonable, a particular logic emerges that is distinct from other institutional contexts (Thornton and Ocasio, Reference Thornton, Ocasio, Greenwood, Oliver, Suddaby and Sahlin2008).

So, while functionally capital markets are characterized by market-based mechanisms of coordination between buyers, sellers, and investors, these markets are also embedded within variegated institutional settings that facilitate different institutional logics which underpin and shape the functioning of markets. Instead of viewing capital markets as homogeneous entities, this chapter therefore proposes to analyse capital markets as variegated – while characterized by market mechanisms, different institutional logics can underlie capital markets, leading to very different market dynamics and outcomes (Ahrne, Aspers, and Brunsson, Reference Ahrne, Aspers and Brunsson2015). Exchanges are hereby important actors that facilitate these different forms of how markets work. How exchanges (i.e., market organizers) are governed and which constraints and incentives they face matters.

Some aspects of their transformation are quite similar across exchanges. All over the world, exchanges have become electronic marketplaces, be it the New York, Shanghai, or Malawi stock exchanges. However, a crucial institutional characteristic where we see significant divergence between exchanges is how they are situated within as well as negotiate the relationship between states and markets.³ For this reason, it makes sense to construct a heuristic typology which distinguishes between two ideal-typical poles on the state–market continuum: ‘state-capitalist capital markets’ and ‘neoliberal capital markets’ (Petry, Koddenbrock, and Nölke, Reference Petry, Koddenbrock and Nölke2023).

In Western economies exchanges have essentially become neoliberal corporations – publicly traded companies that must make profitable business decisions to increase shareholder value; they are situated within an institutional setting informed by a neoliberal logic. The underlying neoliberal institutional logic that informs the functioning of these markets is one of a separation between state and market, depoliticizing markets and instead putting a significant degree of trust in the collective agency of private (financial) actors to achieve efficient outcomes by seeking to maximize (private) profit (Peck and Tickell, Reference Peck and Tickell2002; Major, Reference Major2012). While states are tasked with the role of creating markets in neoliberalism, they should not intervene in these markets once established (Slobodian, Reference Slobodian2018). The state’s priority is rather to enable private profit creation instead of other socio-economic outcomes (Chomsky, Reference Chomsky1999). Instead of ‘natural’, these markets should be conceptualized as neoliberal capital markets.

But capital markets do not have to follow a neoliberal institutional logic. While capital markets have emerged as important economic coordination mechanism globally (Gabor, Reference Gabor2018), these markets can function significantly differently as exchanges and capital markets may be informed by a very different institutional logic – that of state capitalism. While profit creation for private finance capital is the primary underlying principle in neoliberal markets, importantly, in the state-capitalist ideal type, the state intervenes into capital markets to facilitate state objectives (Lai and Daniels, Reference Lai and Daniels2015). In state-capitalist economies, less trust is put in free markets but rather in state guidance, whereby ‘market forces are utilized’ but only ‘as long as state control over key economic aspects remains intact’ (McNally, Reference McNally2013, p. 42).

China is a prime example of this. In China’s capital markets, the state aims to steer market development into ‘productive’ tracks, and this steering role of the state is ingrained into the institutional setup of markets (Gruin, Reference Gruin2019). Consequently, the state, national development goals, and capital markets are much more entangled than in neoliberal capital markets. Instead of profit/shareholder value, the performance of exchanges, their personnel and management are measured by their contribution towards state objectives rather than commercial indicators. They consequently organize market infrastructures in ways that contribute to these state policies both domestically and abroad. By shaping market infrastructures, the Chinese exchanges extend the state’s ability to exercise control within capital markets by monitoring, regulating, and managing the behaviour of market participants as well as the ability to direct market outcomes towards the accomplishment of national development policies. Following orders from the Chinese authorities,⁴ the Chinese exchanges organize the infrastructural arrangements of capital markets in ways that aim to prevent ‘over-speculation’, maintain social stability, serve the real economy, and contribute to economic reform in spite of a controlled integration into global finance (Petry, Reference Petry2020). So, while investors within Chinese markets are largely profit-driven, Chinese exchanges organize the infrastructural arrangements of markets according to state objectives. Rather than neoliberal, capital markets organized by Chinese exchanges – within the context of China’s socio-economic system of state capitalism – produce a different type of capital markets that can be categorized as state-capitalist capital markets.

The defining difference between neoliberal and state-capitalist logic is thus not the existence of markets per se but rather the principles that underlie market organization (profit creation vs state objectives) and the actors that dominate/shape these markets (private finance capital vs state institutions) (Petry, Reference Petry2021b). Exchanges here organize markets by designing market infrastructures that aim to steer markets by monitoring, regulating, and managing the behaviour of market participants towards the accomplishment of certain economic and political objectives – reproducing state capitalism through financial means (Petry, Reference Petry2020). While state influence over capital markets in such a setup is neither absolute nor always effective, a different way of thinking about and actively managing capital markets dominates in the state-capitalist ideal type.

Going beyond the provision of financial infrastructures which all exchanges have in common, this section explored how their distinct institutional embeddedness influences exchanges’ organization of capital markets as different institutional logics facilitate different infrastructural arrangements that shape how markets work. In other words, not all exchanges organize markets equally. Section 4 explores further differences between exchanges, notably the hierarchical nature of the exchange industry and concentrated power of a few global exchanges.

4 Differences: Hierarchical Nature of Exchange Industry

While all exchanges create financial infrastructures, the extent of their individual power derived from these infrastructures differs substantially. Traditionally, every country had an exchange of varying size. Since the 1980s, however, a new global hierarchy between exchanges has emerged – with global exchanges from the West at the top, complemented by a few regional and larger national exchanges. Overall, an enormous concentration of marketplaces, liquidity, and power had taken place.

Instead of equally powerful national marketplaces, a few global exchanges have come to dominate the exchange industry and thereby the organization of financial infrastructures (Petry, Reference Petry2021a): CME Group which operates Globex, the world’s largest futures trading platform, the largest fixed income trading platform (NEX), and which partially owns index provider S&P Dow Jones Indices; ICE Group which runs the New York Stock Exchange (NYSE), the world’s largest stock market, and several large derivative exchanges like NYBOT (New York Board of Trade) or LIFFE (London International Financial Futures and Options Exchange), together forming the world’s second-largest derivative market; Nasdaq Group which operates the iconic Nasdaq stock market, 28 other US and European capital markets, while Nasdaq’s technology is used by 130+ marketplaces globally; Cboe, the world’s largest options exchange, which also owns BATS (Better Alternative Trading System), the world’s largest alternative trading system (ATS), and EuroCCP, Europe’s largest equity clearing house; Deutsche Börse Group which owns index provider Qontigo, Europe’s largest derivatives market Eurex, and Clearstream, the world’s second-largest international central securities depository; and LSE Group which, next to the London Stock Exchange (LSE), owns index provider FTSE Russell, Refinitiv (formerly Reuters Eikon), and LCH.Clearnet, the world’s largest clearing house.

First, these mostly US-based exchanges control the majority of globally relevant financial infrastructures.⁵ They run the largest, most prestigious and profitable venues, own the most important products, indices, and technological know-how, and shape the development of capital markets globally. By operating the futures markets that create the prices for WTI and Brent, ICE and CME essentially shape the world’s oil market; despite Brexit, the majority of Euro-denominated clearing of derivatives still takes place in London via LCH.Clearnet (James and Quaglia, Reference James and Quaglia2019); and a handful of mostly exchange-owned index providers set standards for market accessibility and corporate governance, increasingly steering global capital flows (Petry, Fichtner, and Heemskerk, Reference Petry, Fichtner and Heemskerk2021). Global exchanges are positioned at crucial nodes within the global financial system.

Secondly, global exchanges also shape how capital markets work elsewhere as the former have been both impacted by financial globalization but have themselves also turned into important agents thereof, spreading the development of capital markets globally.⁶ They export their financial infrastructures to ‘underdeveloped’ markets, support their development, and sometimes even run these smaller markets, promising to create growth by capitalizing on their economies of scale and helping create new financial products and services. In return, global exchanges earn fees, buy (a stake in) those smaller exchanges, or have preferential access to their market data and products.

Nasdaq, for instance, provides technology to 130+ market organizers in 50 countries,⁷ 40+ exchanges use LSE Group’s Millennium platform,⁸ Deutsche Börse Group technology is used by over 30 exchanges and it facilitates various cross-listings and joint ventures,⁹ while CME Group has multiple similar cooperations.¹⁰ Especially when exchanges are (relatively) underdeveloped, such infrastructure and knowledge transfers are crucial (Wójcik, Reference Wójcik2012, pp. 114, 121). Not least because global exchanges aided processes of market development, the number of countries with stock exchanges nearly doubled from 59 to 117 between 1980 and 2005 (Weber, Davis, and Lounsbury, Reference Weber, Davis and Lounsbury2009). Through the provision of financial infrastructures, global exchanges create, connect, and shape marketplaces globally, thereby also significantly shaping the way in which developing country capital markets work. They define the rules of the game in global markets: they have hence become the rule-makers of the global financial order – while exchanges on the lower rungs of the global hierarchy often follow their lead as rule-takers.

Importantly, these global exchanges are mostly US-based companies. Financial infrastructures globally converge around characteristically American ‘best practice’ – including denominating trading and clearing in USD. In this respect, US-based global exchanges fulfil a similar role as other actors that disseminate Anglo-American norms in financial globalization (see Sinclair, Reference Sinclair2005, p. 4). By organizing capital markets according to a neoliberal script and disseminating their financial infrastructures globally, global exchanges facilitate and reproduce US financial hegemony within the global financial system. Hegemonic power is ‘hardwired’ into financial infrastructures (de Goede and Westermeier, Reference de Goede and Westermeier2022; also Westermeier and de Goede, this volume).

While all infrastructures derive their power from the provision of financial infrastructures, this section has illustrated the unequal power relations between exchanges, as the central nodes of global financial infrastructures are controlled by only a handful of Western exchanges. Section 5, however, draws attention to contestations of this power constellation through the growing importance and global impact of non-Western exchanges.

5 Contestations: Beyond Western Markets

However, important changes are afoot in the world of exchanges. Since the 2007–2009 global financial crisis, non-Western capital markets have emerged as central nodes in the global financial system as ever more financial flows are directed towards or originate in emerging markets.

While for decades CME was the world’s largest futures market by trading volume, in 2019 the National Stock Exchange of India took this position, and in 2022 CME was also superseded by Brazil’s exchange B3 (see Datz, this volume). Chinese exchanges have toppled Nasdaq and NYSE as the world’s largest initial public offering (IPO) markets, with more companies being listed in Hong Kong, Shenzhen, and Shanghai than anywhere else in the world. Contrary to what one might think, the world’s largest IPOs were not US tech companies. Facebook/Meta, for instance, only ranked 8th; instead, a Saudi Arabian oil company (Saudi Aramco), a Chinese ecommerce giant (Alibaba), and a Japanese investment holding company (Softbank) occupy the top three spots.

Whereas in 2000 non-Western stock markets only accounted for 22.4% of global market capitalization, their share had doubled (46.1%) by 2020. A similar picture emerges for futures exchanges where the non-Western share of global futures/options trading volume increased from 39.5% to 60.6% between 2007 and 2020. This increasing importance of non-Western markets is mainly due to the rise of a handful of large emerging markets – notably China, but also other countries like the BRICS+ (Brazil, Russia, India, China, South Africa, Iran, Egypt, Ethiopia, and the United Arab Emirates) as well as in Asia.¹¹

This increasing financial activity in non-Western exchanges not only means a quantitative shift but it also has two significant implications. First, exchanges in many of these countries operate quite differently. They often tend more towards the state-capitalist (or developmental; see Petry and Pape, Reference Petry, Koddenbrock and Nölke2023) end of our continuum, thus creating pockets of autonomy from the neoliberal capital markets created by global exchanges. Secondly, many of them are increasingly internationalizing themselves – exporting their different ways of organizing markets abroad. This raises questions not only about resistance towards neoliberal convergence but also potential contestations thereof.

While powerful, global exchanges are also constantly in competition with each other as well as with non-exchange trading platforms such as ATS or dark pools and market structure is consequently much more fragmented (Mattli, Reference Mattli2019). Therefore, especially when it comes to the state–market relationship – which means whether exchanges are themselves profit-driven companies subject to market pressures/competition or whether exchanges are subject to state control/influence to achieve certain national development objectives – we can see big differences between Western and non-Western exchanges.

As previously discussed, China is the extreme case where exchanges are state-owned and policy-driven, consequently organizing capital market infrastructures in a way that follows state-capitalist logic (Petry, Reference Petry2020, Reference Petry2021b). But it is far from the only country where markets function differently from global exchanges.

More examples can be found in other BRICS countries. In India, state institutions are still the largest owners of the stock exchanges and regulatory authorities exercise a lot of control over the design of market infrastructures. Foreign investor access is restricted, speculative trading practices such as high-frequency trading are limited, and offshore trading of certain financial products – such as index futures based on the Indian stock market – are severely curtailed. Indian markets are much more state-permeated than Western markets (Petry, Koddenbrock, and Nölke, Reference Petry, Koddenbrock and Nölke2023). And while Russia’s capital markets had been more liberalized previously, the state has equally started to severely intervene in the organization of capital markets via the Moscow Exchange (Viktorov and Abramov, Reference Viktorov and Abramov2022) – a policy that was accelerated in the run-up to the Ukraine invasion and in the face of Western financial sanctions.

Similarly, exchanges in Asian developmental states organize capital markets very differently from Western markets (Pape and Petry, Reference Petry2023). While exchanges are formally listed companies in Korea and Taiwan, foreign ownership is severely limited, and state influence remains extensive. Exchange management is essentially decided by regulators and the exchanges are vital in facilitating certain developmental policies. This includes protecting retail investors as capital markets serve as an important fix in their respective societies, for instance, by banning certain trading activities like short selling or by punishing foreign investors as scapegoats to placate retail investors who lost money in market downturns (also Yasuda, Reference Yasuda2023). Other aspects include protecting their non-freely tradeable currencies and keeping global investors at bay through a variety of infrastructural arrangements to control market access as well as monitoring and intervention measures.

Even in Japan, which is probably closest to Western exchanges, the stock exchange is in a very different position of power vis-à-vis market participants. While ATS are allowed, they only account for a fraction of trading (around 10%), and market regulations are designed in a way that keeps them small. While seemingly open, Japan’s market structure is deliberately designed to maintain its stakeholder model of capital markets. Deregulation only took place at the margins: international high-frequency traders basically driving up share turnover through trading between the ATS and main exchange,¹² accounting for 70.6% of trading in 2022.¹³ The majority of the market are long-term holdings with very little turnover by Japanese corporates and financials (52.1%), which is complemented by a somewhat more active retail investor segment (17.6%).¹⁴ Market infrastructures thus basically reinforce a traditional buy-and-hold market while allowing a certain international high-frequency trading appendix. Across East Asia, exchanges organize capital markets decidedly differently than in Western markets (Pape and Petry, Reference Petry2023).

Importantly, these non-Western exchanges are increasingly internationalizing themselves – exporting their different ways of organizing markets abroad. Chinese exchanges have actively engaged in constructing financial infrastructures along the Belt and Road (Petry, Reference Petry2023). Similarly, Japan Stock Exchange’s acquisition of the Yangon Stock Exchange was partially motivated by the desire to gain political allies and to fend off competition, such as from Chinese and Korean exchanges, which have invested in and operated marketplaces in Bangladesh, Pakistan, Kazakhstan, and Germany (China), or Uzbekistan, Laos, and Cambodia (Korea). As these countries compete for their standing as regional economic powers, according to one exchange representative ‘the Japanese government encouraged that relationship’ while ‘the Korean government [also] strongly encourages Korea Exchange (KRX) to expand their business in Southeast Asia, even though it’s not profitable’ (cited in Pape and Petry, Reference Petry2023, p. 243).

Similarly, we can see the construction of new cross-border financial infrastructures between the BRICS countries, especially with the aim of reducing vulnerabilities vis-à-vis US-dominated market structures and potential sanctions (see Nölke, this volume). This is especially visible in ongoing Sino-Russian financial infrastructure collaborations. To shield themselves from a US-dominated/USD-denominated global financial system, the two countries facilitate RMB/RUB cross-currency trading, developing a unified RMB/RUB liquidity pool and alternative financial payments infrastructures. These collaborations have important material effects as the USD’s share in Sino-Russian trade settlement dropped from 90% in 2015 to only 40% in 2020, while RMB/RUB currency trading surged by 1,067 between February and May 2022. Similarly, Indian and Russian exchanges have been actively discussing the creation of new financial infrastructures to increase connectivity and reduce dependency, and the success of broader efforts towards de-dollarization – and thus reduce the US’s ability to weaponize financial interdependence – also depend on the existence of alternative infrastructural arrangements to facilitate capital market-based investments.

Importantly, how these markets function as well as their internationalization process are fundamentally different from the profit-driven approach followed by Western stock exchanges (Petry, Reference Petry2021a). Increasingly, exchanges in many pockets of global capital markets have developed their own ways of organizing financial infrastructures in ways that differ from neoliberal logics and have even challenged the current global hierarchy of exchanges.

6 Conclusion: Towards Fragmented Global Markets?

This chapter illustrated the role of exchanges as providers of financial infrastructures in global capital markets. While exchanges are one of the institutional foundations of contemporary capitalism, they have received comparatively little attention in existing scholarship. In part, this was because their source of power was unrecognized. Focusing on their role as providers of financial infrastructures thus provides us with a novel conceptual lens to understand their importance as powerful actors within the global financial system. Rather than investors who are active within a market, exchanges play a much more architectural role for capital markets as they create the infrastructural arrangements that enable the functioning of these markets: from market data, indices, financial products, trading platforms to clearing, exchanges create the rules according to which market transactions take place. By deciding the ‘rules of the game’ and acting as gatekeepers, deciding who gets in, what is traded, and how trading is conducted, exchanges are crucial for shaping capital markets, their development, characteristics, and dynamics.

While all exchanges have this in common, there are also important differences between exchanges. First, exchanges are embedded within specific institutional environments that inform exchanges’ organization of capital markets. Secondly, the chapter illustrates the hierarchical nature of exchanges within the global financial system where a handful of Western exchanges dominate the most important financial infrastructures globally and influence how other exchanges organize capital markets. Thirdly, the chapter discusses the growing importance and international reach of non-Western exchanges as potential contestations of the existing global hierarchy.

While this chapter provided a brief overview, more research is needed to analyse exchanges and their role within the global financial system. More in-depth case studies of exchanges are warranted to better understand the nuances of how exchanges create financial infrastructures and correspondingly shape markets, especially by exploring more closely their relationships to market regulators and participants as well as state actors in different contexts within this process. Furthermore, the synergistic effects that emerge from individual financial infrastructures that exchanges create or control should be analysed in more scrutiny. This, for instance, includes the relationship between market data, indices, and index futures; the increasing relevance and interplay of post-trading infrastructures such as central clearing, central securities depositories, and collateral management; as well as the growing infrastructural eco-system for ‘sustainable investment’ like ESG (Environment, Social, Governance) data, analytics, ratings, indices, or futures (also Fichtner, Petry, and Jaspert, this volume). More research is also needed to investigate the global dissemination/diffusion of financial infrastructures propelled by exchanges. What is the nature of the influence that global exchanges can exercise through the provision of infrastructural arrangements to developing and emerging markets, and what determines its size and reach?

Finally, it is noteworthy that the macro context in which exchanges operate has been rapidly changing with growing geopolitical tensions in recent years (Petry, Reference Petry2024). On the one hand, security considerations might impact the previously profit-driven business model of Western exchanges. US financial sanctions against countries like Russia or China, including the forced de-listing of companies and denying access to cross-border infrastructural arrangements certainly had a big impact on Western exchanges, which now have to navigate these more political waters in their search for profit. On the other hand, we can observe increasing efforts from non-Western countries to circumvent US financial hegemony. De-dollarization and multi-polarity thereby rest on the creation of alternative financial infrastructures which might be informed by different institutional logics. Overall, exchanges and their provision of financial infrastructures must continuously adapt in the face of an increasingly politicized and fractured global economy.

Financial infrastructures provide services that facilitate the clearing, settlement, and recording of financial transactions. Insofar as they can allow for these transactions to be made safer and cheaper, infrastructures can boost trading liquidity, which, in turn, tends to reduce price volatility. Far from a static background to financial transactions, financial infrastructures are “spaces for action” constantly in motion (Hall et al., Reference Hall, Leaver, Seabrooke and Tischer2023, p. 923). That this constant motion is mostly “unseen” speaks to the efficiency of systems which, like the swimmers in Warren Buffett’s famous quote, only notice that they are lacking their swim suits when the tide goes out (Berkshire Hathaway Inc., 2001).¹

Thanks to inspired efforts combining insights from international political economy, the sociology of finance, and science and technology studies, financial infrastructures have gained more attention as the protagonists, themselves, of the prevalence of financial logics, products, interest, and operations in economic life, known as financialization (Bernards and Campbell-Verduyn, Reference Bernards and Campbell-Verduyn2019; Petry, Reference Petry2021; Tan, Reference Tan2021; Braun and Koddenbrock, Reference Braun, Koddenbrock, Braun and Koddenbrock2022; Hall et al., Reference Hall, Leaver, Seabrooke and Tischer2023). One of the fruitful contributions of this scholarship is the separation of “infrastructures” from “markets.” Despite their mutually constitutive relationship, a focus on financial infrastructures (their technological evolution, limitations, champions, and competitors) allows for the rethinking of “markets beyond a dominant transactional metaphor that privileges exchange as the cornerstone of the economy” (Pardo-Guerra, Reference Pardo-Guerra2019, p. 11). Financial infrastructures “shape the way core [financial] functions are undertaken” (Bernards and Campbell-Verduyn, Reference Bernards and Campbell-Verduyn2019, p. 777), creating “the facilities and rigidities within which relational and spatial [financial] reorganization takes place” (Hall et al., Reference Hall, Leaver, Seabrooke and Tischer2023, p. 3). In this vein, we add, they can enable or constrain the development of domestic financial markets.

Financial market development is not necessarily about more subordination to foreign financial market forces (Bortz and Kaltenbrunner, Reference Bortz and Kaltenbrunner2017) or the unfettered financialization of the local economy. Beyond the diversification of sources of credit, improving access, liquidity, and reducing costs, financial market development also involves stronger investor protection and corporate governance. In the same vein, a deeper and more “diversified domestic institutional investor base with domestic currency liabilities can […] help offset international capital outflows,” soothing the blow of exogenous economic shocks (CGFS, 2019, p. 5; Sahay et al., Reference Sahay, Čihák, N’Diaye, Barajas, Bi, Ayala, Gao, Kyobe, Nguyen, Saborowski, Svirydzenka and Yousefi2015; Svirydzenka, Reference Svirydzenka2016).² Furthermore, the development of a local investor base can be a (partial) shield to the kind of price sensitivity to global financial shocks that large foreign holdings of domestic assets tend to trigger (IMF, 2014, p. 69). To be sure, financial development provides no assurance of financial stability. Yet, as argued by the Committee on the Global Financial System (CGFS, operated within the Bank for International Settlements), financial infrastructures “with sufficient transparency on pricing and volumes can help maintain confidence in periods of financial market stress, provide information on the build-up of risks, reduce market abuse, and deter other predatory practices in capital markets” (CGFS, 2019, p. 54).

It is well known that “financial institutions and markets around the world differ markedly in how well they provide” key financial services (Čihák et al., Reference Čihák, Demirgüç-Kunt, Feyen and Levine2012, p. 5). Yet the extent to which financial infrastructures not only differ among one another but are differently constrained in how much they contribute to the (further) development of financial markets, has not been explored much by either the emerging literature on financial infrastructures or the broader literature on the international political economy of development.

In this chapter we argue that thinking about the correlation between financial infrastructure and financial development as linear can be too simplistic. Even when they are present, up-to-date, and reliable, financial infrastructures’ contribution to promoting singular markets may not translate into a deepening of the domestic financial system. That is, technological innovations can advance data gathering and analysis, increase the speed of financial operations, produce and distribute more reliable information on investment options, yet not necessarily enhance and broaden the domestic financial system in ways that contribute to financial deepening. The latter (a term often used interchangeably with “financial development”) refers to the “increase in the depth, liquidity, efficiency, and volumes of financial institutions and markets,” along with the diversification of domestic sources of finance (Dabla-Norris et al., Reference Dabla-Norris, Ojima, Arena and Schipke2015, p. 141; Kiyotaki and Moore, Reference Kiyotaki and Moore2005).³ Hence, the deterministic assumption that more developed infrastructures lead to more developed markets begs scrutiny. In this chapter we ask: To what extent do financial infrastructures shape markets in middle-income, developing economies? The question not only probes the contingent relationship between infrastructural changes and financial development, but also explicitly acknowledges “the variegated nature of empirical financialization processes” in developing countries (Petry, Koddenbrock, and Nölke, Reference Petry, Koddenbrock and Nölke2023, p. 147).

The empirical focus here is on Brazil: the largest economy in the region, the country with the highest level of financialization (Karwoski, Reference Karwoski, Mader, Mertens and van der Zwan2020), and the largest stock exchange among its neighbors. Brazil’s financial system, like that of other Latin American countries, is bank-based. Yet, the country has been responsible for most initial public offerings (IPO) activity in the region (OECD, 2019, p. 15), has encouraged high-frequency trading (B3, 2022; Petry, Koddenbrock, and Nölke, Reference Petry, Koddenbrock and Nölke2023), and is home to “one of the best-known initiatives in the region for strengthening investor confidence in equity markets,” the Novo Mercado segment of the Brazilian Stock Exchange, created in 2000 (OECD, 2019, p. 44). It is hence, among regional peers, a crucial case in the effort of understanding financial infrastructures in the context of financial development. If such development is constrained in Brazil, then it is also less likely to materialize elsewhere in the region.⁴

Advances in Brazil’s financial infrastructures have been hard to miss, even if backgrounded in analyses of the country’s financial sector. From the electronic interdealer platform for sovereign bonds (SELIC), the consolidation of a central stock exchange (B3), the successful launch and surprisingly rapid adoption of a digital payments platform, known as Pix⁵ to the blossoming of financial technology companies in less than a decade, it is clear that the Brazilian public and private sectors have embraced financial technology enthusiastically (CGFS, 2019; Duarte et al., Reference Duarte, Frost, Gambacorta, Wilkens and Shin2022; Bakker et al., Reference Bakker, Garcia-Nunes, Lian, Liu, Perez Marulanda, Siddiq, Sumlinski, Yang and Vasilyev2023; Banco Central do Brasil, 2023; see Kaltenbrunner and Orsi’s chapter, this volume). Among these efforts, those which were not designed and executed by the government and are most closely related to the diversification of sources of credit for domestic firms are the centralization and modernization of the Brazilian Stock Exchange.

Through a brief analysis of the Brazilian Stock Exchange since the early 1990s, this chapter highlights both advances in and constraints to capital market development in spite of significant technological strides toward creating up-to-date financial infrastructures. It is argued that infrastructural advances may be necessary but insufficient steps toward that goal in developing economies. Structural characteristics of domestic capital markets – such as the availability of subsidized credit and the crowding-out effect of public securities on private ones – constrain domestic capital markets. In the same vein, conjunctural factors, such as persistently high interest rates, also run counter to private and public efforts to increase competition and dynamism in domestic credit markets, even in the presence of an ever more sophisticated domestic stock exchange.⁶

The chapter is organized in three sections. Section 1 discusses what is meant by an understanding of financial infrastructures within the context of financial development in particular, and situates the Brazilian case in its region. Section 2 describes attempts to modernize Brazil’s financial infrastructures with a focus on the national stock exchange. The section also highlights the ways in which both structural and conjunctural factors have constrained local capital market development, which, in turn, has shaped the role of the stock exchange in the country’s financial system. The conclusion in Section 3 suggests skepticism about deterministic expectations when it comes to linking advancements in financial infrastructures with capital market development. Instead, more productive to understanding the nature and impact of financialization in developing countries is to further inquire about how such financial infrastructures adapt to and evolve in spite of lingering context-specific constraints.

1 Financial Infrastructures in the Context of Financial Development

Despite the growth in middle-income economies’ government and corporate securities markets, corporations in these countries still have less access to longer-term, local currency financial streams, and fewer small firms access equity markets than is the case in advanced economies (Didier and Schmukler, Reference Didier and Schmukler2013; IMF, 2018). In Latin America, in particular, credit to the private sector and liquidity in the domestic equity market are still relatively restricted (Didier and Schmukler, Reference Didier and Schmukler2013). Capital markets are bank-based and have a short-term horizon. The region has not benefited from the global shift in capital allocated toward developing countries’ markets, which in Asia, for instance, has led to a greater volume of IPOs. Even though Latin American listed companies’ market capitalization (i.e., the value companies trade in the stock market) as a share of GDP rose from 28% of GDP on average for the period of 1995 to 2000 to 52% of GDP between 2005 and 2010, the blow from the global financial crisis of 2008 (OECD, 2019) and then the pandemic of 2020, along with political cycles, have led to an overall slow recovery.

According to Schneider’s depiction of the Latin American variety of capitalism (what he calls “hierarchical capitalism”): “in the absence of deep equity and credit markets, business groups, along with [multinational corporations] MNCs, have been the main private institutions for mobilizing large-scale investment,” relying mostly “on retained earnings, international loans, or loans from state agencies” (Schneider, Reference Schneider2013, p. 43). Furthermore, Latin American markets are characterized by a high level of ownership concentration and the existence of large industrial and financial conglomerates which impair liquidity in stock markets, increasing transaction costs and inhibiting investment. From 2009 to 2019, Latin American countries recorded the lowest liquidity ratio compared to other regions. Concentration is present in two forms: “trading concentration in which only a few and large companies are actively traded, usually those included in the local index,” and in the form of the “concentrated ownership structure” of the listed companies (OECD, 2019, p. 24).

Brazil’s financial market is, according to the IMF (2018, p. 30), a “liquid and sophisticated” one. Approximately 475 companies are listed in the Brazilian Stock Exchange, B3, recording an aggregate market capitalization of USD 836 million (in depreciated Brazilian real exchange rate values of May 2023; see B3 2023). The number is widely acknowledged as unimpressive for a country with an economy the size of the Brazil’s (Forbes, 2020). Yet is this evidence that capital markets in Brazil are overregulated and/or financial infrastructures lacking? The answer is “no” on both counts.

Petry, Koddenbrock, and Nölke’s (Reference Petry, Koddenbrock and Nölke2023, pp. 144–145) comparative study of exchanges in Brazil, Russia, India, China, South Africa, and South Korea suggests a conceptual continuum between neoliberal and state capitalist capital markets. In the first, profit creation is the organizing principle and private investors the dominant actors. In state capitalist institutional settings, in contrast, exchanges “organize capital markets to facilitate state objectives” (p. 145), thereby “reproducing state capitalism through financial means” (p. 148). The authors find that Brazil stands out as diverging from the path that points to a state capitalism-based capital market. The ownership structure of the Brazilian exchange is not only private but largely foreign. High-frequency trading is encouraged by domestic financial authorities and the Brazilian Stock Exchange allows for offshore trading of its indices. The authors conclude that investment in Brazil is “relatively liberalized with only a few restrictions” (p. 153). In fact, within their sample of six middle-income economies, Brazil and South Africa are the “most neoliberal in their approach to governing capital markets” (p. 158).

Petry, Koddenbrock, and Nölke’s (Reference Petry, Koddenbrock and Nölke2023) valuable exploration of domestic financial infrastructures contributes to the broader discussion of variegated capital markets by including non-neoliberal logics into the functioning of these markets and their facilitating infrastructures. Given the intentionally simplistic typology (whether neoliberal or state capitalism-based capital markets), variation within the neoliberal “model” remains presumed, but not discussed. In particular, still to be understood are the ways in which neoliberal logic may indeed predominate as the organizing principle of capital markets, which, nonetheless, remain relatively underdeveloped despite financial liberalization. To be sure, studies that explore “subordinated financialization” highlight “the growing but subordinate nature of [developing countries’] financial integration, which is dominated by short-term capital flows that remain funded in [advanced economies’] currencies.” Even though global financial integration, in this perspective, is understood as “fundamentally shap[ing] the financial practices of domestic agents, such as the holding of financial assets by non-financial corporations” (Bonizzi, Kaltenbrunner, and Powell, Reference Bonizzi, Kaltenbrunner, Powell, Mader, Mertens and van der Zwan2020, p. 184), such integration has done little to transpose the structural obstacles that still restrict domestic capital market development. These obstacles, in turn, shape the extent to which domestic financial infrastructures, such as stock exchanges, not only operate as marketplaces, but can influence local financial life as actors of financialization themselves (Petry, Reference Petry, Mader, Mertens and van der Zwan2020, Reference Petry2021; and see Petry’s chapter in this volume).

In this vein, here we are interested in grasping the extent to which financial development can remain a truncated process amid steady financial integration, growing financialization (Bonizzi, Reference Bonizzi2017; Karwoski, Reference Karwoski, Mader, Mertens and van der Zwan2020), and notable digitalization (Paraná, Reference Paraná2018; Bakker et al., Reference Bakker, Garcia-Nunes, Lian, Liu, Perez Marulanda, Siddiq, Sumlinski, Yang and Vasilyev2023) – in large part boosted by modern financial infrastructures. Applying an “infrastructural gaze” (Westermeier, Campbell-Verduyn, and Brandl in this volume) to financial development allows for not only the unpacking of micro and macro relations, but even more specifically, for an understanding of the ways in which micro-financial processes are contingent on macrostructural and conjectural dynamics in ways that differentiate developing from advanced economies. In this sense, beyond “subordination” (evocative of hierarchical ordering and likely dependence), financial development is indicative of particular contingencies related to exogenous dynamics as well as path-dependent and endogenous (domestic) policy directions, as specified later in this chapter.

In the Brazilian case, a neoliberal operating logic in the financial sector is nonetheless shaped by the ubiquitous presence of the state (Taylor, Reference Taylor2020). In 2018, public banks provided 55% of total bank credit. As stated in the 2018 International Monetary Fund’s (IMF’s) Financial Assessment Report for Brazil, “government debt securities are the centerpiece of the fixed income market and are the single most important asset class held by investment funds, pension funds and insurance companies.” Moreover, “the role of public banks and state-owned firms, the critical importance of repos collateralized by government securities as the main instrument for conducting monetary policy and carrying out interbank transactions, and the centrality of government securities as the main liquid financial instrument in Brazil are distinguishing features” of the Brazilian financial system (IMF, 2018, p. 19; see also Lazzarini, Reference Lazzarini2011).

In order to better understand these dynamics, we turn next to a brief empirical analysis of the Brazilian Stock Exchange, B3.

2 The Brazilian Stock Exchange as a Contingent Financial Infrastructure: Micro Innovations and Macro Constraints

Until the early 1990s, prevailing high inflation was a deterrent to Brazilian economic growth and stability, but also “an important source of financing both for the government, in the form of inflation tax, and of self-finance for investing companies – especially for those with strong market power and capacity to increase mark-ups rapidly” (Studart, Reference Studart2000, p. 21). In this context, private financial institutions focused on providing short-term loans and intermediation of the foreign savings. As a result, despite the creation of an independent regulatory body for domestic financial markets (the Brazilian Exchange Commission, or Comissão de Valores Mobiliários – CVM) in 1976, as well as the updating of legislation about duties and liabilities of financial intermediaries and issuers, capital markets “remained fledgling throughout the 1980s and 1990s” (de Mello and Garcia, Reference de Mello and Garcia2011, p. 26; Taylor, Reference Taylor2020). The many financial crises originated in developing countries affecting Brazil in the 1990s further discouraged advancements in the domestic financial sector.

With the price stability brought about by the Real Plan of 1994, regulatory shifts helped shape a new Brazilian financial landscape given: capital market liberalization, the banking reform in 1988, and government bailout programs targeting state banks after the 1995 crisis. Add to these the entry of new foreign investors attracted by the appreciation of the real, more flexibility in regulations involving investment funds and other institutional investors, relatively high interest rates, and the growth of government debt. Capital and financial derivatives markets grew. Foreign financial institutions and domestic institutional investors gained a prominent role in Brazilian capital markets (Studart, Reference Studart2000). However, between 1995 and 2003, there were only six IPOs in the country. Rather than access funds through the Brazilian Stock Exchange, domestic firms relied on foreign markets, through American depositary receipts (World Finance, 2014).

Indeed, while sovereign bond markets underwent a major shift from foreign currency-denominated bonds to local currency bonds, diminishing significantly the exchange rate risk of public debt (Didier, Hevia, and Schmukler, Reference Didier, Hevia and Schmukler2012), equity markets experienced a bumpier evolution. Between 2004 and 2021, the number of IPOs rose substantially, but not consistently (Folha de São Paulo, 2023). The rise was in part the result of the establishment of the then-Brazilian Stock Exchange, Bovespa’s, Novo Mercado in 2000, a listing segment with rules in line with international standards for corporate governance, meant to enhance corporate disclosure, transparency, and accountability (Didier and Schmukler, Reference Didier and Schmukler2013). After the initial period of macroeconomic instability in the early 2000s, Novo Mercado caught on. Total market capitalization increased more than sevenfold from 2003 to 2011. New amendments to the standards were approved by companies on the special listing segments in June 2017, entering into force in January 2018. They included a reviewed definition of independent directors, and stricter rules related to internal audits and audit committees (OECD, 2019).

Among the changes taking place since 2019, by far the most significant were the ones that transformed the stock exchange itself. As part of a number of mergers among Brazilian firms, clearing houses were integrated. In particular, the São Paulo Stock Exchange (Bovespa) merged with the main futures exchange (BM&F) to form BM&FBovespa in 2008. In 2017, BM&FBovespa purchased Cetip, the country’s largest central depository for over-the-counter private securities, and derivatives, becoming B3, the abbreviation for Brasil, Bolsa e Balcão (Agência Brasil, 2017). Its clearing and settlement services are part of a plan to promote “a single set of rules, a single participant structure and register, unified processes for position allocation, clearing and control, a single settlement window, a single risk management system, a single collateral pool, and a single safeguard structure.” The logic was “to provide better liquidity management, more efficient capital allocation, more efficient margin calculation and lower operational risk for participants,” along with a cost reduction of about 30% (CGFS, 2019, p. 40; Agência Brasil, 2017).

B3 is a private firm whose own stocks are traded in the Novo Mercado segment of the exchange, and which is regulated by the National Monetary Council, Brazil’s central bank, and the Brazilian Securities and Exchange Commission (CVM.gov.br). B3 manages the Brazilian stock and derivatives markets. Its total amount negotiated in fixed and variable income reached approximately USD 437 billion in 2022 (B3, 2023). Among its newer products, B3 lists exchange-traded funds (ETFs), albeit the “numbers are still modest,” given low liquidity relative to international markets. According to B3, as of 2020, there were twenty-two ETFs listed on the exchange, “16 referenced to stock indexes, two of them foreign (referenced to the S&P 500), and six tracking fixed income indexes” (Focus, 2020). The number of investors in ETFs grew 141% from 41,468 in December 2018 to 100,029 in November 2019, revealing that these funds became a port of investor entry into stock markets in light of “the improvement in the country’s macroeconomic scenario and the low interest rate” (Focus, 2020). Indeed, B3’s role in the Brazilian financial system is contingent and adaptive. We move next to explaining both the nature of this contingence and B3’s efforts to adapt and expand in spite of it.

2.1 B3 Boxed In: Constraints to Stock Market Growth

Capital market development in Brazil has been constrained by the country’s long battle with high inflation, the primacy of state sources of long-term credit, and persistently high interest rates. These macro dynamics have determined the extent to which diversification of investment outside of government bonds is both feasible and attractive to private investors. By the same token, the nature and scope of the role and impact of the country’s stock exchange is delimited by these characteristic obstacles to the growth and variety of private credit sources and investment opportunities outside of the state and traditional banking system.

Monetary stability has been Brazil’s long-term battle. That is despite the adoption of an inflation-targeting regime and much more solid economic fundamentals, “stress-tested” through many a global crisis (Barbosa-Filho, Reference Barbosa-Filho, Epstein and Yeldan2009; Segura-Ubiergo, Reference Segura-Ubiergo2012; de Gregorio, Reference de Gregorio2019). The combination of political risks, particularly prevalent in electoral cycles, and a history of inflationary challenges have led to contractionary monetary policies which have positioned Brazil’s interest rates among the world’s highest. Their impact on local markets is unescapable, as we explain in what follows.

Another key structural constraint associated with Brazil’s institutional and economic development has been the role of public (development) banks like the Banco Nacional de Desenvolvimento Econômico e Social (BNDES), which provides relatively cheap (earmarked and subsidized) credit to local firms. Since around 2014, earmarked credit in Brazil corresponded to approximately 40% of total credit in the country, most of it distributed by the BNDES (Barroso and Nechio, Reference Barroso and Nechio2019). Although this trend was partially reversed during the Bolsonaro presidency (2016–2020), particularly when it came to subsidized (below market) interest rate loans, returning President Lula da Silva has promised to get the BNDES back to its role as a key source of financing for national firms (InfoMoney, 2023). This role, however, has historically discouraged capital market development, while the particularly concentrated ownership structure of most Brazilian firms made them more reluctant to go public, fearing the loss of internal managerial control (Lazzarini, Reference Lazzarini2011; Schneider, Reference Schneider2013).

In contrast, regulators have attempted to introduce leaner rules when it comes to stock exchange activities in particular. In mid-2022, as a result of consultations between the public regulator and market participants, a new resolution (No. 160-1) by the national Securities and Exchange Commission was instituted, aiming at simplifying IPOs. Retail investors will have access to more transparent and standardized information about IPOs, in an attempt to both protect investors and spur further capital market development (Anbima, 2022).

With monetary instability diminished but not defeated, the benchmark interest rate (SELIC) in Brazil, remains high, well above the European (0.75%), and US rates (2.5%) (Banco Central do Brasil, 2022). In the last 18 years, from 2004 to 2022, the average Brazilian real interest rate was 5% per year (Banco Central do Brasil, 2022). Therefore, investors are highly compensated for their investment allocations in public securities without having to incur in much risk. Shorter-term floating rate or inflation indexed securities are Brazil’s predominant asset class (IMF, 2018).

In fact, a lingering “conjunctural” factor (because some periods of decline have been experienced), high interest rates are a notorious deterrent of growth in domestic capital markets (IMF 2018; OECD, 2019). These rates are mostly the product of iterated and largely successful price stabilization attempts. They also help finance the government deficit. Yet such high interest rates, as explained, make relatively low-risk public securities continuously attractive, crowing out private securities. In addition, the Tesouro Direto platform, launched in 2002 (similar to the TreasuryDirect program offered by the US Department of the Treasury), makes purchasing government bonds easily accessible to individual investors (Miranda, Reference Miranda2018). That is even easier now that the system has been connected to the PIX platform of mobile/digital payments (Ministério da Economia Brasil, 2022).

It is difficult for capital market products to compete with such broadly available and advertised federal securities (Miranda, Reference Miranda2018). The volume of stocks traded in the Brazilian stock market only surpassed that of fixed income investments (bonds) between 2007 and 2010 – excluding 2009, when the impacts of the financial crisis of 2008 were felt. More recently, the volume of investments in stocks beat bonds in 2022, when interest rates were at their lowest level in recent history (ANBIMA, 2022).⁷ The presidential elections in the end of 2022 have since reversed this brief reprieve. Figure 15.1 displays the evolution of nominal interest rates in Brazil over the past twenty-seven years.

Figure 15.1 Brazilian interest rates, 1996–2023.

Source: Author’s elaboration based on data by Ipea, 2023.

Moreover, Brazilian individual investors “favor bank paper over stocks and corporate bonds.” Banks’ certificates of deposits are extremely popular since they offer returns comparable to those on government bonds with similar maturities (Miranda, Reference Miranda2018). Institutional investors are also attracted to the high returns on government bonds. Not unlike their peers in the region, Brazilian pension funds concentrate their portfolios on public bonds; they buy and hold assets, adding little liquidity to secondary markets and not contributing significantly to capital market expansion (Stallings and Studart, Reference Stallings and Studart2006; Park, Reference Park2012; Didier and Schmukler, Reference Didier and Schmukler2013; Datz Reference Datz2014). In a relatively high interest rate environment, investing in low-risk domestic bonds is a conservative but also profitable bet for these large domestic investors (Abrapp, 2022; Previ, 2022–2019; Petros, 2022–2021). Hence, despite the substantial growth of Latin American institutional investors, their role in the stock market and in fostering financial development more broadly has been relatively limited (de la Torre, Reference de la Torre2012; Datz, Reference Datz2013).

3 Conclusion

Financial infrastructures are not merely a set of static foundations on which financialization is played out. As new studies have established, they are actors dynamically engaged in the competitive process of further expanding financial activities. Technological advances are believed to potentialize this role of financial infrastructures, expanding modes and strategies for investing, as well as connecting local and global markets.

Focusing on the largest economy in Latin America, with the largest capital market and stock exchange, we have argued that the extent to which financial infrastructures shape markets in middle-income economies is a function of structural (path-dependent) and conjunctural conditions (cyclical and less unique to the case). Despite significant technological and managerial advances in the operationalization of the national stock exchange, amid an increasingly more enabling regulatory environment, Brazil’s fundraising in capital markets is still relatively limited and greatly affected by macroeconomic cycles, particularly fiscal policy uncertainties – a structural characteristic of the local economy in spite of notable improvements since the 1990s. Persistently high-yielding public bonds still crowd out private securities for the most part. The country’s modern stock exchange hence operates within constraints that make evident the nonlinear connection between the growing technological mastery and ambition of financial infrastructures and the deepening of financial markets. Indeed, infrastructural advances may be necessary but insufficient steps toward this end.

Once we dismiss the deterministic assumption that the development of infrastructures leads to the development of capital markets in the aggregate, we can better understand not only “the facilities and rigidities” created by financial infrastructures in financial (re)organizing, as Hall et al. (Reference Hall, Leaver, Seabrooke and Tischer2023, p. 3) suggest, but also the “facilities and rigidities” within which they operate. What happens despite or even as a result of existing constraints, as well as what fails to materialize given enduring structural obstacles and unfavorable conjunctural trends inform our understanding of financial “development” beyond teleological expectations. This is not just about finding out how infrastructures can help overcome obstacles to (macro)financial development – they simply may not – but, rather, how different platforms are continuously modernizing given domestic obstacles to more robust market development, in a progression that is more adaptive “evolution” than partial equilibrium (thwarted growth).

1 Introduction

There is something peculiar about economic transactions that has to do with the gap between their agreement and settlement. Signing a contract means the parties enter a mutual obligation to deliver and to pay, respectively. Later, when both delivery and the corresponding payment have taken place, the trade has been “settled.” The interval in time and space between agreement and settlement may be large, as when you pay in advance for goods that need to be shipped and even produced – or it may be very small, as when some contemporary financial transactions are settled in “real time” (Riles, Reference Riles2004; Krarup, Reference Krarup2021). However, in all cases, there’s a gap between agreement and settlement that must be handled. What if payment takes place, but delivery fails? Or vice versa? The question is not pure theory. In 1974, due to time differences, a German bank (Herstatt Bank) that had famously engaged in foreign exchange trade ended up declaring bankruptcy after having received Deutsche marks in Frankfurt but before having paid out the corresponding dollar position in New York. The example showed that there was an implicit credit involved in the gap. How do we close the gap between the entering of financial transactions, for example, at a stock exchange, and the actual delivery of assets versus payment of cash among the relevant accounts? Financial infrastructures play a structuring role (cf. Pinzur and Coomb’s chapters, this volume), but my analytical and empirical focus offers a perspective that is both broader (money and credit) and narrower (the European Union (EU)) than generally seen in the literature.

In this chapter, I offer an overview of the biggest European financial infrastructure project to date – the TARGET2-Securities (T2S) settlement platform – and situate it in the longue durée of money and finance (cf. also Roitman’s chapter, this volume). The analysis is motivated by the broader question of how the kind of seemingly fundamental problems of agreement and settlement of economic transactions outlined relate to the historically specific settlement technologies in the EU today. The literatures on money, finance, and financial infrastructures share a broad partitioning among scholars who ascribe priority to the historical contingencies of technologies, regulations, and broader social formations on the one hand (e.g., Callon, Reference Callon1998; MacKenzie, Reference MacKenzie2006; Muniesa, Reference Muniesa2015) and, on the other, those who emphasize the universal nature of money and its problems (e.g., Mehrling, Reference Mehrling2010; Ingham, Reference Ingham2016). While thus raising serious difficulties, the question is paramount to our understanding of contemporary financial infrastructures and lurks in the background of most endeavors in this discipline (Petry, Reference Petry2021; Pinzur, Reference Pinzur2021).

Like most other financial infrastructures, T2S remains little known outside the closed circles of the sector and academic specialists. Nevertheless, T2S is a major achievement of its kind, costing some half a billion euros plus the expenses of adapting the existing national systems – private and public. Unusually for this kind of project these days, the settlement platform was created by the European Central Bank (ECB) and implemented between 2015 and 2017. A few years later, by 2020 it settled almost 177 million transactions representing a total value of €173,000,000,000,000 – plus liquidity transfers, probably of a similar order of magnitude (ECB, 2021). As of 2022, T2S connected twenty European countries, with more in view of joining soon (ECB, 2022). T2S thus marks a high point of European financial infrastructure integration.

When the euro was introduced in 1998, there was a need for an integrated real-time payments system for the Eurozone (on “real time,” see also Riles, Reference Riles2004). This allowed instant arbitrage among national money markets and hence supported the single monetary policy. It was introduced in 1999 under the name TARGET, which stands for Trans-European Automated Real-time Gross Settlement Express Transfer System (see ECB, 2016). In 2007, a new version was launched, unsurprisingly called TARGET2 (Lucas, Reference Lucas2008). As detailed later in this chapter, with TARGET2, the accounts of the national central banks in the Eurozone were directly connected, meaning that payments could be made cross-border in central bank money and hence as fast and as safe as domestic payments. By contrast, the settlement of financial transactions, involving not only money but also securities (stock or bonds), T2S, was only operable about a decade later (Quaglia, Reference Quaglia2010; Porter, Reference Porter2014). Whereas the need for European central banks to build an infrastructure supporting the common monetary policy was almost self-evident, for long the view prevailed that integration of securities settlement infrastructures should be market-driven, that is, provided by private companies.

T2S is situated in the broader program for single market integration in the EU. A central principle in EU treaty law is the elimination of any “prevention, restriction or distortion of competition” (EUR Lex, 2016, §101). The T2S project – and more broadly the creation of financial infrastructures by EU bodies – must be seen in light of this ideal of free and frictionless competition across borders in the EU. As I have analyzed elsewhere, the T2S project can thus be seen as a response to a general problem in the EU of securing competition understood as a “level playing field” (Krarup, Reference Krarup2019a, Reference Krarup2021, Reference Krarup2022, Reference Krarup2023). Paradoxically, the buttressing of private competition requires harmonized and centralized market infrastructures. This provokes problems about when a service – such as the settlement of transactions – is a commodity to be offered by private companies on a competitive basis, and when it is a necessary infrastructure for the level playing field of the single market that demands strong centralized governance (Krarup, Reference Krarup2019a; Brandl and Dieterich, Reference Brandl and Dieterich2023).

However, at the same time, T2S and other contemporary financial infrastructures appear to reflect older and far more widespread problems of credit and settlement than the context of EU law would suggest. In this chapter, I outline these two ways of understanding T2S. First, there is the historically contingent perspective of European integration. Second, we may adopt a more universal perspective on settlement that emphasizes the fundamental dynamics of money and credit. I ask what the relationship between the two perspectives is and whether they conflict with each other. Specifically, I trace the origins and design of the T2S securities settlement platform and use this as a background to address the relationship between the universal and fundamental problems of credit and financial infrastructures, on the one hand, and the specific political and technological context of European market integration on the other. I begin by offering an overview of securities settlement systems (SSS), relating them to general problems of credit and financial infrastructures. I then outline the history of the T2S project, explaining its functioning and construction, showing how T2S relates to the general problems. On this basis, I discuss how the specific technopolitical contingencies of the T2S project, the legal and discursive determinants of EU market integration, and the universal problems of credit and financial infrastructures are related.

2 The Strange World of SSS

When a financial trade takes place, for example, on a stock exchange, that transaction needs to be settled, meaning that the cash must be paid and the financial assets delivered in exchange (cf. Petry’s chapter, this volume). Today, both payment and delivery are essentially digital accounting operations. However, despite digitalization, agreeing on a deal and signing a contract remains different from the actual delivery of the purchased asset and corresponding payment in money. Where and how does payment and delivery take place when it comes to contemporary financial products? The question leads us to SSS. These are parallel and complementary to payments systems, often connected to them in order to be able to effect payment and delivery simultaneously. SSS thus provide essential infrastructural services to contemporary financial markets (see also Golka and Swartz’s chapters, this volume). The present European standard is for settlement to take place two days after the trade (“T+2”). As I detail in the sections that follow, instantaneous settlement is possible, for example, in the highly advanced domestic bookkeeping systems and on the T2S platform, but the standard deference is often employed because complexity and the number of “custodian” institutions that have to be in concert demand it – especially in the case of cross-border transactions.

The “settlement chain” illustrated in Figure 16.1 is a concept used by professionals to describe the three main steps of trading, clearing, and settlement. What happens in the first step – trading – is generally well known: trading can take place on stock exchanges, bilaterally (“over the counter”), or in open market operations, where central banks buy or sell sovereign bonds to affect the short-term interest rate in markets. Some transactions go from here directly to be settled in “real time.” Others (especially those from stock exchanges) pass by a “clearinghouse” that accumulates the multilateral positions of each participant throughout a period of time (such as a day), netting in- and outflows before settlement. Clearinghouses allow participants to save liquidity and plan their financial flows (see also Riles, Reference Riles2004; Millo et al., Reference Millo, Muniesa, Panourgias and Scott2005). Finally, in settlement the actual exchange of money and securities takes place on the accounts of the counterparties (traders). Often, such final settlement takes place in the central bank for cash and in so-called central securities depositories (CSDs) for securities. Like clearinghouses, CSDs are regulated as infrastructures, meaning that they can have little exposure in the market.

Figure 16.1 The settlement chain.

Source: Author

Settlement is thus removed from what we usually imply when talking about financial markets (trading floors, stock exchanges, banks, monetary operations), in terms of regulation, institutions, and time. It is therefore important to remember that, when we begin to discuss credit, money creation, and securities later in this chapter, one should not draw too hasty conclusions from the insights gained in the domain of infrastructures back to financial markets. Nevertheless, there are important analytical and conceptual insights to be gained from this which I will discuss in the sections that follow.

3 The Payment Infrastructures of International Finance

Instruments of credit are virtually as old as the available written records, and so basic operations of financial infrastructures, such as clearing and settlement of credit instruments, have a very long history. In ancient Babylonia and Egypt, credit instruments were used for collecting taxes and governing the seasonality of agriculture (Davies, Reference Davies2010). In the twelfth century, the great fairs in the Champagne region connecting Northern and Southern European industries involved extensive use of agents, partnerships, and professional freighters and couriers, forming a system “based entirely upon credit” with net clearing and settlement (pagamentum, “making peaceful”) at the end (Face, Reference Face1958). In the nineteenth century, London bankers organized the multilateral clearing of checks as follows. When a client of a bank made a payment by check, the receiver would take that check to his bank, which in turn would have to get the money from the payer’s bank. To facilitate this process, every day the London banks would send delivery boys with checks they received to the Bankers’ Clearing House where, by the end of the day, the net position of each participant (between cash receivable and cash payable) was calculated (Babbage, Reference Babbage1963 [1832]). As for today, Perry Mehrling has shown how the basic principles of finance remain highly stable across widely different financial instruments and that there are striking parallels between the fundamental logics of nineteenth century and contemporary finance, including such modern creations as “shadow banking” (Mehrling, Reference Mehrling2010; Mehrling et al., Reference Mehrling, Pozsar, Sweeney, Neilson, Claessens, Evanoff, Kaufman and Laeven2015).

In all of these cases, the instruments of credit and finance are closely connected to the infrastructures designed to safely and efficiently generate, trade, transfer, and settle them. In fact, I would claim it is impossible to separate money and credit from financial infrastructures because money and credit are themselves such financial infrastructures, at least in part. This claim diverges from the definition of money by its “functions” found in contemporary economics textbooks (but dating back to Aristotle’s Nicomachean Ethics vol. 5): a store of value (“a way to transfer purchasing power from the present to the future”); a unit of account (“the terms in which prices are quoted and debts are recorded”); and a medium of exchange (“what we use to buy goods and services”) (Mankiw, Reference Mankiw2012, p. 82). The standard definition dislodges from view the deep and indeed foundational contradictions immanent to the concept of money. The paradox becomes more evident by saying that money is, simultaneously and often conflictually, commodity and credit (Krarup, Reference Krarup2021).

To the extent that money has historically been a material commodity, such as cattle or gold (a view advanced by economists such as Menger (Reference Menger1892) but historically misleading according to Davies (Reference Davies2010)), money was created when that commodity was created (e.g., when gold was mined). Pure commodity money would be highly inefficient because market participants have to earn before they can pay. A merchant who wants to sell goods at a high profit in a distant market needs credit to pay for the goods now in the home market collateralized with the expected future return on the trading. However, when banks extend credit, they do not take material commodity money (such as gold) from their vaults and hand it over. Today, money is created when banks make loans – that is, money is simultaneously commodity and credit (Bank of England, 2014). The bank does not take the money from somewhere else and give it to the borrower. Instead, it simply enters the deposit on the debtor’s account corresponding to the loan obligation. Using simple T-balance sheet notation for economic entities (individuals, firms, or other) with assets (what the entity owns or has a right to) on the left side, and liabilities (what the entity owes to others or to its owners) on the right, money creation can be illustrated, as in Figure 16.2.

Figure 16.2 Money creation through lending.

Source: Author’s elaboration.

Both the balance sheet of the bank and of the borrower thus expands with lending. Indeed, the credit goes both ways in the sense that the bank has just promised to pay out the deposit on demand, while the borrower has promised to pay back the loan (plus interest) within a specified period. The bank makes money from the loan on fees and on the interest rate gap between loan and deposit, while the borrower may make money from being able to invest (i.e., to buy before they sell).

In this way, credit supports the division of labor in society, with the bank specialized in credit rating and in credit risk management, and borrowers exploiting their capacities more fully by being able to invest in their market of expertise, as well as to ride out unforeseen liquidity fluctuations. Borrowers rarely cash out more than small change, but the bank will need a reserve to be able to make payments on behalf of the borrower to counterparties using other banks. In Europe today, such interbank payments pass through the national central bank (via the “reserve deposits” that the private banks, in turn, hold there). This is illustrated in Figure 16.3. Of course, the central bank can grant credit (reserve deposits) to banks in the same way as in Figure 16.2 – and does so almost automatically against legible collateral, especially government bonds, opening up the whole question of state–market relations, which I shall leave aside here (Gabor and Ban, Reference Gabor and Ban2016; Krarup, Reference Krarup2019b).

Figure 16.3 Payment example.

Source: Author’s elaboration.

The T2S is essentially a system of interconnecting national central banks to form a pan-European system where payments are ultimately settled in central bank money. Because central banks don’t involve the same risk of bankruptcy and default on payments as private banks do, payment in central bank money is considered safer and more efficient.

The banking sector can thus be conceptualized as a bookkeeping system. But at the same time, the banking system creates money on a competitive basis by making loans. In this way, banking is both a market and a market infrastructure. Indeed, we have a paradox – a conceptual contradiction: money is both a system of bilateral credit relations and the universal medium in which exchange takes place. It is both market and market infrastructure.

Bookkeeping money ideally requires a fully integrated, but also centralized and hierarchical, system where central bank money has a “higher quality” than commercial bank money (Mehrling, Reference Mehrling, Taylor, Rezai and Michl2013). First, the central bank cannot go bankrupt because what it owes to the commercial banks is its own liabilities and these it can create at will (however, it can go bankrupt if it cannot pay other central banks what it owes them, creating an international hierarchy with the US Federal Reserve Bank at the apex). Second, the fact that the liabilities of all other banks in the system are “promises to pay in central bank money” means that the credit of different banks take on the exact same value – at least in “normal times,” when a crisis does not threaten to make a specific bank illiquid. Today, we take this for granted, but historically and logically there is no reason why this has to be so. In a horizontal system of binary relations (“free banking”) the value of the liabilities of each bank would be different. In the “wildcat” years of largely unregulated US banking without a central bank, geographical distance between banks and varying quality of the banks issuing not only deposits but also their own dollar banknotes meant that banknote brokers – like foreign exchange brokers today – exchanging “foreign” notes for local ones could charge discounts of sometimes more than 40% (Dillistin, Reference Dillistin1949; see also Haveman, Reference Haveman2015).

3.1 Money and Credit on the T2S Platform

We are now in a position to appreciate how the money side of T2S – payments – functions and how it relates to historical problems of financial infrastructures. T2S, which is connected to TARGET2, runs both deferred net settlement and real-time settlement. One challenge with real-time settlement is the coordination of liquidity flows – does the payer have enough money in their settlement account so as to not deadlock the flow of transactions? In order to avoid participants holding large liquidity buffers in the settlement system, T2S has a function called “auto-collateralization” whereby payees are automatically credited with the cash they need to settle transactions in real time. Auto-collateralization can be either “on stock,” using securities that the payee has available in the system, or “on flow,” using the very incoming securities that the credit is used to buy. The latter option may strike the reader as almost magical at first. However, the logic is in fact similar to that of a mortgage – and to many other forms of collateralized credit – where the real estate purchased serves as collateral for the very credit used to finance the purchase.

As illustrated in Figure 16.4, in auto-collateralization everything happens at once as a simple bookkeeping operation: the cash never actually goes to the buyer’s account, but goes directly to that of the seller. The buyer has opened a free-of-charge intraday credit with the central bank that they will have to pay back before the end of the day. The historical overview and the introduction to balance sheet analysis should make clear that auto-collateralization is “just” a sophisticated implementation of basic principles of money and finance. T2S thus manifests the virtually infinitely flexible and fully integrated role of credit-commodity money as a market infrastructure (Krarup, Reference Krarup2021).

Figure 16.4 Auto-collateralization on the T2S platform.

Source: Author’s elaboration.

The takeaway message in this section is, firstly, that by offering a highly integrated and efficient settlement system at the apex of the “hierarchy of money” (Mehrling, Reference Mehrling, Taylor, Rezai and Michl2013) in Europe, T2S offers a favorable situation for the participating financial institutions. Both real-time and deferred net settlements are possible; however, the distinction between the two becomes blurred due to the affinity of automatic settlement credit and clearing. Indeed, the temporal gap between trade and settlement can be conceived as a kind of outstanding credit where the checks received by the payees are still only promises to pay (the payer’s bank may default on it, or even go bankrupt in the meantime), which introduces the complexity of risk and capital into the seemingly trivial settlement process and blurs its separation from the market (Millo et al., Reference Millo, Muniesa, Panourgias and Scott2005; see also Riles, Reference Riles2011). Second, we should appreciate that banks are inextricably both market players (granting credit on a competitive basis) and market infrastructures (operating payments). Finally, as a public settlement infrastructure, T2S cannot be decoupled from credit creation, even if the credit is not money, officially (Millo et al., Reference Millo, Muniesa, Panourgias and Scott2005; Krarup, Reference Krarup2019b, Reference Krarup2021). All in all, the attempt at separating settlement from markets through the creation of infrastructures like T2S does not escape the double nature of money and credit.

Figure 16.5 summarizes the analysis of money and the problems that the paradox of money poses for clearing and settlement. As a contractual relationship between market agents, money is either credit (capital, “producing” rent or interest) or a commodity (used in exchange). But at the same time, money is a system or infrastructure. As the generalized commodity for payment, money is the “medium of exchange,” whereas as the generalized measure of credits it is the “unit of account.” As we have seen, these “functions” do not simply add up, but produce distinct problems – which the TARGET systems can be seen as attempts to handle at the European level.

Figure 16.5 Money as credit and commodity.

Source: Author’s elaboration.

4 Securities and Custody across Borders

I now turn to the securities side of settlement, having dealt with the liquidity side. Historically, when stocks and bonds were material sheets of paper held by the owner, it could take much longer than the present European standard of two days (T+2) to settle a securities transaction, not least due to the need for physical transportation. Professional “custodian” banks are generally used to take care of the practical aspect of settlement. In the case where the transacting parties are clients with the same custodian bank, the sheets of paper do not need to move at all – perhaps not even to a different box in its vaults – but can simply be ascribed to another account (Norman, Reference Norman2007, p. 11). This is the principle of immobilization of securities: if all transacting parties – directly or indirectly through other banks – had deposited their securities in accounts with the same custodian, then settlement would in principle be simple bookkeeping, as illustrated in Figure 16.6. In addition to immobilization, over the years the dramatic increases in the computational power of information technology allowed for the complete dematerialization of securities, which would no longer be issued in physical form, but only as numbers in electronic accounts – as pure bookkeeping (ECB, 2007c, p. 7). Physical existence and movement of paper was thus eliminated altogether.

Figure 16.6 Custody (immobilization) of securities.

Source: Author’s elaboration.

However, custody is also a competitive business and the differences between national jurisdictions, technical standards and systems, language, and even culture means that many banks only provide custody services within their domestic context, or only across a few countries in a particular region. But even the biggest and most specialized custodian banks can get into trouble. For example, with financial internationalization growing rapidly, the apex of the global financial system in New York experienced a severe paperwork crisis in 1968 (Norman, Reference Norman2007; Wolkoff and Werner, Reference Wolkoff and Werner2010). Executing a single transaction involved some thirty different documents with hundreds of messengers – which one trader describes as “low paid, incompetent and seemingly non-English speaking” (quoted in Norman, Reference Norman2007, p. 21) – traveling around Wall Street (Wolkoff and Werner, Reference Wolkoff and Werner2010). Stock exchanges reduced opening hours and even closed on Wednesdays to give back-offices time to unload, yet they were unsuccessful in preventing settlement and delivery failures, with losses reaching some 4 billion dollars and about 160 broker-dealers closing, merging, or filing for bankruptcy (Wolkoff and Werner, Reference Wolkoff and Werner2010). Other important overload crises in international settlement infrastructures include Euroclear’s electronic jam around 1978. Indeed, the exponential growth from a literally nonexistent international bond market in 1965 to $18 billion outstanding by 2006 (BIS figures reported by Norman, Reference Norman2007, p. 34) could not have taken place without continuous development and integration of financial infrastructures.

In New York, the paperwork crisis eventually led to the establishment of a CSD, owned by the stock exchange and the securities dealers, where all domestic securities could be immobilized and transferred by book entry (Norman, Reference Norman2007, p. 41). The CSD would only occupy itself with the actual settlement – all the services related to trading, issuing, and holding securities – such as credit provision, dividend payments, cross-border settlement, and underwriting – would still be the domain of commercial banks. Some European countries already had CSDs (Norman, Reference Norman2007, p. 39), but, like their US counterpart, they were not linked across borders. The continuous rise in cross-border financial activity, therefore, also provoked important developments in “global custody.” Major US banks like Chase Manhattan, State Street, and the Bank of New York pioneered this business by offering their clients “a single access point to national CSDs through a network of intermediaries” (Norman, Reference Norman2007, p. 86). One of the major US custodian banks, JP Morgan, set up a so-called international CSD, or ICSD, in Brussels. The ICSD later became Euroclear and was sold off to its users – primarily international custodian banks, such as BNP Paribas and Société Générale. Together with its main competitor Clearstream – set up in Luxembourg a few years later by a consortium of European banks (ECB, 2007c, p. 10) – Euroclear played an important role in the events that led to the T2S project about three decades later, as we shall see.

Many CSDs were initially set up in close collaboration with – and sometimes based on strong pressure from – central banks to allow settlement in central bank money. For example, in France, a CSD for government bonds was created by the central bank (later merging with the CSD of the stock exchange), and in Denmark a CSD with cutting-edge technology was set up by the financial sector, pushed by the central bank. Now, delivery of securities in the CSD and payment of cash in the central bank could take place simultaneously to eliminate any risk that the one would settle without the other. The technique became known as delivery versus payment or DvP, first introduced in the 1980s. Nevertheless, even if national CSDs are directly linked (which they are in some cases) or if banks hold securities in one of the ICSDs, they will need a custodian bank to handle all the legal and technical aspects of custody.

As depicted in Figure 16.7, the landscape of cross-border settlement in Europe thus remained complex even after the euro was implemented, compared to the streamlined domestic systems. This meant that cross-border settlement was substantially more expensive, less efficient, and less safe than domestic settlement (Giovannini Group, 2001). Contrary to domestic settlement, cross-border settlement is not always in DvP mode, nor does it use central bank money. Even settlement between the two ICSDs, Euroclear and Clearstream, could be complicated before they relaxed mutual animosities and established efficient accounting relations with each other (Norman, Reference Norman2007).

Figure 16.7 Cross-border settlement in Europe before T2S.

Source: Author’s elaboration.

In the words of economists, post trade is highly concentrated because it is a network industry: the more clients you have, the more you can settle internally, and the cheaper it can therefore be done. The global custodian will seek to constantly optimize liquidity across the different countries and systems in which it is active – avoiding surplus in one country and deficit in another (at a penalty overdraft rate of interest). Custody is also a fixed cost industry with large economies of scale: if a custodian bank settles between two countries, it needs experts to deal with the differences in things like legislation. But once a system is in place, it is comparatively inexpensive to treat 1,000 transactions instead of 100. What the sterile language of utility and costs neglect is that these features are rooted in deeper structures of clearing and settlement which are simultaneously characterized by a problem of fragmentation and a logic of centralization (Krarup, Reference Krarup2019a).

5 Toward T2S

Already the Treaty of Rome (1957, Article 3.c) had established the objective of “the abolition, as between Member States, of the obstacles to the free movement of [goods], persons, services and capital.” The free movement of capital attracted increasing political efforts from the mid-1980s on (Grossman, Reference Grossman and Richardson2012, p. 195). But for capital to move – as we have seen – post-trade infrastructures need to be in place. Discussions on clearing and settlement of securities in Europe dates back at least to the late 1970s, but change was slow until the introduction of the euro made progress more urgent.

Around 2000, there was widespread optimism about the integration of securities settlement infrastructures making leaps toward integration. An Action Plan (European Commission, 1999) was adopted, followed up by the Markets in Financial Instruments Directive (MiFID) in 2004, which effectively harmonized securities trading (but not settlement) across Europe and thereby created competition between stock exchanges, leading to a wave of mergers and acquisitions in the field (Haan, Oosterloo, and Schoenmaker, Reference Haan, Oosterloo and Schoenmaker2015, pp. 90–94). Two reports commissioned by the European Commission estimated that the cost of settlement of cross-border securities transactions in Europe was about eleven times higher than domestic settlement and defined a strategy for private and public action to remove “barriers” by 2006 (Giovannini Group, 2001, 2003). Looking back on a process that would eventually take another ten to fifteen years, the challenges and complexities were clearly underestimated.

Indeed, there was no sign of anything like the ECB-led T2S project around 2000 because financial infrastructure integration was seen as a private-sector responsibility. Market-driven integration, supported by legal harmonization, was widely believed to be within reach (Norman, Reference Norman2007, p. 103) and more in line with the principles of an open-market economy with free competition enshrined in the treaties and in the Statute of the ECB and of the Eurosystem of central banks (EU, 2012, Art. 2; see also Giovannini Group, 2001; Lamfalussy Committee, 2001; European Commission, 2004). As late as 2006, Commissioner McCreevy stated that “an industry-led solution is the best outcome for improving the efficiency of clearing and settlement in the EU” (McCreevy, Reference McCreevy2006, p. 4).

However, we have seen how money and credit require integrated and indeed centralized institutional structures in place. Economists speak of network externalities and economies of scale pushing for strong centralization and possibly even a natural monopoly because the biggest firm will have a competitive advantage and drive out all its competitors. Once the monopoly is established, however, the firm will have “monopoly power” and therefore be able to charge a higher price and make a “monopoly profit.” Indeed, the national CSDs were monopolies, including the US CSD, which served as a reference in the Giovannini reports.

Economists claim that without competition the pressure for innovation will be lost – disregarding (as economists so often do) the historical fact that many CSDs were originally public or created on the background of strong central bank demand (Van Cayseele and Mededinging, Reference Van Cayseele and Mededinging2004, p. 3; Serifsoy and Weiß, Reference Serifsoy and Weiß2007, p. 3038). So they advocated for “contestable quasi monopolies” for European settlement (Van Cayseele and Mededinging, Reference Van Cayseele and Mededinging2004; see also Rochet, Reference Rochet2006; Kemppainen, Reference Kemppainen, Mayes and Wood2007; Milne, Reference Milne, Mayes and Wood2007a, Reference Milne2007b; Serifsoy and Weiß, Reference Serifsoy and Weiß2007). According to these authors, such regulation would mitigate barriers raised by: (1) firm-to-firm hostilities, such as the missing link between Euroclear and Clearstream or (2) by exclusive technical standards, such as in most integrated domestic systems where the CSD, stock exchange, and central bank formed a close-knit whole – “silos” where you have to either buy the whole package or not be connected at all.

The strategy of contestable quasi-monopolies, supported by legal and technical harmonization, was essentially the vision adopted by the Commission in the early 2000s. Indeed, a number of mergers took place. The Scandinavian CSDs attempted to merge in the late 1990s, and there were proposals of merging the French and the German CSDs, but they failed (Norman, Reference Norman2007, pp. 141–149). The big question was what would happen with the two ICSDs, Euroclear and Clearstream. The German CSD and Clearstream merged in 1999, owned by Deutsche Börse. Shortly after, Euroclear acquired the French, Dutch, and Belgian CSDs with the explicit ambition to create a “single shared platform” for the three countries in close corporation with their common stock exchange, Euronext – the so-called ESES (Euroclear Settlement for Euronext Securities) platform. This was “the first attempt to establish a truly cross-border marketplace for securities” (Panourgias, Reference Panourgias2015, p. 3).

Euroclear’s idea was to integrate not only settlement, but also the other elements of the CSD business – notably issuing securities and servicing the various events that occur during the “life” of a security, such as coupon and dividend payments, tax claims, splitting, and so on – all summarized under the term “corporate actions.” With this project well underway, Euroclear continued acquiring further CSDs – the UK (2002) and the Finnish and Swedish (2008) (Euroclear Bank, 2024). Euroclear was moving toward a successful first step in its overall ambition for a “single settlement engine” for all its CSDs (see Panourgias, Reference Panourgias2015). The result of the principal mergers is depicted in Figure 16.8.

Figure 16.8 Euroclear and Clearstream groups.

Source: Author’s elaboration.

But the wave of mergers soon died out again. Clearstream did not pursue expansion any further. The Euroclear project was unprecedented, but stagnated due to a growing list of difficulties and, it seems, lack of support from local market players and regulators.

6 The T2S Project: Resigning from the Market to Save the Market

Then, in 2006, the ECB decided to force a new way ahead (for details on this turning point, see Krarup, Reference Krarup2019a, Reference Krarup2021). The ECB announced that it was “evaluating opportunities to provide settlement services for securities transactions” by setting up a new service “which may be called TARGET2-Securities” (ECB, 2006). Following a feasibility study (ECB, 2007a) and a public consultation (ECB, 2007b), the T2S project was launched by the Governing Council of the ECB on July 17, 2008 (ECB, 2008). In the press release, the ECB stated that “T2S constitutes a major step forward in the delivery of a single integrated securities market for financial services … T2S will provide a single, borderless pool of pan-European securities, as well as a core, neutral, state-of-the-art settlement process” (ECB, 2008).

The ECB essentially set out to create a single securities settlement platform not only for the Eurozone, but for the whole of the EU, owned and operated by the Eurosystem (composed of the ECB and the national central banks). However, there was now an appreciation that the vision faced a long path ahead and that considerable work of legal harmonization would be required (McCreevy, Reference McCreevy2007). Elsewhere, I have analyzed the series of controversies that played out before T2S was in fact implemented from 2015 onwards, including the difficult legal harmonization (Krarup, Reference Krarup2019a). Here, I simply note that the apparent U-turn in strategy from private to public initiative seems to have been made possible not simply by the fact that settlement is a natural monopoly, but more profoundly by the paradoxical nature of money and credit instruments as, simultaneously, market and infrastructure.

The simple principle of T2S is to bring all securities accounts from the national CSDs onto the same pan-European settlement platform where transactions can be settled in DvP mode and in central bank money via a connection to the T2S. This is illustrated in Figure 16.9. A bank will thus have a cash account with its central bank, which in turn is connected to the whole Eurosystem of central banks via TARGET2, and a securities account with its CSD, which in turn is similarly connected with the whole Eurozone via T2S. The idea is that, in this way, the Eurosystem-operated T2S platform will provide cheap, safe, and efficient settlement in DvP mode and central bank money for the whole Eurozone.

Figure 16.9 T2S: A pan-European settlement platform.

Source: Krarup (Reference Krarup2019a), Taylor & Francis Ltd, http://www.tandfonline.com/; see also ECB (2024, p. 21).

According to the ECB’s online introduction to T2S, the platform has the following benefits:

• making it easier for investors to buy securities in other EU countries

• reducing the cost of cross-border securities settlement

• increasing competition among providers of post-trade services (i.e. clearing and settlement services) in Europe

• pooling collateral and liquidity, meaning that banks no longer need to keep these in various locations and can quickly move them to where they are needed

• reducing settlement risk and increasing financial stability by using central bank money for transactions on the platform. (ECB, 2022)

In brief, T2S connects all the CSDs of the participating countries and hence offers an integrated DvP system for cross-border settlement using central bank money. Financial institutions holding securities accounts in a national CSD can hold a dedicated cash account on T2S to settle transactions on the platform. Moreover, T2S offers optimization tools such as auto-collateralization and other algorithms, which are particularly interesting to large institutions. It is even possible for direct participants to make instructions directly in T2S, circumventing their CSD and central bank. T2S connects twenty-one CSDs from twenty European countries, including one non-euro country, Denmark, with the option to settle in the Danish krone (ECB, 2022).

Following the 2008 financial crisis, it was realized that T2S had the additional benefit of unlocking securities held passively in different countries as buffers (collateral) by international financial institutions through pooling and optimizing the “liquidity” of collateral (Krarup, Reference Krarup2019b). Moreover, T2S was later acknowledged to constitute an important prerequisite for the Commission’s new plans for the next steps in financial market integration, such as the Capital Markets Union and various new regulations (European Commission, 2015).

7 Concluding Discussion: A European or a Universal Problem?

Theoretically, T2S confronts us with a dilemma. On the one hand, we have seen how the paradoxes of credit are age-old and, in that light, the T2S project appears almost natural. On the other hand, we have seen how T2S constituted a break with the dominant strategy for financial market integration in Europe around 2006, and that the road from conception to implementation was long and difficult. How do we square the quasi-universality of the logic of credit and settlement with the contingencies of the EU? The question is obviously fundamental and hence very difficult to answer. However, even raising it and offering some initial observations about it affords a contribution to contemporary social studies of finance.

T2S is more than the robinsonade of a new technology. It responds to, literally it seems, universal problems of credit and settlement, as well as to the telos of market integration enshrined in EU treaty law, understood as the removal of all barriers to free competition (Krarup, Reference Krarup2022). Perhaps the relationship between the two mechanisms is that markets have been made central to the European integration project via treaty law since the Treaty of Rome (1957). Indeed, it is not obvious that the paradox of money as market and as infrastructure, respectively, should become a central problem of European governance, except for the fact that it has become a cornerstone of European integration via the objectives of removal of barriers to competition and trade. Paradoxically, the removal of such barriers became the motivation and legitimation of the T2S project, although it at least resembles a public monopoly (Krarup, Reference Krarup2019a).

In this account, the pursuit of market integration understood negatively as the removal of barriers to competition runs into paradoxes about what that “market” is, raising questions about the provision of adequate (harmonized, centralized, efficient) market infrastructures, notably of clearing and settlement. For example, we have seen how clearing and settlement cannot be isolated from credit and hence some sort of money creation.

In my previous work on T2S (Krarup, Reference Krarup2019a, Reference Krarup2019b, Reference Krarup2021, Reference Krarup2022), I have emphasized the distinctively European side of these problems. However, more work is needed to settle the question of the relationship between the specifically European and the broader, ancient problems of money and credit between market and market infrastructure. For now, based on the analysis given, I propose what I call the “amplification thesis”: that the inscription of a distinctly competitive conception of the market in core treaty texts amplifies the problems of credit and settlement and market infrastructures in European integration policy.

T2S was not a predetermined fate of the Treaty of Rome. Besides all the contingencies of history and politics, the problems inscribed at the core of the European project of defining “the market” and delimiting it from “market infrastructures” and from “government” means that new responses to the paradox of money must be developed and replace old ones when these break down. T2S was such a new response in a contingent situation and has, so far, been a largely successful one. However, the fundamental conceptual problems are far from settled.

For example, I do not think that the problem of government is simply imposed upon the paradoxes of credit and financial infrastructures by European treaty law. I call it the “amplification thesis” and not the “imposition thesis” because the problem of governance emerges from within those paradoxes, but are amplified in Europe, it seems, because afforded a central legal and political position. In this perspective, T2S represents a technopolitical response to ancient problems or paradoxes of credit and settlement – the most recent response in a long lineage of responses and probably not a final solution to the problems (Krarup, Reference Krarup2021). Returning to Figure 16.5, we may thus add a third dimension – that of governance or government (public or private in the sense of centralized power of organization), as in Figure 16.10.

Figure 16.10 Government in the competitive conception of the market.

Source: Author’s elaboration.

Government emerges from four types of problems in the original plane: (1) problems of “frictions” in the relations of exchange and capital circulation; (2) problems of “delivery versus payment” in exchange, such as default risk or technical barriers to transactions; (3) problems of “risk” in the system of exchange (market) and capital (economy), such as the risk of liquidity and credit “freezing up” (Krarup, Reference Krarup2019b); and (4) problems “hierarchy” with credit as capital. I have not developed the fourth point here, but I’m referring to the “hierarchy of money” (Mehrling, Reference Mehrling, Taylor, Rezai and Michl2013) and the way it leaves different types of institutions with different sources of rent in a hierarchical structure of credit and payment infrastructure institutions, as we have seen – rather than establishing a “level playing field” for all.

1 Introduction

The subordinate position of developing and emerging countries’ (DECs) currencies in the international monetary system is an important constraint on autonomous development and structural change. Currently, DEC currencies hardly fulfil any functions of money on the international level (and at times not even the national level).¹ If DEC currencies have been demanded by non-residents or non-nationals, this demand has been largely for purposes which do little to support – or even undermine – development and sustainable structural change. Specifically, as of 2023, hardly any DEC currency – potentially with the exception of the Chinese renminbi – acts as an international unit of account (both for trade and financial transactions), means of payment, and store of wealth. The recent increase in demand for DEC currencies has been largely driven by short-term, speculative carry-trade purposes to take advantage of favourable interest rate differentials and exchange rate dynamics (Orsi, Reference Orsi2019).

This international monetary asymmetry, however, fundamentally shapes and at times constrains macro-financial dynamics and policy-making in DECs, a phenomenon also known as monetary or international financial subordination (Alami et al., Reference Alami, Alves, Bonizzi, Kaltenbrunner, Koddenbrock, Kvangraven and Powell2023). For example, DEC currencies’ limited use as an international trade invoice and settlement currency generates a structural need for foreign exchange to pay for imports. The inability of DECagents to borrow long term in domestic currency (act as a long-term store of wealth) or use their currencies as international funding currency (means of payments in financial transactions), on the other hand, increases their vulnerability to international monetary and financial conditions. Thus, reducing monetary subordination through supporting a more broad-based and resilient demand for DEC currencies is an important element of a sustainable development strategy.

The existing critical political economy literature on the asymmetric international monetary and financial system (e.g., Prates and Andrade, Reference Prates and Andrade2013; Kaltenbrunner, Reference Kaltenbrunner2015; Bonizzi, Reference Bonizzi2017; Alami, Reference Alami2019; Koddenbrock, Reference Koddenbrock2020) has so far largely focused on the broad macroeconomic (e.g., balance of payments) and financial (e.g., the extent of financial integration) structures that both underpin and would need to change to increase monetary sovereignty in DECs. So far, this literature has paid little attention to the infrastructures, which both underpin and could be used to build monetary sovereignty from the bottom up.

The small literature on local currency payment systems in DECs (e.g., Khiaonarong, Reference Khiaonarong2013; World Bank, 2014; Arner et al., Reference Arner, Buckley, Lammer, Zetzsche and Gazi2022) is largely policy-focused rather than conceptual, emphasizes their ability to stimulate regional trade rather than build monetary autonomy, and highlights their technical and regulatory constraints rather than complementary policy measures and political economy dynamics. It thus presents infrastructures as mere technical devices and depolitizes the profound politicalness of payment infrastructures. The few exceptions are Trucco (Reference Trucco, Tussie and Riggirozzi2012), Fritz and Mühlich (Reference Fritz and Mühlich2014), and Caldentey, Tomassian, and Melo (Reference Caldentey, Tomassian, Melo, Barrowclough, Kozul-Wright, Kring and Gallagher2022), who present comparative analyses of different regional payment systems in Latin America as a means to reduce the region’s excessive dependence on the US dollar and create some more policy space for autonomous development. Yet, these contributions are largely based on quantitative data which allow limited insights into the specific technical, macroeconomic, and political constraints on using these systems to reclaim monetary sovereignty.

The role of payment infrastructures for both underpinning and building international monetary power has received some recent attention in international political economy and critical infrastructure studies (e.g., Dörry, Robinson, and Derudder, Reference Dörry, Robinson and Derudder2018; de Goede, Reference de Goede2020; Westermeier, Reference Westermeier2020; Eichengreen, Reference Eichengreen2022; Nölke, Reference Nölke, Braun and Koddenbrock2022). However, this literature largely focuses on the top of the monetary hierarchy, that is, the dollar (SWIFT: Society for Worldwide Interbank Financial Telecommunication) and its potential contenders (e.g., the Chinese CIPS: Cross-border Interbank Payment System). Those writings which have analysed monetary and financial infrastructures in DECs have largely interpreted them as colonial devices, which impose systems developed in and for the Global North to subordinate financial spaces (e.g., Davies, Reference Davies2015; de Goede and Westermeier, Reference de Goede and Westermeier2022). As of yet, little attention has been paid to whether and how local currency payment and settlement mechanisms can be used to build monetary sovereignty in DECs from the bottom up. Put differently, the question arises whether states in DECs can use and indeed build their infrastructural power (both in the more ‘macro’ sense as in Coombs (this volume), or in the more ‘micro’ sense laid out in Pinzur (also this volume) to reclaim autonomy over their monetary space in a hierarchic and structured international monetary system.

This chapter attempts to generate some initial answers to these questions using the Local Currency Payment System (in Portuguese Sistema de Pagamentos em Moeda Local or in Spanish Sistema de Pagos en Moneda Local), the SML, between Argentina, Brazil, Uruguay, and Paraguay as a case study. The SML is a unique regional payment system that encourages the use of local currencies as trade invoice and settlement currencies in regional trade and service operations.² It was initiated by the Brazilian Central Bank (BCB) in June 2007 and started operating between Brazil and Argentina in September 2008. Uruguay joined in October 2014 and Paraguay followed in July 2018 (Zayas, Reference Zayas2020). However, despite some initial successes, the adoption of the SML has stalled over recent years and the use of regional currencies remains limited.

This chapter generates initial insights into why the attempt by regional central banks to foster the use of their currencies by using their ‘infrastructural power’ has had limited success. Using this infrastructural lens, it identifies some of the political, economic, and technical constraints of a more extended use of the SML. It draws on two main empirical sources. First, primary data in the form of twenty-nine semi-structured interviews with policymakers (the BCB), users (companies and trade associations), and financial intermediaries (banks) of the SML conducted between August 2017 and August 2019 (Orsi, Reference Orsi2019).³ Secondly, presentations and discussions at the first multi-stakeholder policy summit on the SML held at the Pontifical Catholic University of São Paulo on 2 March 2020, organized by the Universities of Leeds and Liverpool. The summit brought together representatives from all three SML stakeholders – users, financial intermediaries, and policymakers – and focused explicitly on identifying the current barriers that stall a broader use of the SML. The empirical analysis focuses on the period between 2008 and 2019, when the COVID shock hit and affected global trade relations worldwide.

On an empirical level, the results provide a detailed discussion of the operational, macroeconomic, and political constraints on establishing DEC regional currency payment systems. These include: on the operational level, issues such as high transaction costs, the inability to remove the counterparty risk, and the lack of affordable trade credit in regional currencies; on the political economy level, the unwillingness of cross-border banks to offer and advertise the system, and finally persistent macroeconomic challenges which undermine the willingness of local agents to receive and hold regional currencies.

On a conceptual level, the detailed insights into the decision-making of SML stakeholders point to three issues. First, the experience of the SML shows that to increase the acceptance of DEC currencies in the context of international financial subordination, the use of infrastructural power by the state (in a wide definition which also includes the central bank) might be a necessary condition to build monetary sovereignty from the bottom up. Indeed, as will be discussed in more detail later in this chapter, the SML has been conceived, implemented, and operated by the regional central banks, given the unwillingness of private financial institutions to provide local currency services (for a discussion of the role of the state in international financial subordination see, e.g., Santos (Reference Santos2023) and Alami et al. (Reference Alami, Alves, Bonizzi, Kaltenbrunner, Koddenbrock, Kvangraven and Powell2023)).

Secondly, however, our results also show that given the heightened external vulnerability, macroeconomic instability, and general economic uncertainty – and the specific class interests attached to those – the use of infrastructural power is also fundamentally more circumscribed in financially subordinate economies than in advanced economies. This also means that in this context, fixing technical and operational issues will be important, yet not sufficient, to create a stable demand for DEC currencies. Instead, addressing the political relations – which an infrastructural lens helps us to unearth on a ‘micro’ level – and the hierarchic macro-financial structures, which underpin the global economy, remain essential to both understanding and potentially mitigating international monetary and financial subordination.

Finally, and related to the above – yet more focused on monetary theory and practical implications – our results also show that whilst important, bottom-up attempts to encourage DEC currency use through payment infrastructures will not be sufficient to establish a more comprehensive and sustainable demand for this currency. Instead, what is needed is a comprehensive and complementary development of all money functions at the same time. Supporting solely the unit of account function in trade transactions, as envisaged by the SML, will not be sufficient. Indeed, recent literature on the dominant currency paradigm in economics has shown that international money functions are complementary and need to be developed in a comprehensive and complementary way (Gopinath and Stein, Reference Gopinath and Stein2021; Gopinath and Itskhoki, Reference Gopinath, Itskhoki, Gopinath, Helpman and Rogoff2022). The conclusion of our research supports this statement. However, in contrast to this literature that – in line with neoclassical economic tradition – highlights a currency’s primary role as a medium of exchange, this chapter adopts a Post-Keynesian/Minskyan perspective and shows the fundamental importance of denominating agents’ liabilities in local currencies, that is, to make DEC currencies a funding currency (Kaltenbrunner, Reference Kaltenbrunner2015). Indeed, as Minsky argued in 1993: ‘as eventually international indebtedness will be denominated in the currencies of the countries with large offshore assets, they must also accept that their currency will be a reserve currency of their debtors, for it is convenient to hold liquid assets in the currency in which your debts are denominated’ (Minsky, Reference Minsky1993).

Following this introduction, Section 2 will give a very brief overview of the aims, objectives, and workings of the SML. Section 3 presents a snapshot of its recent empirical developments in the four major user countries: Argentina, Brazil, Uruguay, and Paraguay. Section 4 discusses our findings with regard to the main barriers to greater use of the SML, and Section 5 concludes with some conceptual and policy considerations.

2 Aims, Objectives, and Workings of the SML

The SML was created with the primary purpose of providing exporters and importers with the use of local currencies through quicker and cheaper operations than in the foreign exchange market, thus lowering demand for the US dollar and stimulating regional trade. Before the SML, nearly 100% of regional trade was conducted in the US dollar. Although the SML was an initiative of analysts and technicians from the BCB, its creation also served the greater political objective of promoting the currencies of Mercosur countries and strengthening regional integration. It had significant support from the then presidents of Brazil and Argentina, Luiz Inácio Lula da Silva and Cristina Fernández Kirchner.

On the firm level, the SML was conceived to address the failure of cross-border correspondent banking to provide affordable or even any foreign exchange services to local companies, in particular small and medium-sized enterprises (SMEs). SMEs face structural difficulties in accessing normal foreign exchange services and are particularly exposed to detrimental exchange rate movements. The provision of less bureaucratic,⁴ low-cost, local currency financing that mimics domestic payments rather than cross-border foreign exchange services, was thought to be particularly beneficial to these smaller actors. Financial institutions, on the other hand, were thought to be able to provide such cheaper funding, because they did not have to access dollar-funding markets and/or assume exchange rate risk themselves.

Operationally, the SML allows both parties in a cross-border trade (or service contract in some countries) to pay in their respective local currencies, whilst the ultimate settlement of net operations is done in foreign exchange (usually the US dollar) by the respective central banks.⁵ As discussed in more detail later in this chapter, the currency of denomination of the operation between exporters and importers depends on the specific bilateral agreement between the participant countries. In order to conduct the SML operations, the respective central banks establish a competitive local currency rate of exchange, the SML rate. The conversion rate is calculated using triangulation of the local currencies to the US dollar exchange rate and must be used in all SML operations. In general, this SML rate, which does not include the spread normally charged by private financial institutions, is more competitive than the market rate for SMEs (less so for big firms) and independent of the size of the foreign exchange operation.

Figure 17.1 illustrates the working of the SML with the example of an Argentinean company which uses the SML to pay for an imported product from a company in Brazil. Both of the companies need to have a bank account in a financial institution in Argentina and Brazil that is authorized by their respective central banks to operate with the SML. To pay for the imported product, the company in Argentina will send the equivalent amount in Argentinean pesos to its bank in Argentina. This financial institution sends the money in Argentinean pesos to the central bank in Argentina, which communicates with the central bank in Brazil through the SML system. When the central bank in Brazil receives the payment in its reserves, it sends the equivalent amount in Brazilian real (BRL) to the bank in Brazil, which credits it to the account of the company in Brazil.

Figure 17.1 The working of the SML.

Source: Authors’ elaboration.

It is important to draw attention to two facts. First, at the moment, neither central bank is willing to hold the currency of the other in their foreign exchange reserves. For this reason, the transaction between the two central banks is settled in a foreign currency, normally the US dollar. As will be discussed later in this chapter, this means that whilst the SML removes the foreign exchange risk for the private actors, on the macroeconomic level it only lowers the need for reserves to the extent that the central banks could net some of the operations.

Finally, it is important to note that in contrast to previous regional payment systems – in particular, the Reciprocal Payment and Credit Agreement (CCR) between central banks from the Latin America Integration Association – in the SML the central banks only assume very limited credit risk. Whereas in the CCR central banks acted as a payment guarantor for the counterparty countries, in the SML the central banks’ risk is limited to a ‘contingency margin’ (which only exists with Argentina and Uruguay). Credit risk is limited by the fact that payments are organized in a sequential order; that is, the respective central banks only transfer money which they have already received. The contingency margin is only given to other central banks when the value of the transfer is below the transfer costs and/or when specific problems arise during the operation through SML.⁶

3 The SML and the (International) Use of DEC Currencies

As discussed in Section 1, local currency regional payment systems as key financial infrastructures could be one way of increasing monetary sovereignty from the ‘bottom up’ by increasing demand for DEC currencies and thus reducing dependence on the US dollar. Specifically, the use of local currencies in cross-border regional trade as envisaged in the SML supports their role as regional trade invoice and domestic settlement currencies. In this context, two questions arise: (a) whether such systems are successful, that is, whether private agents adopt local currencies to conduct regional trade operations and (b) whether the increased use of local currencies as a means to invoice and settle regional trade also fosters the use of local currencies for other money functions, in particular that of store of wealth and means of settlement also in financial operations.

Table 17.1 summarizes the different international functions of money, drawing on the existing international political economy and Post-Keynesian literature on currency internationalization and currency hierarchy.

The first function of money, to act as a means of payment, refers to the ability of a domestic currency to facilitate international trade. A currency is an international means of payment when it is employed as a vehicle for foreign exchange operations (vehicle currency) and/or an instrument for trade settlement (trade settlement currency). The second function of international money measures the relative price of assets, goods, and services in the international market – the unit of account function. A currency is internationalized as a unit of account when foreign investors use it to denominate both cross-border trade contracts (invoice currency) and financial contracts (funding currency). Lastly, the third function of money in this framework is the store of wealth function, which indicates the ability of an asset denominated in a certain currency to preserve (investment currency) or even appreciate (speculative investment currency) its value through time. Economic agents store their wealth by investing in assets that not only serve as a store of value themselves but, most importantly, in assets that are denominated in a stable currency, both with regard to domestic inflation and exchange rate volatility (Orsi Reference Orsi2019).

One major benefit of the SML is that it substitutes the US dollar as the main trade invoice and domestic means of payment for regional trade operations. As discussed earlier, whereas importers can use their local currency to settle the transaction, the ultimate settlement of the operation takes place by the respective central banks in US dollars. Though this maintains the macroeconomic need for foreign exchange (as discussed in more detail later in this chapter), the ability of DEC agents to pay for cross-border regional trade in local currencies reduces their exchange rate risk and, in the case of importers, their need to acquire the US dollar for payment. According to the neoclassical dominant currency paradigm, the increased use of local currencies as a regional trade invoice and settlement should also foster their use for other money functions, such as the unit of account in financial transactions and the store of wealth. For example, the provision of a direct local currency exchange rate (rather than triangulating via the US dollar as is current practice) was envisaged to contribute to promoting regional currencies as units of account and creating an active market for regional currencies to reduce the dollar’s role as a vehicle currency.

Yet, as discussed in more detail in the next section, despite these advantages the uptake of the SML and use of regional currencies in regional trade has remained rather limited. Even less so we observe the increased use of regional currencies for other money functions. The infrastructural lens adopted in this chapter allows us to identify both the specific technical and operational limits of the SML, and the bigger political economy and macro-structural barriers to increasing monetary sovereignty in financially subordinate economies.

4 Usage and Uptake of the SML

The SML has legislative authorization to operate within countries in the Mercosur: Brazil, Argentina, Paraguay, and Uruguay. It works differently for each country. For instance, the agreement with Argentina states that the trade operation must be denominated in the currency of the exporting country. In Uruguay and Paraguay, the invoice currency can be either the currency of the importer or the exporter. Additionally, whilst the SML with Argentina only allows users to send and receive trade-related transactions (and retirement pensions), with Uruguay and Paraguay users can also send and receive service payments and unilateral transfers, that is, remittances. Due to data reasons and the dominant position of Brazil in the SML, this section will focus mainly on the bilateral relations of Brazil.

According to data retrieved from the BCB website, nearly 100% of the SML operations consist of exports from Brazil to Argentina, as shown in Table 17.2, and are thus denominated in BRL. As indicated, in the case of Argentina, SML operations are denominated in the currency of the exporter. Brazil generally holds a trade surplus with Argentina, and the figures in the SML are even more asymmetric. Given that most exporters in Argentina have a strong preference for holding US dollars, many companies do not engage in trade using local currencies. Concerning its dynamics, one can observe a steady increase in the value of SML transactions from its inception in 2008 until around 2013, when it started to stagnate. A similar trajectory can be observed in the number of operations, which reached a peak in 2015 and have declined since. As a share of total exports, SML exports from Brazil to Argentina reached a peak of nearly 7% in 2014 and have declined to slightly over 5% since. The share of Brazilian imports from Argentina via the SML reached its peak at 3.47% also in 2015 and currently stands at 2.5%.

Table 17.3 shows the volume and number of SML operations between Brazil and Uruguay. The numbers are far below those with Argentina. As a share of total exports and imports, SML operations reached 1.63% and 2.16% respectively. However, in contrast to Argentina, we can observe a steady increase in operations, both with regard to volume and number of operations. Between 2018 and 2019, the amount of exports and imports from Brazil to Uruguay via the SML has increased by 26% and 141%, respectively.

According to our interviews, these lower numbers are due to the smaller economic size of Uruguay and lower trade operations with Brazil, and the more recent nature of the SML agreement. Interviewees also noted that Brazil’s trade with Uruguay is much more balanced than that with Argentina.

Finally, Paraguay was only incorporated in the SML with Brazil in 2018 and, by that time, policymakers from the BCB believed that it was still too early to draw any conclusions regarding the participation of the BRL in the operations. The data available is presented in Table 17.4. The total trade with Paraguay under the SML accounts for 9% of the total trade with Argentina, which is almost the same level as Uruguay. The exports and imports increased by 14% and 27%, respectively, from August 2018 to December 2019. With regards to exports and imports as a share of total exports and imports, SML operations reached 1.21% and 1.30% respectively.

Similar to Uruguay, interviewees did not expect that operations using the BRL would turn out to be as asymmetric as they are with Argentina. Also in line with Uruguay, agents from both countries can freely choose which local currency denominates the contracts, which gives more scope for other currencies in the Mercosur to become more regionalized.

With regards to the objective of the SML to support trade by regional SMEs, the discussion and data presented at the SML policy summit showed that the SML has been of limited success. For example, according to Barra de Castro (Reference Barra de Castro2020), the share of SMEs in the SML was only 10% in the case of Brazil–Argentina operations, and a little below 25% in the case of Brazil–Uruguay. Instead, data show that SML operations are dominated by the processing industry (in particular in the case of Brazil–Argentina) and the automobile sector. These insights are also confirmed by regional data. For example, data on the users of SML by location show that trade is mostly done with the Brazilian states that are geographically closer to Argentina. One reason for this geographic bias is that the south-east of Brazil, where São Paulo is located, concentrates most of the industries in Brazil, in particular regarding regional automobile value chains.

In sum, this data showed that after an initial increase in the uptake of the SML, usage had already stagnated before the COVID-19 shock, particularly in the case of operations between Brazil and Argentina, which dominate the system by size. With regards to the type of usage, the evidence seems to point to a relatively high share of large companies rather than SMEs. Although general economic conditions have an important role to play in these dynamics (e.g., the economic downturn in Brazil since 2013), the next section uses its infrastructural lens to identify some of the specific constraints which have weighed on a more extended uptake of the SML. It draws on extensive SML stakeholder interviews conducted between 2017 and 2019, and general insights from the first multi-stakeholder policy summit on the SML held in March 2020.

5 Identifying the Barriers and Constraints of Building Monetary Sovereignty using an Infrastructural Lens

6 Conclusion: Conceptual and Policy Considerations

The discussion in this chapter has shown the opportunities, but also significant constraints, on setting up regional payment systems that foster the use of DEC currencies as cross-border invoices and – at least partial – settlement currencies. On the operational and technical level, our results point to a range of potential measures which need to be considered to enable the success of such endeavours. These include, among others: efficient, flexible, and compatible communication, messenger, and anti-money-laundering systems, which can compete with those used by private banks for foreign exchange services; frequent publication of the exchange rate used in the payment system to reduce the exchange rate risk and contribute to building a market in local exchange rates; and the harmonization of existing procedures, protocols, and practices. Our results also pointed to significant capacity constraints both on the side of the users – in particular smaller ones – and the banks, which could be addressed with targeted training campaigns. From an infrastructural perspective, these results show the importance of focusing on the persistent human relations underpinning seemingly automated systems. Indeed, just because new relations are set up, this does not mean that old relations disappear, potentially slowing down innovations (what Star (Reference Star1999) calls an installed base).

These technical and operational issues aside, the infrastructural lens adopted in this chapter pointed to three key potential constraints on using infrastructural power to build monetary sovereignty in internationally subordinate spaces. First, our research pointed to important informational and political economy constraints. Indeed, given the potential loss of lucrative foreign exchange services, local banks – which continue to be the intermediary between central banks and the ultimate users of the SML – have little interest in offering the service, or do so at excessive transaction fees. Here, increased transparency requirements on the banks, competition from other payment system providers, and targeted information campaigns might be essential to ensure that the regional payment systems are offered more widely and comprehensively. As discussed further later in this chapter, the substitution of private financial services through state operations – for example, the use of state banks to provide regional currency payment system services, or indeed the use of central bank digital currencies (CBDCs) – might be necessary.

A second key constraint identified in our research is the inability to access low-cost, local currency trade financing and the higher counterparty/credit risk for exporters in the SML. Indeed, financing in local currency, that is, the denomination of agents’ liabilities in that currency, is an important precondition to remove currency mismatches in cross-border balance sheets and take advantage of the ability to denominate trade in those local currencies. Given the structural upward pressures on interest rates in many DECs, this type of credit might have to be provided by public and/or regional banks in the face of lacking private sector willingness. Similarly to low-cost and local currency trade financing, credit/counterparty risk insurance could be provided by public institutions if the private sector is not prepared to assume the risk.

Finally, our research pointed to the substantial macroeconomic constraints on setting up regional payment systems, and hence regional DEC cross-border currency use. Persistent macroeconomic and exchange rate volatility undermines agents’ ability and willingness to receive local currency in cross-border trade, as has been observed in Argentina, for example. Thus, macroeconomic management to preserve the value stability of DEC currencies will be an important counterpart to infrastructural innovations, such as a payment system that attempts to enhance the use of DEC currencies.

On a more conceptual level, these three constraints point to two important issues when trying to build monetary sovereignty from the bottom up through the establishment and promotion of regional payment systems. First, they show the complementary role of (international) money functions which feed into, and support each other. Setting up payment systems which enable the use of DEC currencies as invoice currencies and means of payment in cross-border trade will not be successful if not supported by measures which also support these currencies as store of wealth and unit of account in financial transactions. This complementarity of international money functions has been highlighted in mainstream economic research (e.g., Gopinath and Stein, Reference Gopinath and Stein2021; Gopinath and Itskhoki, Reference Gopinath, Itskhoki, Gopinath, Helpman and Rogoff2022). Yet, whereas this mainstream literature emphasizes the crucial role of currencies as a medium of exchange and payment in cross-border trade, our results show that unless DEC agents can also denominate their liabilities in local currencies – that is, unless DEE currencies can also be used as funding currencies (e.g., through the provision of affordable local currency trade credit), DEC agents will have little incentive to accept these currencies as means of payment. These findings are in line with a Minskyan interpretation of international cross-border relations which emphasizes the inter-relation between agents’ assets and liabilities and the driving role of liability structures (e.g., De Conti, Biancarelli, and Rossi, Reference De Conti, Biancarelli and Rossi2013; Kaltenbrunner, Reference Kaltenbrunner2015; Bonizzi, Reference Bonizzi2017; Murau and Pforr, Reference Murau and Pforr2020; Pape, Reference Pape2020; Bonizzi and Kaltenbrunner, Reference Bonizzi, Kaltenbrunner, Bonizzi, Kaltenbrunner and Ramos2021).

Secondly, our results confirm the important role of the state in enabling and supporting the creation of monetary sovereignty from the bottom up in subordinate financial spaces. Given the structural and systemic subordination of DEC currencies in the international monetary system, market-based mechanisms or the provision of private infrastructures will not be sufficient to enhance the demand for these currencies. Instead, the state needs to play an active role in supporting and enabling all money functions at the same time. This includes the use of infrastructural power, for example, through the set-up and management of payment infrastructures as shown by the experience of the SML in this chapter, but also the complementary macroeconomic management and provision of low-cost credit to support the store of wealth and means of financial settlement (funding currency) role respectively. Even in the case of payment infrastructures, state provision might be essential in the face of a lack of incentive from the private financial sector. This state provision could, for example, come through the use of CBDCs, in which cross-border payment services would be provided by the central banks directly rather than through financial intermediaries. More research is needed in this area, but rather than an option, in subordinate spaces CBDCs might become a structural necessity to build monetary sovereignty from the bottom up.

1 Introduction

In this chapter we apply a financial infrastructural framework to analyze the politics of global correspondent banking relationships (CBRs), the agreements by which a bank in one country agrees to provide financial services to clients on behalf of another bank elsewhere in the world.¹ CBRs are a vital aspect of the global economy, enabling institutions and people access to global financial markets and services (Rice, von Peter, and Boar, Reference Rice, von Peter and Boar2020). They are especially important for the sending and receiving of remittances, the lifeblood of survival and development for people and countries around the world (World Bank, 2022). Banks have maintained CBRs at least since the eighteenth century and, until recently, have consistently expanded the network of CBRs globally (Schenk, Reference Schenk2021).

In the early 2010s, however, banks in the Global South began raising an alarm. Banks in wealthier economies, they said, were unceremoniously severing these agreements, leaving banks in the Global South with fewer financial service providers. The potential impact was considerable: higher costs for remittance inflows, slower service times for financial services, limited access to global capital markets, or even an inability to fund vital imports like food and energy.

For their part, banks culling these relationships blamed overzealous regulation targeting money laundering and terrorism financing. Soon, global financial institutions, the financial press, and policymakers all were echoing the same refrain. The rising costs of compliance and the risks of noncompliance meant that relatively low-profit correspondent accounts were not worth the trouble. De-risking, they argued, threatened to increase the cash intensity of developing economies, thereby reducing regulatory oversight. De-risking showed that the Anti-Money Laundering and Counterterrorism Financing (AML/CFT) regime had gone too far and was possibly even counterproductive (see, e.g., The Economist (2014) for a summary of this position).

Despite little evidence that the roots of de-banking lay in AML de-risking, the critique appeared to shift the global AML/CFT agenda. Global meetings of AML experts focused less on assessing the regime’s effectiveness and more on alleged unintended consequences. Put differently, for the first time in the AML/CFT regime’s twenty-five-year history, the AML agenda focused on whether there was too much regulation. Why was this critique so effective, when other, more established critiques about the regime’s fairness (e.g., Naylor, Reference Naylor2001; Vlcek, Reference Vlcek2018; Gilmour, Reference Gilmour2022) and effectiveness (e.g., Findley, Nielson, and Sharman, Reference Findley, Nielson and Sharman2014; Gutterman and Roberge, Reference Gutterman, Roberge, Allum and Gilmour2019) had less impact?

An infrastructural framework helps us understand this case and sheds light on the politics of global correspondent banking more broadly. Efforts to reassess regulation really only gained traction once banks flexed their infrastructural power and began cutting CBRs: de-banking under the guise of de-risking. The result was a powerful coalition: global banks seeking to roll back regulation, de-risked jurisdictions seeking to maintain access to global financial markets, and political actors in the Global North who for various reasons were interested in maintaining North–South financial relations.

The case also provides useful insights regarding the politics of global financial infrastructures. While Mann’s infrastructural framework and much of the resulting literature stresses the state’s far reach into civil society, this case, like Braun (Reference Braun2020) and Braun and Gabor (Reference Braun, Gabor, Mader, Mertens and van der Zwan2020), highlights how the state’s entanglements in liberalized global financial markets can limit the state’s own power vis-à-vis banks. Much of the global financial infrastructure is not a public good, but a private one. The social and material ties that make up financial infrastructures are not accidental but carefully cultivated and often colonial in origin and practice. They are not friction-free pass-throughs but power-laden relationships. They are not always in the background, at least for those to whom access is not guaranteed. Finally, the social relationships and material connections that comprise CBRs are path dependent. There are moments at which the right drivers can create critical junctures and generate more fundamental change in the system. We discuss two such potential drivers: alternative payment systems and the “indigenization of finance” (Griffin and Martin, Reference Griffin and Martin2023, p. 4). The overwhelming signal from the case, however, is that banks in the Global North retain primary control over the infrastructures of global finance and the financial and political power that comes with it.

In the following section we briefly review the literature on global financial infrastructures, stressing those aspects on which this research can shed the most light. In Section 3, we provide a primer on global correspondent banking and an analysis of the debate over de-risking, emphasizing the predictions made about its impact and how those claims shifted the political agenda relating to AML/CFT. In Section 4, we show that the predictions regarding de-risking were not very accurate. In Section 5, we analyze this disconnect – unrealized impact that led to an agenda shift – as a case of infrastructural power. We also examine what responses have developed that might lessen the control over finance that Global North banks currently have. In Section 6, we conclude by considering the lessons of the case of de-risking for our understanding of global financial infrastructures.

2 Financial Infrastructures and Infrastructural Power

As the editors of this handbook note in Chapter 1, financial infrastructures “make possible the movement of other elements that are vital for the economy, including services, capital, or know-how” (Westermeier, Campbell-Verduyn, and Brandl). The servers and computers and networks that comprise the informational backbone of global finance are a vital part of the story. Procedures or processes are part of the infrastructure, as are relationships. In other words, the global financial infrastructure comprises a set of relationships, made active by sets of material objects, relationships, and ideas that define how finance can and should flow.

Bernards and Campbell-Verduyn (Reference Bernards and Campbell-Verduyn2019, p. 777) argue that infrastructures, which “are as much a heuristic device as a specific set of objects,” display five key characteristics.

1. 1. Facilitation – they make other actions possible.

2. 2. Openness – they are nonexcludable.

3. 3. Durability – they persist over time.

4. 4. Centrality – they shape how markets function.

5. 5. Obscurity – they operate in the background and generally remain unnoticed.

Insofar as infrastructures are the way things get done, change must happen in and through infrastructures. At the same time, both the physical and social aspects of infrastructures generate positive feedback dynamics, creating path dependence and some inherent resistance to change – especially radical change – as new technologies (and new ideas and new participants) must interface with preexisting ones (Bernards and Campbell-Verduyn, Reference Bernards and Campbell-Verduyn2019).

Given the basis in Mann’s (Reference Mann2012) foundational work, much of the literature on global financial infrastructures emphasizes the power of the state. Control of, and through, infrastructures is one of the key ways that modern, liberal states exercise power beyond what older, more overtly despotic forms of the state were able to exercise (Carruthers, Reference Carruthers1999). Financial infrastructures can protect or even extend hegemonic power (Konings, Reference Konings2010). In this volume, Coombs distinguishes among four types of infrastructural power, all of which underscore the power of the state to shape the actions of market actors and, thus, the market itself.

The case of global CBRs also highlights, however, that the accrual of power by the state is only part of the story. To begin, control of infrastructure can lead to an accrual of power by nonstate, that is, market, actors, as well. This power gain is especially dramatic when it entails control over “public” goods, or perhaps better said, over goods on which the public depends (Mann, Reference Mann2012; Busemeyer and Thelen, Reference Busemeyer and Thelen2020). When a firm or group of firms become necessary in the provision of supposedly public goods, those firms can restrict and monetize access to that necessary infrastructure. This power is not dependent on a firm’s complete control of the infrastructure, but is likely more a question of whether market actors are functionally dependent on a firm’s services. For example, to be maximally competitive, market actors need to pay national stock exchanges for access to a series of mutually reinforcing products, making the exchanges “global providers of financial infrastructures” (Petry, Reference Petry2021, p. 576) and granting them significant market power.

This enhanced role for market actors can also mean that state actors face limitations on their ability to act as they might otherwise prefer. For example, the actions of central banks give rise to financial innovation and the increasingly important shadow banking system, creating an “infrastructural entanglement” (Braun, Reference Braun2020, p. 396; see also Braun and Gabor, Reference Braun, Gabor, Mader, Mertens and van der Zwan2020). Market governance is now dependent on that shadow banking, especially as market-based banking has become a more prominent tool of market governance (Braun, Reference Braun2020; Braun and Gabor, Reference Braun, Gabor, Mader, Mertens and van der Zwan2020). The state’s strategies for shaping market actors simultaneously create a dependence on those same actors. The result is a curtailment of the state’s reach and an extension of the reach of market actors. The case of CBRs, then, at least raises the possible outcome that market actors can control global financial infrastructures and thus gain power vis-à-vis the state. The politics of global financial infrastructures is not, in other words, only a question of which state has power or how much power a given state has vis-à-vis civil society, but rather which actors – state or nonstate – have what power and over whom?

This political dynamic is especially true of the global payments infrastructure, which is “profoundly political and was historically built through colonial violence and political struggle” (de Goede, Reference de Goede2020, p. 353; see also Westermeier and de Goede and Atme, this volume). These power dynamics have only intensified with the mutual financialization of security and the securitization of finance (de Goede, Reference de Goede2020; see also Amicelle and Jacobsen, Reference Amicelle and Jacobsen2016; de Goede and Sullivan, 2016). Especially relevant to our case study, de Goede, citing Bedford, argues that infrastructures “operate as ‘hard-wired’ forms of regulation, that ‘incarnate’ legal measures and give them force beyond normative codification” (Bedford, cited in de Goede, Reference de Goede2020, p. 354). CBRs are the backbone of this system. A necessary question, then, is who, if not the state, controls the global payments infrastructure?

Much has been made of the changing landscape in global payment systems, to be sure. The advent of blockchain technology might boost the potential for decentralized finance, enhanced capacities for person-to-person lending, and the disintermediation of banks. We return to this later in this chapter, but note here that these changes arguably still represent more potential energy than kinetic.

A second contender for the largest landlord in the global payment space is SWIFT, the Society for Worldwide Interbank Financial Transactions. Scholars very recently have begun taking up the task of understanding SWIFT, especially from an infrastructural perspective (see, e.g., Robinson, Dörry, and Derudder, this volume). As the group’s involvement in sanctions enforcement against Iran and Russia show, SWIFT is not a “neutral payment network,” but rather “is inscribed with power and security politics from their beginnings, and remain important but overlooked sites of political-economic power” (de Goede, Reference de Goede2020, p. 352). The case of SWIFT, de Goede argues, is a reminder that infrastructures have agency, embody political rationality and sediment power relations, and construct and enable collectivities. Particularly relevant to our research, de Goede finds that: “Infrastructures hard-wire core-periphery structures, routings, and dis/connections, with profound effect on the space of (political) community” (de Goede, Reference de Goede2020, p. 356). More specifically, SWIFT, through an unequal internal power structure, reinforces preexisting external power structures, lending additional power to just a few international financial centers (Dörry, Robinson, and Derudder, Reference Dörry, Robinson and Derudder2018).

While we do not dispute that SWIFT reinforces preexisting power asymmetries, the case of de-risking reminds us that banks, distinct from the states in which they operate, are also powerful actors and remain so even in an era of shadow banking (Nosrati et al., Reference Nosrati, Kern, Reinsberg and Sevinc2023). In fact, banks ultimately were able to use their infrastructural power to push states in a direction that states previously had resisted. In the case study that follows, we consider all of these dynamics: private ownership of a global infrastructure, the political power stemming from that ownership, and which actors, ultimately, have the greatest share of that political power.

3 The Debate over De-risking: Claims and Consequences

Correspondent banking relationships are “an arrangement under which one bank (correspondent) holds deposits owned by other banks (respondents) and provides payment and other services to those respondent banks” (BIS, 2003, p. 16). Put most directly, “correspondent banking requires the opening of accounts by respondent banks in the correspondent banks’ books and the exchange of messages to settle transactions by crediting and debiting those accounts” (BIS, 2016, p. 9). The relationships are generally reciprocal and normally entail different currencies. They are essential elements of the global economy, facilitating investor access to global financial markets, and ensuring global trade and remittances can continue to flow. For decades, reaching back to the Herstatt crisis in 1974 (Mourlon-Druol, Reference Mourlon-Druol2015), the system has worked without any apparent crisis caused by correspondent banking, even as various rounds of globalization and technological shifts meant a massive increase in the system’s complexity.

In the early 2010s, this long period of stable growth hit a pothole. Financial institutions in the Global South voiced concern over a pattern that saw banks in the Global North cutting off CBRs or, in some cases, pulling out of countries or territories entirely, even in cases where there was long tradition of business relations.² Banks in the Global North pointed to what they claimed was overzealous anti-money laundering regulation: regulators and bank examiners required not just “Know Your Customer” policies, but also, they argued, that banks “Know Your Customer’s Customers.” In addition, banks argued that the fines for violations were increasing dramatically. The Customer Due Diligence required to meet such a standard, and the risks of failing to do so, were simply too costly to make maintaining CBRs worth it.

Not everyone accepted this connection. The global standard setter for the AML/CFT regime, the Financial Action Task Force (FATF), provided a direct counternarrative. FATF defined de-risking as “terminating or restricting business relationships with clients or categories of clients to avoid, rather than manage, risk in line with the FATF’s risk-based approach” (FATF, 2014). It also underscored the variety of possible drivers beyond AML: “De-risking can be the result of various drivers, such as concerns about profitability, prudential requirements, anxiety after the global financial crisis, and reputational risk. It is a misconception to characterise de-risking exclusively as an anti-money laundering issue” (FATF, 2014, emphasis added).

Despite FATF’s counterclaims, ultimately the discourse linking AML to de-risking took hold. Think tanks like Oxfam International and the Center for Strategic and International Studies echoed the claim (Durner and Shetret, Reference Durner and Shetret2015; MacDonald, Reference MacDonald2019). It was repeated in hearings on de-risking held by the US House Financial Services Committee (FSC Majority Staff, 2018). The international financial institutions joined in, although they also allowed for the possibility of other drivers (World Bank, 2015, p. 9). In the summer of 2016, when the de-risking discussion was arguably at its peak, the World Bank and the Association of Certified Anti-Money Laundering Specialists (ACAMS) hosted a two-day stakeholder workshop to discuss the problem. Their report on the findings and recommendations of that workshop reflect all of the discussions mentioned (World Bank and ACAMS, 2016). ACAMS and the World Bank hosting the workshop is reflective of the dominance of the discourse that de-risking was a problem and AML was the cause.

Not only did this discourse become a consensus in public discourse, it changed policy discussions, too.³ In the wake of the de-risking debate, efforts started in both Europe and the USA – the two strongest proponents of the AML/CFT regime – to reconsider elements of the project. Following two calls for comments in 2020 – one on a proposed rationalization of AML regulation, the other on the drivers and impact of de-risking – the European Banking Agency published an opinion on de-risking which explicitly links de-risking to poor AML risk management and acknowledges that there are ways in which regulatory and supervisory authorities can discourage de-risking with clearer guidance and less categorical judgements (EBA, 2022). In the United States, also in 2020, a law ostensibly designed to strengthen AML/CFT regulation – the Improving Laundering Laws and Increasing Comprehensive Information Tracking of Criminal Activity in Shell Holdings Act (aka the “ILLICIT CASH Act”) – begins with a discussion of the dangers of de-risking and calls for a study of how best to address the problem. Since then, the US Treasury has published a de-risking strategy (Department of the Treasury, 2023). Perhaps the best example of the diffusion of this discourse is FATF itself. In 2021, FATF began focusing on the regime’s “unintended consequences,” with de-risking noted as a key item.

This success in changing the framing on AML/CFT is surprising. FATF was founded in 1989 and the regime it guides has advanced steadily since, creating tighter standards, developing more tools for enforcement, and working to diffuse the standards on a global scale. In short, proponents have steadily deepened and widened the regime over thirty years. This has been true despite critiques that evidence for the regime’s effectiveness was lacking. This intensification of the regime increased after the 9/11 attacks in the United States, when members added counterterrorism financing to the regime’s goals. The regime’s securitization made it difficult to critique efforts. Adding to the puzzle, FATF members in 2012 decided to move away from tracking only whether the right laws were on the books and focus also on whether states’ regulatory systems were actually effective at preventing laundered money from entering the financial system. So how did de-risking move to the top of the agenda? In the following section, we show that the actual impact of de-risking is likely not the answer, as the impact was not as dire as many predicted. These muted outcomes and the actual patterns of de-risking suggest that something other than concern over AML was driving the de-risking agenda.

4 The Impact of De-risking: Much Ado about a Little?

One possible explanation for the rise of de-risking to the top of the AML agenda is that de-risking was, in fact, having the predicted impact. That is, it was widespread, it was costly, and it was caused by AML rather than some other more pedestrian cause. In this understanding, moves across the regime to consider reform are, therefore, positive and surprising signs of responsiveness. To consider this explanation, we draw here on the plethora of reports that were generated as a result of this concern. The patterns of de-risking found in that body of evidence, we argue, suggest that the predicted impact of de-risking ultimately was more dramatic than its actual impact.

5 Discussion

Predictions about the impact of de-risking were dire. To be sure, a few specific cases seem to live up to these predictions and they are important in their own right. But the evidence given suggests that the systemic impact of de-risking was either overstated, largely averted, or some combination of the two. Those dire predictions laid the blame for this coming doom squarely at the feet of AML: standards and consequences that were too high, especially in Europe and the USA; systems that were too weak in the de-risked jurisdictions. These predictions hit their target. The AML/CFT regime had been largely immune to critique since its inception, but especially after members securitized the regime following the 9/11 attacks in the United States. The fears over de-risking shifted the agenda.

An infrastructural perspective suggests that global banks were able to achieve this by leveraging their control of CBRs. The threat of exit from the world’s most valuable markets as a means of protesting AML was never a credible one. The threat of big banks to exit CBRs, however, was.

This strategy only works, however, if other important actors were interested in ensuring that banks in the Global South had continued access to CBRs with banks in the Global North. In other words, someone had to care. There are surely varying rationales for those concerns. For some, especially those on the receiving end of de-risking, the potential economic harm was the motivation. Their concern might have been necessary, but it surely was not sufficient to shift the agenda.⁷

For people and institutions in the Global North, other rationales might be at play. On the micro-level, former Chairwoman of the United States House of Representatives Committee on Financial Services, Maxine Waters, has a long-standing interest in US–Caribbean relations. As a result, de-risking was and remains a particular concern for her and she uses her institutional power to keep the issue high on the agenda. For example, it was under her watch that the Committee held multiday hearings on de-risking. In April 2022, Waters co-chaired, with Barbados Prime Minister Mia Mottley, the “Roundtable Discussion on De-risking and Correspondent Banking” (Salmon, Reference Salmon2022).

There are other interpretations. It is arguably in the interest of advanced economies to avoid economic meltdowns and promote sociopolitical stability in their respective neighborhoods. There are postcolonial interpretations of these interests, too. Ensuring the continued financial dependence of other countries on US and European banks allows the USA and European Union (EU) to exercise oversight and control over those countries. In this sense, building and maintaining CBRs constructs political power for states, but also for banks who can deny those services.⁸ De-risking represented a threat to that system of control. In Europe, the European Commission is funding a correspondent banking program to address issues within the EU and collaborate with the EU AML/CFT Global Facility, which provides capacity building to non-EU countries, with meetings such as a new regular regional conference on correspondent banking in Eastern and Southern Africa (EU AML/CFT, 2022).

The ability of banks to leverage CBRs toward shifting the agenda on AML/CFT shows that banks, and especially banks in North America and Europe, still hold the lion’s share of power in global financial relations. While scholars correctly have paid more attention to SWIFT in recent years, the case of de-risking shows that banks retain substantial agency. The de-risking story is also a reminder that global financial infrastructures are not, in fact, global public goods; they are not nonrivalrous and nonexcludable. It may be the case that banks are unable to completely shut off the taps; it is especially the case that no one bank can on its own exclude access, at least in the long term. Cutting off CBRs can reduce the flow to a trickle, however, unless and until alternative arrangements can be made. In global finance, this means higher costs, lower competitiveness, and less growth.

De-risking and CBRs are also a reminder that infrastructure is neither a given, nor accidental. Infrastructure is, in fact, a set of relationships. Like all relationships, these must be cultivated, fostered, and tended to. And like all relationships, there can be imbalances of power that are exploited for the benefit of one side over the other. In the case of CBRs, banks give considerable thought to CBRs. But the case also shows that states see them as a point of considerable concern. In this sense, the common refrain that infrastructures are invisible until they break down may be an overstatement, at least for those who can be easily excluded from them. Those on the weak side of these agreements are likely more sensitive to the fact that the agreements are neocolonial and simultaneously create long-term vulnerabilities and short-term opportunities; to them they are both visible and politicized (see also Langenohl’s contribution to this handbook).

In that vein, it bears watching whether any developments or initiatives may lead to a loosening of those colonial ties. We note a few possibilities and discuss those here by way of conclusion.

The continued disintermediation of banks via alternative payment systems is one such possible point of reform (see also Nölke, this volume). These systems are able to bypass SWIFT and traditional banks more generally. To date, however, they represent a small fraction of global business. In the longer term those numbers might increase. But to the extent that those technologies remain rooted in, or are routed through, international financial centers, they risk recreating or reinforcing the same power structures that shape global finance today, just as SWIFT has (Brandl and Dieterich, Reference Brandl and Dieterich2023). To the degree that these alternative systems are built around technologies that are highly energy-intensive, their use risks exacerbating the climate change that already poses an existential threat to precisely the people that the new technologies are supposed to help.

The G20 is undertaking an initiative designed to prevent this kind of problem in the future. This includes the development of multilateral payment platforms, which are designed specifically to operate across jurisdictions and thus could supplant CBRs (see BIS, 2023). It also includes the use of “liquidity bridges,” agreements among central banks to allow extraterritorial branches of a bank to draw on their local central banks using collateral held in in the home office’s territory. The theory is that this reduces the amount of collateral that a service provider is required to hold, thereby reducing the costs (see BIS, 2022). Both are part of a larger “G20 Roadmap for Enhanced Cross-Border Payment” system (Financial Stability Board, 2023).

A final note of optimism comes from what Griffin and Martin (Reference Griffin and Martin2023) refer to as bank indigenization (see also Roitman’s contribution to this handbook). In the eastern Caribbean, at least since 2009, some leaders have been calling for a “rationalization” of the regional financial system, moving from a multitude of small, independent economies dependent on large international banks, and toward a multicountry economy. Decisions by international banks to close CBRs have galvanized previously lagging efforts on this front, leading to the creation of consortia of indigenous banks, which together were large enough to buy assets from foreign banks that had pulled out of the region (Griffin and Martin, Reference Griffin and Martin2023).

That said, as Bernards and Campbell-Verduyn (Reference Bernards and Campbell-Verduyn2019) have argued, infrastructure is a process as much as material object. Efforts to find alternatives to the neocolonial politics of global financial infrastructure are bound to meet resistance (see also Kaltenbrunner and Orsi, this volume). Some of that resistance is the result of path dependence. Some of the resistance is more strategic, as the owners and users of that infrastructure seek to maintain the advantages that come from it. That includes banks writ large, but also political actors that are able to achieve political goals by borrowing an otherwise private infrastructure. This exemplifies Mann’s idea that the same infrastructure can be used simultaneously by different social powers and toward different ends. This case raises the question of what happens when two actors are using the same infrastructure for seemingly opposite ends: one to exclude, one to include. Time will tell who “wins” that tug-of-war, but the logic of an infrastructural approach suggests that the advantage rests with those who control the infrastructure.

1 Introduction

Money and finance have been conceptualised as an infrastructure for the economy and for society (Muellerleile, Reference Muellerleile2018; Ricks, Reference Ricks2018). Finance has developed its own infrastructures, defined as ‘the socio-technical systems enabling basic yet crucial financial functions to be carried out, but that tend to be taken for granted and assumed’ (Campbell-Verduyn, Goguen, and Porter, Reference Campbell-Verduyn, Goguen and Porter2019, p. 911). As financial activities have become more complex and speculative, centralised ordering institutions such as central banks and financial infrastructures have evolved (Norman, Shaw, and Speight, Reference Norman, Shaw and Speight2011) to smooth the conduct of finance and commerce across space and time. This chapter engages with SWIFT (Society for Worldwide Interbank Financial Telecommunication) as a long-standing, monopoly-like infrastructure and employs a meso-level infrastructural gaze, showing interdependencies between micro-level, often backgrounded, socio-technical systems and processes, and macro-level concerns of legitimacy and power (see Chapter 1 of this volume).

What constitutes financial infrastructure is not exactly defined. It broadly includes organisations that conduct the core financial markets’ processes and functions of risk mitigation, trading, clearing, and settlement (see Handel, this volume; Genito and Lagna, this volume). Exchanges take care of securities trading activities and have evolved into large groups, whose activities and market data shape financial markets (see Petry, this volume), while post-trade activities, like clearing and settlement,¹ are performed across a variety of actors. Every economic and financial transaction necessitates payment, with clearing and settlement of payments performed by various payment systems for different kinds of payments.

SWIFT, however, does not fit into these categories of financial infrastructure. While many infrastructures store and transfer value, whether as money or as securities, SWIFT, and this is a key distinction, transfers data/information about value between banks and financial infrastructures internationally. SWIFT’s original role and raison d’être was in providing a secure, digital, international financial messaging system for international payments for a small group of Western banks in the 1970s. Since then, it has expanded into messaging for post-trade securities transactions, which now accounts for more of its messages than payments (SWIFT, 2021a). It has also expanded its membership globally to other financial actors beyond banks. It further offers more shared services to its member financial institutions, such as payments reference data to ensure proper routing of transactions, and for financial crime compliance, which all banks must do. SWIFT’s quasi-monopoly position began with the adoption of a cooperative solution among rival banks due to distrust in a service provided by one leading bank (Citi). It then grew via network effects and standards, adding increased benefits for members. In so doing, it has become a critical ‘infrastructure for infrastructures’ (Robinson, Dörry, and Derudder, Reference Robinson, Dörry and Derudder2023, p. 485).

This chapter unravels SWIFT’s role as trust provider by examining its workings, technologically and organisationally. Trust is integral to money and finance. Much of the sector’s growth has come from extending trust from smaller to ever larger networks (Rubinstein, Reference Rubinstein2022). Given that infrastructures are, broadly, essential supporting/enabling objects and simultaneously the relation between objects (Larkin, Reference Larkin2013), and featuring long-term, near-ubiquitous reliability (Plantin et al., Reference Plantin, Lagoze, Edwards and Sandvig2018), financial infrastructures are a key method of scaling trust. Styling itself as ‘the most secure trusted third party’ (Scott and Zachariadis, Reference Scott and Zachariadis2014, p. 38), SWIFT refers to two dimensions:

• the financial messaging infrastructure network (SWIFTNet), and

• the organisation, a cooperative, in which SWIFTNet is embedded.

Viewing SWIFT as a ‘club’, its purpose is not messaging specifically but connectivity generally, allowing it to extend trust among its members and more broadly to financial flows. Here, we combine literature on trust and clubs to study the relationship between SWIFT’s organisational design and its effectiveness in bringing about strategic change to retain its pre-eminence (Robinson, Dörry, and Derudder, Reference Robinson, Dörry and Derudder2024). Infrastructural power is usually concerned with state authority and macro-political-economic governance in national monetary networks centred around public actors, for example, central banks (see Coombs, this volume). However, SWIFT is integral to the workings of global finance, acting as a boundary object (see Pinzur, this volume) that enables cooperation and resolves tensions between local and global scales, and between public and private networks, by extending different forms of trust across space, an essential prerequisite for collaboration between financial competitors. Put differently, national networks are connected into a global network by private financial actors using SWIFT’s messaging network as members of its organisation. Alongside physical networks, ideas, and standards, trust is an important component of ‘the binding medium’ (Easterling, Reference Easterling2016, p. 6) of infrastructure.

The next section explores and defines the concept of trust in finance. Sections 3 and 4 explain the architecture of global financial infrastructure as based on the account money form. Sections 5 and 6 demonstrate the significance of SWIFT’s messaging network and organisational form in engendering trust among competitors and as a key relational form of agency that fosters collective action to mediate technology, geopolitical, and market challenges. The chapter closes with a critical reflection and outlook.

2 Trust in Money and Finance

Trust – or the ‘social, geographical, and discursive nodal points of trust and authority’ (de Goede, Reference de Goede2005, p. 185) – is foundational to the banking business, which is likened to ‘a massive, complicated and delicate confidence trick’ (Arnold, Reference Arnold2023, para. 1). A definition of trust, which is ‘a complex and slippery notion’ (Nooteboom, Reference Nooteboom2002, p. 1), encompasses several reasons and motivations for broadly having confidence or reliance that actors or things will not fail us. This can be based on control in the form of incentives or contracts; on self-interest or assurance, such as dependence or legal coercion; or it could be a strong sense of ‘real’ trust based on motives beyond self-interest. As this brief list shows, the sources of trust are distinct, lying in individuals, organisations, or a system as a clear rule provider and enforcer to (better) calculate others’ behaviour and action. Central bankers, for example, consider trust to be confidence that ‘authorities will act predictably in the pursuit of predefined objectives and that they will succeed in their task’ (Carstens, 2023, p. 6) of maintaining trust in the monetary system as a public good and foundation of an economy. Trust, however, can take forms such as behavioural, competence, intentional, and informational in people, institutions, and organisations, but is not limitless: ‘someone has trust in something, in some respect, and under some conditions’ (Nooteboom, Reference Nooteboom2002, p. 8). SWIFT’s technological messaging infrastructure and cooperative organisational form play a crucial role in scaling trust in money and finance globally.

Representations of trust as radiating down from central banks to lower-order financial actors as well as residing in networked groups of financial experts neglect the role of the financial ‘plumbing’ in providing trust (Campbell‐Verduyn and Goguen, Reference Campbell‐Verduyn and Goguen2019). Finance is a network industry, in which competitor firms must necessarily collaborate to a certain extent. This has been evident historically in financial infrastructures, from exchanges and clearing houses up to credit card schemes, which have been mutually owned by the financial actors that use them. Trust is thus also important between organisations in enabling relations: it reduces relational risk, or the risk of something going wrong in a relationship; is economically relevant because it reduces uncertainty, bringing material benefits for cooperation and savings on search, contracts, and monitoring because it reduces fear of opportunism; and involves an acceptance of more influence from partners. This is the purpose of governance, which acts with other governmental instruments like contracts, incentives, reputation, and via networks (Nooteboom, Reference Nooteboom2002).

Through governance, trust is related to authority and power. The financial system comprises the combined interactions, competitive and cooperative, of its participants. Authorities and financial institutions are not the only components of the financial system. Financial infrastructures are key nodes themselves but also the socio-technical mesh (both material, like cables and network equipment, as well as immaterial, like rules and conventions for using this equipment and executing processes and functions) interlinking nodes. Trust in the reliable working of such large, impersonal social structures at societal level, or system trust, is a crucial phenomenon in modern times. It builds on both ‘the authority attributed to formal social positions as well as on the reliability of technical systems, standards and procedures’ (Bachmann, Reference Bachmann, Nooteboom and Six2003, p. 64). Private actors have been granted forms of legitimate or private authority over important domains, both domestically and internationally, usually associated exclusively with the state (Hall and Biersteker, Reference Hall, Biersteker, Hall and Biersteker2004). Such authority is deemed legitimate because it is ultimately delegated by interdependent public authorities (Pauly, Reference Pauly, Hall and Biersteker2004), such as those with regulatory supervisory oversight over financial institutions and infrastructures. Legitimacy implies that those governed consent to or recognise authority, which they do without coercion, but rather for reasons like persuasion or trust (Hall and Biersteker, Reference Hall, Biersteker, Hall and Biersteker2004); legitimacy is invoked in the ability to mould relationships by bundling and shaping the interactions of multiple social actors in generally accepted ways (Bachmann, Reference Bachmann, Nooteboom and Six2003).

Trust cannot easily be conjured from nothing and is in some ways its own prerequisite. Once established, infrastructure’s stability and durability are analogous to the confidence and reliability synonymous with trust. Embedding infrastructure in a cooperative is an important way to initially engender trust among users and subsequently spread it via shared norms and practices surrounding infrastructure usage to new users and beyond. Micro-level socio-technical systems become thereby linked with macro-level concepts such as power.

In what follows, we show SWIFT’s role in extending trust beyond national jurisdictions, within which central banks and national financial regulators/supervisors nominally only maintain trust in their own currencies. While in recent decades many financial infrastructures have been privatised, SWIFT remains a not-for-profit-maximisation cooperative, co-owned by financial institutions. We argue that the cooperative organisational form is a key enabler of trust among financial institutions and aids their collective strategic agency.

3 Money Forms and the Architecture of Financial Transactions

The architecture of financial infrastructure is contingent upon the money form that it supports. The two money forms for payment are physical objects/tokens, such as cash, and accounts/claims, such as commercial bank deposits. Token money transactions feature immediate settlement and no information exchange once the token is deemed valid (Adrian and Mancini-Griffoli, Reference Adrian and Mancini-Griffoli2019). However, such transactions generally require physical proximity. Account money evolved from token money in medieval Europe when moneychangers transformed from custodians of physical coin to deposit banks. Instead of physically transferring coin as payment, they logged ownership of coin deposited with them in books, and then transferred ownership, thereby immobilising coin and creating account or book-entry money. This also allowed netting, or extinguishing one debt with another, leading to banks becoming trusted central intermediaries.

As such, banks conducted transactions for many parties across their books, with only minimal final settlement in physical money. Account money thus has two components: value, residing in and cleared/settled across the ledgers of financial institutions, and data/information about that value, requiring transmission via trusted channels (see Robinson, Dörry, and Derudder, Reference Robinson, Dörry and Derudder2023, p. 486, figure 2, for an illustration). Value, also a kind of data, can be considered money at rest and is a representation of value inherent in and created by our ecology and societies (Scott, Reference Scott2022). Data is more accurately transaction information, such as payment instructions, and manifests money in motion. Account money payments do not need physical proximity or immediate settlement; rather, they require information to verify account holder identities. Account money nowadays resides in electronic accounts/ledgers of various siloed financial institutions, for example, banks. Effecting payment means changing these accounts (settlement) in response to instructions. Instructions are communicated electronically across distance in email-like messages. This secure transmission of financial information is the purview of SWIFT and of particular significance for cross-border payments, in which SWIFT’s origins lie.

4 SWIFT and Financial Messaging

There are important differences between domestic and international payments. SWIFT (Euromoney, 2019, para. 11) describes global banking as ‘a network of federated payment systems, where fiat currencies are settled in different jurisdictions, each with their local regulations and requirements – independent, yet interdependent on each other’; these payment systems are connected by correspondent banking ‘into a meaningful value transfer system’ (depicted in a stylised manner in Figure 19.1). Domestic payments (or payments in one currency) are centralised in a national payment system,² to which banks are directly connected as members or indirectly via a member. The payment system is generally publicly run by the central bank; it has responsibility for that currency. Interbank payments are settled in the payment system in central bank money, and payment information is communicated via the payment system’s messaging system. In providing both, the central bank underwrites trust in the system. However, the lack of a global currency and central bank means that there is no single global payment system and this ‘banal’ fact makes cross-border payments more complex (Brandl and Dieterich, Reference Brandl and Dieterich2023).

Figure 19.1 Federated global payments system.

Source: Authors’ elaboration.

As per this description, the various national payment systems are connected to each other via correspondent banking (see Nance and Tsingou, this volume). This is a decentralised system of bilateral contractual agreements, called correspondent arrangements or correspondent relationships, between commercial banks operating in different locations. Most banks lack a physical presence overseas and so engage the services of banks elsewhere for international business. For cross-border payments, banks in different locations hold reciprocal (‘nostro’/‘vostro’) accounts with each other from which they make payments. Banks have an arrangement for each currency they make payments in (‘currency corridors’). Any bank in one place doing business on behalf of a bank in another place is technically a correspondent; however, transactions are hierarchically concentrated in a small number of mainly Western banks. These banks are called global transaction banks (GTBs). GTBs have a physical presence in many jurisdictions and direct access to payment systems there. Correspondent banking has existed for centuries and remains a mainstay of bank internationalisation as well as a critically important mode of cross-border funds transfer, both for trade and for interbank payments, such as central bank swap lines.

SWIFT’s function here, and the reason for its foundation, is providing secure transmission of payment information for correspondent arrangements between over 11,000 banks in more than 200 (para-)sovereign territories. A massive rise in cross-border funds transfers from the 1960s led to Western banks needing standardised, digital, and secure communication for the increased volume of transaction information. SWIFT’s messages have become the standard for parts of the finance industry,³ and these, as well as its network and systems, have gone through various upgrades. Correspondent banking and SWIFT have been derided as legacy systems, ripe for technological disruption. In response, SWIFT has transitioned from serial transmission of messages along the correspondent banking payment chain, towards partial platformisation via a new transaction management platform aimed at helping banks to make economic use of transaction data (Robinson, Dörry, and Derudder, Reference Robinson, Dörry and Derudder2024).

While cross-border payments messaging is SWIFT’s raison d’être and still what it is mostly associated with, SWIFT now processes more messages for securities transactions (SWIFT, 2021a). Securities were physical, paper-based instruments until inefficiencies in trading and settlement were exposed by a paperwork crisis on Wall Street in the late 1960s, following a rise in trading volumes. This led to immobilisation and dematerialization of securities, with electronic issuing, custody, and recording and transfer of ownership in accounts at custodian banks and newly created infrastructures like central securities depositories (CSDs). Securities accounts were updated in response to transaction information communicated between parties. The account money form thus also underpins financial asset custody (Chan et al., Reference Chan, Fontan, Rosati and Russo2007; Milne, Reference Milne, Diehl, Alexandrova-Kabadjova, Heuver and Martínez-Jaramillo2016). SWIFT’s securities operations began in the 1980s via collaboration with international CSDs on bond transactions. This was followed by the admission of securities institutions as SWIFT members, and the expansion of messaging standards to accommodate further securities transactions (Scott and Zachariadis, Reference Scott and Zachariadis2014), allowing SWIFT to further extend trust beyond payments and serve as an obligatory infrastructural component of international financial flows.

5 Facilitating Trust in Cross-Border Payments

Payment settlement has evolved over time to become consolidated in public central banks (Norman, Shaw, and Speight, Reference Norman, Shaw and Speight2011). Unlike private entities, states can guarantee the stability of their money’s value across space and time (Pistor, Reference Pistor2019). The perceived credibility of this promise makes money ‘essentially a relationship of trust’ (Brandl and Dieterich, Reference Brandl and Dieterich2023, p. 538). Central bank money is therefore the safest settlement asset and is at the top of the monetary hierarchy (Mehrling, Reference Mehrling, Taylor, Rezai and Michl2013). Beneath central bank money, the majority of money in use is credit money created by commercial banks in a kind of monetary public–private partnership (Ingham, Reference Ingham2020). Private commercial banks have accounts with the central bank where payments are settled: the payment system links public and private money (CPSS, 2003). Lack of trust in money would mean a loss of ability to reliably and confidently conduct everyday social and economic activities that we take for granted, for example, to safely effect payment and to exchange cash for the same amount of money at different commercial banks.

Trust in domestic payments is anchored in the central bank as the provider of the unit of account, the final means of settlement, and the guarantor of the smooth operation of the payment system (BIS, 2021). Cross-border payments that can include multiple ‘long chains’ of correspondent arrangements (Campbell-Verduyn, Goguen, and Porter, Reference Campbell-Verduyn, Goguen and Porter2019) are different. In this tightly intertwined network, banks are interdependent by reciprocally holding balances and extending credit (Wandhöfer and Casu, Reference Wandhöfer and Casu2018). In the past, based more on reciprocity (Molteni, Reference Molteni2021), trust in the intentions and behaviour of partner banks is now more transactional and controlled via contracts (Lyddon, Reference Lyddon2012). Only those banks directly connected to each other have established ‘trust’ relations over time. Trust, for example, erodes when regulatory violations in a payment chain, for example, anti-money laundering, mean that all parties in the chain are liable. The reputational and financial costs of entering into a ‘bad’ correspondent relationship has led to a decrease in correspondent banking services in a process of de-risking (Prentice, Reference Prentice2019) in recent years. In light of this and other challenges, SWIFT has spearheaded efforts to reorganise its network and correspondent banking to maintain trust in both.

SWIFT’s standing is based not on asset transfer, but on security, reliability, integrity, and confidentiality in proprietary financial data, a non-trivial undertaking with the technology available when it was founded. SWIFT’s ability to achieve and subsequently maintain this is a key element perpetuating trust in both the organisation and its systems. The quasi-monopoly international payments messaging system, SWIFT also relays domestic payments messages for some central banks (CPSS, 2005). It additionally offers them a shared backup generic payment settlement system, the Market Infrastructure Resiliency Service (MIRS), in case of a failure of their system, for example, due to natural disaster, cyber-attack, or hardware failure (SWIFT, 2014). SWIFT thereby also helps central banks underwrite trust in their domestic payments. Only the parties to a transaction are able to read messages about a transaction, which SWIFT provides for via authentication and encryption with latest generation IT security. Continuous network uptime and availability for fast and assured message delivery is guaranteed via multiple layers of data-centre resilience, redundancy, physical security, and processes for implementing critical changes, while SWIFT also accepts some liability for its messages (Scott and Zachariadis, Reference Scott and Zachariadis2014).

Trust also comes from the rules that an infrastructure’s users abide by diligently. For example, correspondent banking payment messages are only sent once relevant account balances have been updated, meaning that the previous leg of the payment has already been settled (Wandhöfer and Casu, Reference Wandhöfer and Casu2018). While types of some messages convey promises, both binding and non-binding, others ‘are the very performance promised in the previously or concomitantly issued message’ (Kozolchyk, Reference Kozolchyk1992, p. 47). Banks trust that the content of SWIFT messages is correct and untampered with, that the message is genuinely from the sender, and that transactions within have been settled. In this way, individual (local) material conditions extend beyond just the immediate parties to one leg of a longer transaction chain, translating into system-wide (global) trust and performativity.

6 SWIFT: A Club

SWIFT’s organisational form is pivotal in co-constituting trust. It combines trust based on established rules and practices as well as on the ability of SWIFT to enforce them (system trust) and trust based on individual relationships (personal trust). A way to conceptualise SWIFT is as a club (Buchanan, Reference Buchanan1965; Keohane and Nye, Reference Keohane, Nye, Nye and Donahue2000; Tsingou, Reference Tsingou2014, Reference Tsingou2015), which provides an analytical grasp on this complex singular organisation and its relation to trust, power, governance, and its ability to change.

The first feature is that of club goods. Economics posits the theory of clubs as arrangements for the consumption of goods shared by owner-members. Network effects reduce the cost for a single member (Buchanan, Reference Buchanan1965). Spurred by communication technologies, such goods are widespread in financial infrastructures, such as in cross-border payments.

A central driver in SWIFT’s creation as a cooperative was a lack of trust among competitor banks. At the time that banks needed a secure, digital communications system, First National City Bank (now Citi) had a messaging system that it proposed all banks use. However, other banks’ mistrust of competitor’s intentions and of becoming reliant on that competitor’s proprietary system was a key reason for a cooperative solution. In the 1980s, Citi envisioned broader usage of its private electronic funds transfer system, which other banks could use, ‘but only for a fee and only on Citibank’s terms’ (Bátiz-Lazo, Haigh, and Stearns, Reference Bátiz-Lazo, Haigh and Stearns2014, p. 121). SWIFT’s cooperative form engendered organisational trust in its motives and intentions beyond any individual bank’s self-interest, while its ability to provide a secure messaging infrastructure created confidence in its competence – an important dimension of system trust – rather than in personal trust relations between individual member banks. Shared ownership-usage of SWIFT’s messaging system in return for membership fees makes it a club good, while SWIFT’s profits are returned to members in the form of cheaper services. For example, the cost of sending a letter of credit by telex in the 1980s was USD 10–25, compared to USD 0.50 by SWIFT (Kozolchyk, Reference Kozolchyk1992). SWIFT’s messages have continuously dropped in price, allowing member banks to make large profits. Overall, SWIFT creates benefits for its members by doing things that nobody else will do, such as common provision of unprofitable activities, saving duplicate work and cost. Although SWIFT is not responsible for its members’ security, it has introduced a security control framework for its users, recognising that hacking incidents are a significant security and reputational problem (Bergin, Reference Bergin2016).

Trust, then, is itself a club good, which generates further benefits. This takes us to the second, social and cultural meaning of clubs as distinct and powerful communities of practice (CoP) (Wenger, Reference Wenger1998). Affiliation ties granted by club admission allow the assessment of members’ trustworthiness, community commitment, and adherence to norms, even without personal ties or direct interaction as members (Pak, Reference Pak2013). A specific benefit is collective learning, such as in CoP, which, via an organisation’s simultaneous presence in many places, allows the connection of decentralised knowledge, both tacit and codified, and local and non-local (Malecki, Reference Malecki2000). Headquartered in Brussels, SWIFT also has offices around the world, including innovation labs, as well as local country user groups consisting of member bank employees with direct connections to the organisation, allowing SWIFT to ‘co-create’ with its members (SWIFT, 2021b).

SWIFT’s reputation also adds value to its annual Sibos conference, an important community hub (Scott and Zachariadis, Reference Scott and Zachariadis2014). It serves as a field-configuring event (Lange, Power, and Suwala, Reference Lange, Power and Suwala2014), at which like-minded individuals from competitor banks can discuss common problems. Collective learning and community fora are thus forms of relational and social capital that help to build interpersonal and, by extension, interfirm trust among SWIFT members and their employees. However, SWIFT’s trusted reputation may not extend evenly within its member banks, but only among employees familiar with it. Operating across many different segments, financial institutions are not monoliths. SWIFT primarily services transaction banking, encompassing areas such as payments and post-trade. Investment banking activities, for example, may use different infrastructures and services.

Thirdly, gatekeeping as a specific form of access control is central to clubs. Club goods are not only about inclusion and availability to members. They necessarily involve exclusion to discourage free riding. Inclusion and exclusion are normal features of all kinds of groups and organisations, which the club notion helps to illuminate. SWIFT has three main user categories with different levels of access to SWIFT services:

• supervised financial institutions are entitled to full usage of SWIFT services;

• non-supervised financial industry entities may use almost the full suite of services; and

• closed user groups and corporate entities (including some non-financial firms), which are restricted to using messaging only within certain closed groups.

SWIFT users who are involved in the same business as the other shareholders and who send financial messages are eligible to become SWIFT shareholders; in practice they are mainly licensed/supervised financial institutions such as banks, securities broker/dealers, and investment managers (SWIFT, 2020). Unsurprisingly, there are restrictions on full SWIFT membership and access, given that banking itself functions as a club, with restricted access: state-imposed entry requirements guard the reputation and trust in members, and regulations guide behaviour in a way that benefits all members (Goodhart, 1988). However, at times, powerful members defend existing club boundaries to preserve advantages they enjoy (Stearns, Reference Stearns2011). SWIFT’s original member banks were not always keen on allowing new kinds of members to join. While securities firms and infrastructures were admitted in 1987, international fund managers’ efforts to join were originally blocked until 1992, while non-financial firms were allowed access in 2002 via closed user groups (Scott and Zachariadis, Reference Scott and Zachariadis2014).

There are always limits to trust, however. While, for example, SWIFT has thousands of member banks, most only own a tiny sliver. Board membership is partly composed according to network usage. This favours the large, mostly Western, GTBs who process most transactions, send most SWIFT messages, and drive SWIFT’s revenue. Although SWIFT’s network has global reach, it features asymmetries in connectivity, sedimented by the legacy of ‘particular dispositions within its infrastructural setup and routes, which emerge from past political choices’ (de Goede and Westermeier, Reference de Goede and Westermeier2022, p. 6).

A fourth and final aspect of clubs relates to governance. Clubs are a model of multilateral cooperation where negotiations and bargaining that produce compromise, decisions, and actions are obscured by being taken in a private setting (Keohane and Nye, Reference Keohane, Nye, Nye and Donahue2000). Sheltered from outside influences, the club is a private forum allowing room for competition for influence and ideas, while avoiding conflict and ironing out differences. While this model is usually associated with elites, it is also connected with private authority, in which trust in expertise, experience, and competence leads to legitimate governance based on delegation of technical issues (Tsingou, Reference Tsingou2014, Reference Tsingou2015). SWIFT’s legitimacy as a private authority stems from regulatory oversight by central banks, its cooperative ownership by regulated financial institutions, and from a variety of sources and roles, some of which it has performed for over forty years. These include:

• its function as standards developer/repository and role as an International Organization for Standardization (ISO) registration authority (designated as a competent body by the ISO);

• its status as an accredited market infrastructure; and

• its capacity as community hub and conference organiser for the global finance community.

SWIFT’s development and diffusion of its messaging standards has enabled the industrialisation of financial services on a global scale. SWIFT’s governance structure is partly organised to grant a country-level voice, from national user groups, ensuring communication between users and SWIFT to keep a global focus, to national member groups of shareholders, to the director voting formula (Scott and Zachariadis, Reference Scott and Zachariadis2014). It is not unusual, however, that the common direction the organisation forges is likely to suit the interests of its most powerful members, in this case the very few GTBs. While SWIFT is therefore a class alliance, it represents the hegemony of a particular transnationally oriented class fraction (Bieler and Morton, Reference Bieler, Morton, Jessop and Overbeek2018).

7 Conclusions

SWIFT as financial infrastructure provides communication, spatial integration, and fundamental functions of capitalism, such as the smooth functioning of exchange, and upholding property rights by keeping records and transfer of ownership. Sometimes cooperatively owned, this infrastructure demonstrates that the very core of financial markets is itself not always market-based. This chapter sought to provide an ordering mechanism to grasp the essences of SWIFT as a monopolistic infrastructure for infrastructures, by mobilising the concepts of trust.

Trust among club members is an essential precondition in mobilising collective strategic action to preserve dominance. Since 2017, in response to fintech challengers targeting inefficiencies in correspondent banking and in SWIFT’s legacy messaging system, SWIFT has coordinated and rolled out changes across its network worldwide, thereby building on collective learning among its members. As demonstrated in this chapter, system trust is a key part of the connective tissue of infrastructure.

SWIFT has also been reluctantly involved in geopolitical controversies. In ‘the SWIFT Affair’, there was uproar that prompted a reconfiguration of SWIFT’s data centre locations (Dörry, Robinson, and Derudder, Reference Dörry, Robinson and Derudder2018) after SWIFT allowed US authorities access to transaction data, including of European Union (EU) parties, following the 9/11 terrorist attacks in New York (de Goede, Reference de Goede2012). Financial sanctions on cross-border payments can be enacted in two ways: one involves targeting the information component, SWIFT, while the other involves targeting the settlement component by banning correspondent banks from processing currency transactions on behalf of banks in the issuer country (Robinson, Dörry, and Derudder, Reference Robinson, Dörry and Derudder2023). SWIFT has been forced by the USA and EU to disconnect banks in, amongst others, Iran on two occasions and Russia in 2022. While SWIFT wishes to remain neutral and to avoid disconnecting members and countries, its near-monopoly messaging infrastructure is a choke point that can be leveraged as a political tool.

Due to the possibility of future sanctions, certain countries are reducing USD dependence. They use alternative currencies and clearing/settlement systems, as well as alternative financial messaging systems to SWIFT (see Nölke, this volume; cf. Nölke, Reference Nölke, Braun and Koddenbrock2023). Established in the 1970s, SWIFT is a child of the post-1945 Bretton Woods cementing of USD hegemony, cross-Atlantic Eurodollar flows, the beginnings of financial globalisation, and the attendant dominance of Western banks, who crafted their private financial infrastructure according to their needs. A shift towards a multipolar monetary order will see attendant new financial infrastructures and shifts in existing infrastructure (see Westermeier and de Goede, this volume).

Challenges to SWIFT’s primacy in financial communications are not only about geo-politics/geo-economics, but also purportedly about economic efficiency and financial inclusion, for example, the United Nations sustainable development goals aim of reducing the cost of remittances. While SWIFT has recently upgraded its messaging infrastructure to compete in the digital platform era, other fintech challenges remain. The first is a nascent trend towards direct bilateral and multilateral interlinking of central banks’ national payment systems with the aim of improving cross-border payments efficiency, but with the possible effect of bypassing correspondent banking arrangements and SWIFT. A further challenge is from a new money form based on cryptocurrency, namely digital tokens on distributed ledger technology (DLT)/blockchain. While new technologies like blockchain have raised questions about trust in finance, they have not succeeded in their aim of removing trust entirely (Campbell‐Verduyn and Goguen, Reference Campbell‐Verduyn and Goguen2019). Incumbent banks, infrastructures, and central banks have incorporated the technology to make financial transactions more efficient through ‘tokenization’ of money and securities. This money form features ‘atomic’ instant combined communication and settlement of transactions, without the separate processes inherent in account-based money. It may thus replace existing financial infrastructures, including SWIFT, with entirely new DLT-based infrastructures.

Infrastructure consists of both technical ‘hardware’ and social ‘software’, including organisations in which it is embedded. SWIFT’s centrality as an infrastructure for infrastructures is not neutral but contingent on and enrolled in larger power struggles, which inform attempts to change it. Examining the money form(s) that financial infrastructures support allows us to speculate about potential infrastructural futures of new money forms. Change is inevitable, and understanding how this complex twin infrastructure of SWIFT and correspondent banking will navigate these challenges remains an exciting task for the future.

1 Introduction

Since the 1970s, SWIFT (Society for Worldwide Interbank Financial Telecommunication), which is based in Belgium, has become the dominant institution for recording cross-border financial transactions.¹ However, its dominance has recently been challenged by some large emerging markets. The Bank of Russia’s SPFS (System for Transfer of Financial Messages) was approved for cross-border use by the Russian Parliament in March 2019. India, Turkey, and Venezuela have expressed their interest in using the system, Belarus actually joined in 2021, Iran in 2022. China introduced its payment system called CIPS (Cross-Border Interbank Payment System) in 2015, which has seen a significant increase in transactions over the past few years, including the involvement of Russian banks. The system not only has a separate messaging system from SWIFT, but also covers a complete payment system, including clearing and settlement.

How can we make sense of the emergence of alternative financial messaging systems and payment systems based on an infrastructural lens? Subsequently, I will link the emergence of alternatives to the discussion on financial infrastructures and argue that the emergence of alternative infrastructures can be seen as a backlash against overt political use of the dominant infrastructure. Next, I will provide some background information on the cross-border payment process. At the center of this chapter is an account about the geoeconomic conflict about SWIFT and the emergence of Russian and Chinese alternatives in response to this conflict.

2 The Argument: Alternative Infrastructures as Backlash against Overt Political Use

During the 2020s, we have seen the development of an “infrastructural gaze” in social science studies of finance (see Westermeier, Campbell-Verduyn, and Brandl, this volume). The basic idea is to marry the macro-level concerns of international political economy (IPE) with the micro-level concepts of science and technology studies (STS). Two forms of gazing are particularly privileged. On the one side, a perspective more strongly anchored in SST attributes an agential role to infrastructures, highlighting how their technical features shape political activity (see Pinzur, this volume). On the other side, a perspective more informed by concerns of IPE departs from the macropolitical context when looking at infrastructures in finance, highlighting how these infrastructures determine the distribution of power (see Coombs, this volume). Given the point of departure outlined above, the second perspective is more relevant for this contribution.

At the core of Coombs’ perspective is Michael Mann’s concept of infrastructural power, a concept frequently invoked in the context of studies on the political aspects of financial infrastructures (see also, e.g., Konings, Reference Konings2010; Weiss and Thurbon, Reference Weiss and Thurbon2018; Bernards and Campbell-Verduyn, Reference Bernards and Campbell-Verduyn2019; Schwartz, Reference Schwartz2019; Braun and Koddenbrock, Reference Braun, Koddenbrock, Braun and Koddenbrock2022). At the core of the concept, defined in contrast to (often earlier ages of) despotic power, is the question of how the modern state has become able to wield so much power about the population within its territory. Whereas some applications of the concept use it to explain the power of finance actors over states and other financial actors (e.g., Braun and Koddenbrock, Reference Braun, Koddenbrock, Braun and Koddenbrock2022, p. 17), other applications apply the concept in order to explain how the expansion of financial markets (“financialization”) also increases the (infrastructural) power of the state (in particular of central banks), based on cooperation with financial sector actors (e.g., Konings, Reference Konings2010).

Since Coombs (this volume) is dissatisfied about the close linkage of infrastructural power with financialization in existing research, he develops a very subtle typology of instrumental, communicative, and network-forming infrastructural power, based on other works by Michael Mann. These types of power allow for a broader infrastructural analysis. However, Coombs’ typology still does not fully grasp the empirical developments described. All three types of infrastructural power ultimately go back to the power of ideas (even in case of “instrumental”), thereby missing the brute exercise of power by financial sanctions (and the subsequent establishment of alternative infrastructures). In the end, we may not be talking about infrastructural power at all in the overt power politics about SWIFT and its alternatives, given the indirect and diffuse nature of infrastructural power, if compared to other types of power (see Westermeier, Campbell-Verduyn, and Brandl, this volume).

There are further indications that the subtle approach of “infrastructural power” may not be entirely suitable for covering SWIFT sanctions and the development of Chinese and Russian alternatives. While the focus of Mann’s infrastructural power approach is upon relations between states and society (or economy), in case of SWIFT we are talking about relations between states (or geopolitical power blocs). Moreover, the focus of STS-informed approaches to infrastructural power usually is on one single infrastructure, not on the emergence of competing alternatives (for an exception see Campbell-Verduyn and Hütten, Reference Campbell-Verduyn and Hütten2023). Finally, existing approaches toward infrastructural power often focus on the Global North (or on global capitalism as a whole), not on North–South or West–East struggles (for an exception see de Goede and Westermeier, Reference de Goede and Westermeier2022).

Arguably, the emergence of an alternative payment infrastructure is a geoeconomic reaction to the geopolitical power play of the Western governments. Emerging economies have been warned about potential economic sanctions in this field. The Western threat of excluding Russia from SWIFT was frequently discussed when tensions between Russia and NATO (North Atlantic Treaty Organization) increased at the start of 2021, due to a Russian military buildup near the Ukrainian border (Faulconbridge, Reference Faulconbridge2021; Shagina, Reference Shagina2021; Smith, Reference Smith2022). In September 2021, the European Parliament (EP) had stated that the “EU should be ready to use its leverage and call for the exclusion of Russia from the SWIFT payment system to deter Russian authorities from engaging in further aggressive behaviour” (EP, 2021), echoing previous EP resolutions threatening the exclusion of Russia from SWIFT (Götz, Reference Götz2021).

During the 2014 Crimea crisis, discussions about Western sanctions against Russia already included the possibility of disconnecting the country from SWIFT. This led to the creation of the CIPS and the SPFS systems. In 2020, there were discussions in the USA about decoupling China from SWIFT. The focus was on how to respond to human rights issues related to the Uyghurs in China and the repression of the protest movement in Hong Kong (O’Toole, Reference O’Toole2020). In 2012 and 2017, smaller countries like Iran and North Korea were completely excluded from SWIFT.

Given this power play, the subtle notion of “infrastructural power” does not seem to be adequate for the analysis of the utilization of SWIFT as a sanction instrument and its repercussions with regard to the emergence of alternative payment systems. We should rather talk about “infrastructural geopolitics” (de Goede and Westermeier, Reference de Goede and Westermeier2022), or, better still about “infrastructural geoeconomics,” given that – in contrast to the Iran sanctions covered by de Goede and Westermeier – we are not only talking about (potential) war, but also (and even more so) about a long-term geoeconomic competition, particularly with regard of the US dollar as global trade currency.

Using SWIFT for “weaponized interdependence” (Farrell and Newman, Reference Farrell and Newman2019) by the USA has some clear costs for the latter. Many years ago, experts cautioned about the potential unintended consequences of this behavior, specifically about the emergence of alternative systems like SPFS, as noted by Jones and Whitworth (Reference Jones and Whitworth2014). Warnings have been intensified amidst the Russia–Ukraine tensions 2021/2022, emphasizing that disconnecting Russia from SWIFT could enable the Chinese government to develop strategies for handling similar challenges. According to Smith (Reference Smith2022), if disconnecting from SWIFT does not produce the desired results, it may result in the United States losing its related deterrence with Russia and China.

From a broader viewpoint, the decline of institutions like SWIFT could also harm the financial system of the United States, as “the extension of US infrastructural power abroad diminishes state capacity at home” (Weiss and Thurbon, Reference Weiss and Thurbon2018) – a claim which links Mann’s concern about state capacity with the geoeconomic issues of SWIFT-related sanctions. The main point being conveyed is the significance of a worldwide financial system that depends on the US dollar to fund the substantial deficit in the US current account (Schwartz, Reference Schwartz2019). Correspondingly, even before the Ukraine war the Republicans’ think tank Defense Priorities was already “counting the cost of financial warfare” and asked for “recalibrating sanctions policy to preserve US financial hegemony” (Gjoza, Reference Gjoza2019, p. 1), whereas the more bipartisan think tank Center for a New American Security echoed this concern and feared a “move away from dollar-based clearing and payments” (Harrell and Rosenberg, Reference Harrell and Rosenberg2019, p. 2). The US Treasury has expressed similar concerns across the Obama, Trump, and Biden administrations (Wong and Nelson, Reference Wong and Nelson2021, p. 13; Shagina, Reference Shagina2022, p. 3).

Considering the recent SWIFT-related sanctions imposed on Russia, it seems improbable that these warnings will be taken into account. As a result, significant emerging markets will likely keep on building cross-border payment systems that are within their own jurisdiction.

3 Background: Infrastructures of the Cross-Border Payments Process

To comprehend the significance of the global payments message infrastructure, especially SWIFT’s role, we must examine the cross-border payment process. This is a topic that macro-level international political economy research has historically overlooked, until very recently (Farrell and Newman, Reference Farrell and Newman2019; Nölke, Reference Nölke, Braun and Koddenbrock2022a, Reference Nölke2022b). However, social studies of finance have been very attuned to this topic, although usually with a strong focus on the micro-level (Campbell-Verduyn, 2017; Westermeier, Reference Westermeier2020; de Goede and Westermeier, 2022; Brandl and Dieterich, Reference Brandl and Dieterich2023; McDowell, Reference McDowell2023; Robinson, Dörry, and Derudder, Reference Robinson, Dörry and Derudder2023). Correspondingly, we need to combine the “zooming in” of social studies of finance with the “zooming out” and focus of the big picture of international political economy (see Westermeier, Campbell-Verduyn, and Brandl, this volume).

The process of making a payment involves electronic messages that are exchanged between financial institutions. These messages are used to facilitate the transfer of funds from the sender (originator) to the recipient (beneficiary) of the payment (US Department of Treasury, 2006; Wong and Nelson, Reference Wong and Nelson2021). Unless both the originator and beneficiary use the same institution, there are usually two financial institutions involved – one for the originator and one for the beneficiary. Additionally, there is typically some type of financial infrastructure in place. When two customers of the same financial institution want to transfer funds, it is a straightforward process. The person sending the money gives instructions to the institution, which then carries out the payment by recording the transaction in its accounting system. When two separate financial institutions, typically banks, are involved, they require a system of infrastructure which might include a separate financial messaging system like SWIFT.

It is sensible to categorize various subtypes of payments and their systems because of their wide range (Bech and Hancock, Reference Bech and Hancock2020, pp. 22–28): Typically, there are separate payment systems for retail and wholesale transactions. The term “retail” pertains to a high volume of small payments made for purchasing goods and services. These payment systems can be either private or public. Securities trading is typically part of the “wholesale” sector, involving fewer but larger transactions.

To fully grasp the function of SWIFT, it is important to differentiate between two processes: clearing and settlement. Settlement specifically pertains to the movement of funds. Due to the high volume of transactions that are sent in groups, called batches, financial institutions often need to reconcile these transactions with each other before they can be settled. Clearing involves reconciling and transmitting transactions, which is usually done through automated clearing houses, although it can also be done directly between two banks.

There is a third distinction between two types of settlement: “real-time gross” and “deferred net,” and there are some types that combine both. A real-time gross settlement” (RTGS) system settles each payment as soon as it is received. This system needs a lot of money available, unlike a “deferred net settlement” (DNS) system, which has higher settlement risks but is less expensive. In the second system, payments are cleared at the end of a defined time period based on the net amount. Most securities trading involving wholesale payments are conducted through RTGS systems. The Fedwire Funds Service is the most significant system, operated by the US Fed since 1918 and exclusive to the United States. The main payment system used for cross-border wholesale trading is CHIPS (Clearing House Interbank Payment System), which is based in the USA. This is a private organization that was established in 1974, and it focuses on clearing and settling high-value payments, such as bank loans and securities. The system uses a hybrid DNS–RTGS system. Still, access to SWIFT is crucial for maintaining comprehensive control over the payment messages generated by both Fedwire and CHIPS, particularly in the case of cross-border transfers.

Cross-border transfers are more complicated than domestic transfers. Usually, they operate via the system of “correspondence banking,” although the latter is not exclusive to cross-border transfers: “Correspondent banking is an arrangement, where one bank (the correspondent) holds deposits owned by other banks (the respondents) and provides payments and other services to them” (Bech and Hancock, Reference Bech and Hancock2020, p. 32). While some origins of the principle of correspondence banking date back to about 1400, the system has been established since the late 1800s (Rice, von Peter, and Boar, Reference Rice, von Peter and Boar2020, p. 38). Since not all banks have a correspondence relationship, fund transfers can involve a chain of transactions. The sender is directing their bank to utilize financial infrastructure to communicate with a bank in the beneficiary’s country via a correspondent bank. The process involves clearing and settling to transfer funds to the beneficiary’s financial institution.

Correspondence banking, however, is retreating slowly, but steadily. We have seen a reduction of about 20% in the number of correspondent banks between 2011 and 2018, in spite of rising values of payments (Rice, von Peter, and Boar, Reference Rice, von Peter and Boar2020, p. 38). One of the main reasons for decreasing profitability is the rise in regulatory requirements such as those related to money laundering, tax havens, and terrorist financing. Additionally, alternative cross-border payment systems that leverage technological advances have contributed to the development of alternatives to SWIFT.

In 1977, SWIFT was created as a means of sending payment instructions between different countries. However, it does not handle the process of clearing or settling payments. Almost half of the messages sent through SWIFT are related to securities transactions, reflecting its dominant global position for communication in wholesale operations (SWIFT, 2019, p. 3). Ripple, a fintech company, has attempted to create a quicker wholesale alternative to SWIFT and the correspondence banking system by implementing distributed ledger technology. However, this alternative only accounts for a small portion of the market. This is similar to J.P. Morgan’s Liink information-sharing system (Wong and Nelson, Reference Wong and Nelson2021, p. 8).

This is because SWIFT introduced a faster and more transparent payment service called “gpi” (global payments innovation) to counter these initiatives. Additionally, SWIFT has implemented another platform to improve speed, which was launched in late 2022. Correspondingly, the “infrastructural power” (Weiss and Thurbon, Reference Weiss and Thurbon2018; Schwartz, Reference Schwartz2019; Braun and Koddenbrock, Reference Braun, Koddenbrock, Braun and Koddenbrock2022; Coombs, this volume) of SWIFT with regard to cross-border wholesale payments still is undisputed. In 2020, SWIFT accounted for over 90% of the cross-border transactions totaling $140 trillion, which is equivalent to 152% of the global GDP (The Economist, 2021). However, SWIFT’s uncontested position may face challenges due to political conflicts in the future.

4 Geoeconomic Conflicts over SWIFT

For many years, SWIFT ran without disruption and received little attention from political economists. However, in 2012, an advocacy group based in the United States called United Against Nuclear Iran initiated a campaign against SWIFT. They claimed that SWIFT’s continued dealings with Iranian banks and institutions violated sanctions imposed on Iran by the European Union (EU) and the USA. Following the passage of legislation by the US Senate Banking Committee, sanctions against SWIFT were authorized if the company continued to provide services to Iranian financial institutions. SWIFT responded rapidly by indicating its willingness to comply with any sanctions arrangement developed by the EU and the USA. In March 2012, SWIFT cut off twenty-four Iranian institutions from their global financial signaling system in compliance with an EU regulation that prohibits the provision of financial messaging services to sanctioned institutions. This decision was significant for SWIFT, as it was turned into a geopolitical weapon.

Since Iran, “‘de-SWIFTing’ was readily recognized as the single most effective sanction currently in existence on a macro scale” – or as the “nuclear option” (Caytas, Reference Caytas2017, p. 14). The use of this terminology is making the role of SWIFT seem greater than it is. This is also true for Iran. The decoupling was just an addition to the existing US sanctions against any bank that carries out transactions with Iran, that is, making use of its power over the system of correspondence banks and CHIPS (O’Toole, Reference O’Toole2020; Smith, Reference Smith2022). More powerful than SWIFT decoupling is the latter sanction, potentially leading to a situation where the US government imposes heavy fines or withdraws the US license of any bank that conducts business with states blacklisted by the USA. For example, in 2014, BNP Paribas was fined 9 billion dollars (Götz, Reference Götz2021).

In 2016, many Iranian institutions were temporarily reconnected with SWIFT. This was due to the “Joint Comprehensive Plan of Action” or “Iran deal” that was agreed upon between Iran, the permanent members of the United Nations (UN) Security Council, Germany, and the EU. The negotiations involved bringing Iranian institutions back into the global financial system, which was a significant aspect of the agreement (Farrell and Newman, Reference Farrell and Newman2019, p. 69).

The Iran situation, however, was just the beginning of the potential use of SWIFT for geopolitical purposes. This was demonstrated again during the 2014 Crimea crisis, which was further highlighted by the Russia–Ukraine tensions in 2021 and the ensuing war that began in 2022. The US government proposed disconnecting Russia from SWIFT following the annexation of Crimea, but SWIFT did not comply. However, the utilization of SWIFT as a weapon has become increasingly common. In 2017, the Belgian government ordered SWIFT to block North Korean banks from accessing its system for correspondence banking, as these banks were still using it despite being sanctioned by the UN. This move was based on a UN report and was in line with the other EU countries (Weiland, Reference Weiland2017). SWIFT has complied and even disconnected all other banks in North Korea (Wong and Nelson, Reference Wong and Nelson2021, p. 14).

In 2018, the Trump administration withdrew from the Iran deal and warned that it would impose sanctions on the SWIFT board if it maintained their collaboration with Iran. This has brought back the issue of Iran. European countries, in contrast, did not withdraw from the Iran deal (Thießen and Jehmlich, Reference Thießen and Jehmlich2018, p. 4). Although the USA has no legal authority over SWIFT, it still gave in and removed Iranian institutions from its list due to concerns about the global financial system’s stability (Götz, Reference Götz2021; Wong and Nelson, Reference Wong and Nelson2021, p. 13). The USA also imposed secondary sanctions concerning Iranian institutions, leading to a comprehensive retreat of European banks from transactions with the latter. Subsequently, some European governments tried to resist US pressure by coming up with an alternative system for transactions with Iran (INSTEX, Instrument in Support of Trade Exchanges), circumventing the system of correspondence banks, CHIPS, and SWIFT, but this was not successful.

Finally, the by far most comprehensive utilization of SWIFT as geopolitical weapon has been taking place since the Russian war against Ukraine. After the Russian invasion, exclusion from SWIFT played a very prominent role in the public debate. Calls for an immediate exclusion of all Russian banks from SWIFT were initially countered by concerns about the practical consequences, which are difficult to overlook, given the close interconnectedness of these banks with the global financial system. So far, the EU has excluded a total of thirteen Russian (as well as four Belarusian) banks from SWIFT in three rounds. During the SWIFT exclusion on March 14, 2022, it affected the Bank Otkritie, Novikombank, Promsvyazbank, Bank Rossiya, Sovcombank, VEB, and VTB Bank. On June 14, 2022, additionally the Rosselkhozbank, Sberbank, and the Credit Bank of Moscow were excluded. Finally, the “anniversary” of the invasion was marked by the exclusion of Alfa-Bank, Tinkoff Bank, and Rosbank.

The EU has now imposed a complete transaction ban on most of these banks and has frozen their assets in the EU. Similar sanctions have been imposed by the UK. The USA has also placed relevant banks on the “Specially Designated Nationals” list. Correspondingly, US institutions may not conduct business with these banks. In contrast to the case of Iran, however, the USA have mostly refrained from imposing secondary sanctions, due to concerns of rising tensions with neutral economies in the Global South. The weaponization of cross-border payment infrastructures clearly poses a strategic dilemma to the West (Nölke, Reference Nölke2022b): The current payment-related sanctions on Russia are moderate in their effects, but a tightening of the sanctions could easily speed up the development of alternative infrastructures in China and Russia.

5 The Russian Alternative to SWIFT

In response to the threat of SWIFT decoupling after the annexation of Crimea, Russia launched its own cross-border financial messaging system called SPFS in November 2014. This was done as a precautionary measure and due to repeated warnings about the possibility of SWIFT decoupling in 2014 (Wenhong, Reference Wenhong2020). The SPFS is designed similarly to SWIFT, operates alongside it, and is intended to fully replace SWIFT if Russia loses access to it (which has happened to most Russian banks since the war on Ukraine). Moreover, it was meant to have a closed payment system where transactions cannot be monitored by the USA via access to SWIFT data (McDowell, Reference McDowell2023, p. 85).

As of 2023, the SPFS system’s usage is mostly limited to Russia. However, the Russian government is actively promoting it at international summits like the ones held by the Shanghai Cooperation Organization and BRICS (Brazil, Russia, India, China, South Africa, Iran, Egypt, Ethiopia, and the United Arab Emirates). In 2019, the Venezuelan government was reportedly considering joining the Russian system in response to concerns about facing new sanctions that may result in being excluded from SWIFT (Laya and Andrianova, Reference Laya and Andrianova2019); still, no Venezuelan bank was listed as an SPFS participant by 2021 (McDowell, Reference McDowell2023, p. 102). In the same year, Russia and Turkey reached an agreement to use ruble and lira instead of the dollar in bilateral trade, and to use SPFS for cross-border financial information (McDowell, Reference McDowell2023, p. 98). Also in 2019, Iran announced the connection of its recently developed payment signaling system, System for Electronic Payments Messaging (SEPAM), to the Russian system (Financial Tribune, 2019). In 2023, Iran finally joined SPFS, after Belarus in 2021. Still, these signaling systems are limited by the fact that they do not include clearing and settlement. If foreign business partners require US dollars – the usual trade currency – Russian banks still would need correspondence banks with access to CHIPS (McDowell, Reference McDowell2023, p. 85). In trade with India, however, the two governments have agreed to settle in rupees and to use bilateral settlement, in order to support the strongly growing trade between the two countries (Venkiteswaran, Reference Venkiteswaran2022). Alternatively, rubles or dirhams – the currency of the United Arab Emirates – are being used, with payment messages transferred via SPFS (Venkiteswaran, Reference Venkiteswaran2023).

The exact number of foreign banks using SPFS is unknown, since Russia has stopped publishing this information since the outbreak of the war, in order to protect SPFS cooperation partners from Western sanctions. By 2020, 400 financial institutions had joined, mostly from Russia, but also 23 foreign banks, from Armenia, Belarus, Germany, Kazakhstan, Kyrgyzstan, and Switzerland (McDowell, Reference McDowell2023, p. 85). This is very limited if compared to the roughly 11,000 institutions from 200 countries covered by SWIFT – but the main purpose of SPFS is not to match SWIFT, but to have a workaround in case of Western sanctions.

In addition to creating SPFS, Russia also implemented additional measures to protect itself from possible financial sanctions. These measures included building up large foreign reserves and establishing a domestic credit card system called “Mir” that lessens the impact of Mastercard and Visa being cut off for Russian consumers (Gricius, Reference Gricius2020). It has been reported that Russia is creating a digital version of their currency called the digital ruble, similar to the Chinese plans (see Section 6). A digital currency does not need to rely on SWIFT, but can find other ways to communicate (Shagina, Reference Shagina2022, p. 5; Westermeier, Reference Westermeier2023). However, SWIFT has been very active in establishing a cross-border central bank digital currency (CBDC) platform, in order to become a leading actor in this field, too.

Although the disconnection from SWIFT due to Western sanctions in 2022 caused short-term capital outflows, currency volatility, and inconveniences for transactions with Russia (such as reverting to telex, email, or fax for financial messaging), it appears that the medium-term impact can be managed (Smith, Reference Smith2022). This is also due to the fact that the sanctions still leave loopholes. As of 2023, Gazprombank – the most important Russian bank for energy trade – is still connected to SWIFT, and two major European banks – Raiffeisen Bank International and UniCredit – still operate in Russia (Nölke, Reference Nölke2023). In contrast, a study of TARGET2 transaction data indicates that for those ten Russian banks that were disconnected from SWIFT in 2022, TARGET2 transactions were comprehensively terminated (Drott, Goldbach, and Nitsch, Reference Drott, Goldbach and Nitsch2022). However, this development is mainly based on the blocking sanctions that the EU has issued more or in parallel with the exclusion from SWIFT, not on the exclusion as such.

6 The Chinese Alternative to SWIFT, CHIPS, and US-Linked Correspondence Banking

The Chinese response to SWIFT sanctions is more extensive. China has been using CIPS since 2015. This system is more than just a financial messaging platform like SWIFT. It includes clearing and settlement capabilities, making it a complete payment system. While it still utilizes SWIFT for most cross-border financial communications, it can also function without it if required (Friesen, Reference Friesen2023, p. 15). CIPS distinguishes between direct participants (under the legal supervision of the People’s Bank of China) and indirect participants (many from abroad). The former have an account with CIPS (and a separate CIPS terminal), the latter may use CIPS via the direct participants.

Since the 1910s, China has undergone a global policy shift which includes the development of CIPS. The Chinese strategy is primarily focused on the idea of “global connectivity” (Godehardt, Reference Godehardt2020). This strategy involves creating both physical and digital infrastructures that are centered on China. China has realized the potential threat of being separated from the Western financial infrastructure. As a result, they have decided that solely working within existing institutions, such as setting up a data storage center called Finance Gateway Information Service in China in cooperation with SWIFT in 2021, is not enough. China needs to complement its strategy by developing a new set of institutions centered in China. This goes further than the Russian strategy to create an “Economic Fortress Russia,” given that China aims to create alternative (financial) infrastructures centered on China (Petry, Reference Petry2023).

The amount of payments processed within CIPS is currently still limited: “The Chinese system … processes approximately 15.000 transactions per day, amounting to the dollar equivalent of $50 billion. Meanwhile, CHIPS, the US version, processes 250.000 transactions per day, exceeding $ 1.5 billion” (Norrlöf, Reference Norrlöf2023). Correspondingly, China is “astute enough not to challenge SWIFT until the CIPS has matured, but no doubt one day the challenge will come” (Prasad, Reference Prasad2017, p. 116).

Although the Chinese alternative to SWIFT has not gained many users yet, its usage is increasing rapidly. According to a Nikkei survey, there was an 80% rise in payment settlements based on CIPS between 2017 and 2018 already. This increase was particularly observed in countries that are under US sanctions, such as Russia and Turkey, and countries involved in the Belt and Road Initiative (Kidda, Kubota, and Cho, Reference Kidda, Kubota and Cho2019). From October 2015 to May 2021, the number of participants in CIPS grew significantly, from 195 to 1,189 (Wong and Nelson, Reference Wong and Nelson2021, pp. 9–10), rising to 1,280 participants from 103 countries in January 2022 (Cipriani, Goldberg, and Spada, 2023, p. 27) and, by February 2023, to 1,366 participants, 79 direct and 1,287 indirect (Friesen, Reference Friesen2023, p. 15). By February 2023, the number of foreign banks in CIPS was at least 613 (CED, 2023, p. 6). In addition, the faster-growing economic region where the alternative system is being used is not the traditional – and comparatively stagnating – center of the global economy covered by SWIFT.

Since several Russian banks are linked to CIPS as indirect participants (and one Chinese bank is connected to Russian SPFS), the payment system allows China–Russia transfers, even if the Russian banks are sanctioned by exclusion from SWIFT (Cipriani, Goldberg, and Spada, 2023, p. 27). The issue of China’s payment system has resurfaced amidst growing tensions between China and the USA, which haven’t eased up after Biden became president. The bipartisan US consensus regarding the need to slow China’s rise poses a significant threat, leading the Chinese government to increase efforts to promote their alternative payment system. To avoid being hurt by potential US sanctions too badly, the Bank of China has advised the country’s banks to avoid SWIFT messaging (PYMNTS, 2020).

In addition, China has been increasing efforts to create a CBDC, which could serve as an alternative to traditional cross-border payment systems (Greene, Reference Greene2021; Friesen, Reference Friesen2023, pp. 16–18). This type of digital currency does not rely on SWIFT or correspondence banking, which is currently dominated by US banks. China plans to expand the use of its digital renminbi (also known as digital yuan, DCEP, or e-CNY) from domestic retail payments to wholesale cross-border trading in the future. This is in line with China’s strategy to take advantage of having the first major currency to introduce a CBDC.

Many market participants believe that the digital renminbi could be as risky as the physical renminbi, due to the closed nature of the Chinese financial system (Kärnfelt, Reference Kärnfelt2020; Shagina, Reference Shagina2021, Reference Shagina2022). Therefore, it is even more crucial for China to support global CBDC standards, especially a multi-CBDC arrangement (known as the mBridge project), than to expand the use of the digital renminbi. Interlinked CBDCs allow central banks to settle payments between the related countries in their own currencies, without resorting to correspondence banks and the US-controlled CHIPS settlement system.

In the future, a multi-CBDC arrangement that works efficiently could offer a cheaper and faster option for cross-border payments compared to the current correspondence bank and SWIFT-based system (Auer, Haene, and Holden, Reference Auer, Haene and Holden2021), even if SWIFT is very active in establishing a cross-border CBDC infrastructure itself. As a result, it might weaken the position of the US dollar as the primary global currency and the ability of the USA to monitor international financial transactions (Campbell, Reference Campbell2021; Lewis and Li, Reference Lewis and Li2021). In addition, the widespread adoption of CBDCs may make it easier for governments to implement advanced capital controls due to the significant level of state oversight in the use of these digital currencies (Greene, Reference Greene2021).

7 Implications: Alternatives to SWIFT and the Future of the Global Financial Infrastructure

In contrast to the subtle forms of domination discussed in the context of infrastructural power (see Coombs, this volume; Pinzur, this volume), we have witnessed an overt case of geopolitical confrontation, with long-term geoeconomic implications. The increasing use of SWIFT as a weapon has led to the creation and adoption of alternative cross-border payment systems, as a (potential) defense against Western sanctions. China, with its state-capitalist economy, is at the forefront of alternative systems, particularly in the use of CBDCs for cross-border transfers.

The increase in the number of competing payment infrastructures can also hurt the currently dominant (“financialized”) mode of the global financial system (Braun and Koddenbrock, Reference Braun, Koddenbrock, Braun and Koddenbrock2022). According to Fichtner (Reference Fichtner2017), the current system has a high level of centralization in its financial infrastructures, which are controlled by Anglo-American entities. However, if there were a further development competing infrastructures, this could potentially weaken this important aspect of the current global financial order. This development is increasingly causing concern among US think tanks, including Carnegie (Greene, Reference Greene2021). Similar to the USA, China one day could use its payment system in order to exercise its own “infrastructural geopolitics” against other countries (de Goede and Westermeier, Reference de Goede and Westermeier2022).

For the time being, however, the focus is on geoeconomic competition (Babic, Dixon, and Liu, 2022), most notably on the function of the US dollar as trade currency. Correspondingly, the development of Russian and particularly Chinese alternatives to SWIFT (and the related US-dominated system of correspondence banks (see Westermeier, Campbell-Verduyn, and Brandl, this volume, as well as Nance and Tsingou, this volume), should rather be counted as a case of “infrastructural geoeconomics,” that is, the pursuit of geoeconomic strategies via (financial) infrastructures.

First indications for the reduction of the role of the US dollar as the dominant global trade policy were already visible in 2023, driven by the Western sanctions on Russia after its invasion of Ukraine. Daily transactions using CIPS have increased by 50% (The Economist, 2023) and the renminbi’s share of global trade finance has more than doubled during the first year after the onset of the war, and now nearly reaches the role of the euro (Lockett and Leng, Reference Lockett and Leng2023). Alternative geoeconomic financial infrastructures are clearly gaining ground.

Acknowledgments and Funding

I am very grateful to Carola Westermeier and Malcolm Campbell-Verduyn for extremely helpful comments on a previous version. Research was funded by the StateCapFinance project funded by the German Research Foundation/DFG (No. 855/7-1).

1 Introduction

At the 2009 G20 Pittsburgh Summit, global leaders agreed that over-the-counter (OTC) derivatives should be standardized and routed through central clearing counterparties (CCPs or clearing houses). This move aimed at mitigating the risk that these instruments posed to financial stability (G20 Leaders Statement, 2009; Stafford, Reference Stafford2017, Reference Stafford2018; ISDA, 2021). OTC derivatives – especially credit default swaps – played a major role in the 2008 global financial crisis (FCIC, 2011). Thus, in the period between the bankruptcy of Lehman Brothers on 15 September 2008 and the G20 Pittsburgh Summit that started on 24 September 2009, pressure had mounted on G20 leaders to address the safety and transparency of OTC derivatives markets.

Derivatives are financial instruments (or contracts) whose value derives from the value of underlying assets and variables (Hull, Reference Hull2021, p. 23).¹ Professional investors use derivatives for three main reasons: to hedge against potential losses in investment portfolios; to speculate on the future direction of asset prices and variables; and to arbitrage between the values of two or more securities (Hull, Reference Hull2021, pp. 33–39).² Since the late nineteenth century, derivatives trading has occurred on both organized exchanges and OTC markets (Swan, Reference Swan1999). Organized exchanges are regulated marketplaces where market participants buy and sell standardized contracts. Trades and risk are managed centrally through CCPs. By contrast, before the post-2009 reforms, OTC derivatives markets were self-regulated spaces where investors traded non-standardized derivatives (often complex ones) bilaterally, without channelling them through clearing houses (Hull, Reference Hull2021, pp. 24–27). By the early 2000s, OTC derivatives trading had expanded dramatically more than trading on organized exchanges had (see Figure 21.1).³ OTC derivatives markets had become a vast, opaque, and decentralized network connecting the trading floors of major financial organizations (Schinasi et al., Reference Schinasi, Craig, Drees and Kramer2000, pp. 9–30). Quite tellingly, Frank Partnoy (Reference Partnoy2009, p. 18) referred to OTC derivatives markets as the ‘wild Wild West of trading’, because in these opaque, decentralized, and practically unregulated markets traders benefited from designing a large range of bespoke derivatives contracts that were not available on organized exchanges. However, despite such benefits, OTC derivatives markets entailed a significantly higher level of risk compared to organized markets (Steinherr, Reference Steinherr2000).

Figure 21.1 National amount (US$ billions) of financial derivatives on global OTC markets and organized exchanges, 1998–2011.

Source: Lagna (2013, p. 14) based on BIS data.

In this chapter, we delve into the transformative measures implemented by policymakers and regulators to improve security and transparency in OTC derivatives markets following the 2009 G20 Pittsburgh Summit. We explore how these efforts substantially increased the ‘infrastructural authority’ (Genito, Reference Genito2019) that CCPs traditionally held over exchange-traded derivatives, which represented a smaller segment of global derivatives markets. According to Genito (Reference Genito2019), the concept of infrastructural authority refers to the ability of CCPs, as private organizations, to influence derivatives trading through their clearing and settlement services.⁴ As policymakers and regulators pushed for the central clearing of OTC derivatives, CCPs expanded their influence beyond exchange-traded derivatives, encompassing the majority of global derivatives trading. Importantly, while this process enhanced the transparency and safety of derivatives markets, it also transformed CCPs into what has been termed ‘the new too-big-to-fail institutions’ (Stafford, Reference Stafford2017) of global finance.

Our chapter is structured as follows. In the next section, we examine the infrastructural authority of CCPs before the 2009 reforms. We then trace the expansion of CCPs’ infrastructural authority resulting from the post-2009 reforms. After that, we study the implications of CCPs’ heightened infrastructural authority for financial stability. Finally, we conclude with an overview of our analysis and a call for regulators and policymakers to take into consideration the ‘infrastructural properties’ (Campbell-Verduyn, Goguen, and Porter, Reference Campbell-Verduyn, Goguen and Porter2019, p. 928) of CCPs.

2 CCPs’ Infrastructural Authority over Exchange-Traded Derivatives before 2009

Derivatives were historically traded on both organized exchanges and OTC markets (Swan, Reference Swan1999). Exchange-traded derivatives have a long history tracing back to commodity futures trading in the United States during the late nineteenth century (Levy, Reference Levy2006). US commodity exchanges such as the Chicago Board of Trade and the Chicago Mercantile Exchange (CME, or Merc) established the foundations of modern-day derivatives trading as a risk management business that included standardized contracts, open outcry trading pits (today almost completely replaced by electronic trading), the possibility to close out trades through cash settlement without commodity delivery, and, most importantly for the purpose of this chapter, the practices and technologies of central clearing (Moser, Reference Moser and Telser2000; Millo et al., Reference Millo, Muniesa, Panourgias and Scott2005; Levy, Reference Levy2006; Pinzur, Reference Pinzur2016). In the early 1970s, organized exchanges expanded their business beyond commodity derivatives to include the trading of futures and options contracts on financial derivatives (Markham, Reference Markham1987).

Central clearing is the major benefit of trading derivatives on organized exchanges. It mitigates counterparty risk and provides a transparent platform for clearing, settlement, and reporting trades. Crucially, central clearing is the socio-technical construct through which CCPs historically exerted their infrastructural authority over exchange-traded derivatives (Genito, Reference Genito2019). Central clearing is legally based on counterparty substitution through ‘novation’, which means that a CCP becomes the counterpart in each trade, selling derivatives contracts to buyers and buying them from sellers, while also clearing and settling such contracts (Loader, Reference Loader2020). CCPs have several firewalls to protect against possible defaults of participating members. The margin system is the first and most important firewall (Norman, Reference Norman2011).

In the margin system, the clearing house collects liquid collateral – for example, sovereign bonds and cash-like instruments – from traders, and such collateral is used in case of default to make up for financial losses (Genito, Reference Genito2019, pp. 945–946). In derivatives markets, the margin system includes the initial margin paid into the investor’s account to enter the market; the variation margin, which reflects the daily gains and losses between traders; and the maintenance margin as the lowest amount an account can reach before a margin call is issued asking a trader to bring the margin back to the initial amount (Hull, Reference Hull2021, pp. 51–52). Should the margin requirements be exhausted, CCPs can also resort to other firewalls such as default funds and, in the last instance, their own capital (LCH, 2024).

The key point is that, contrary to bilateral trading, CCPs allow investors to be individually exposed only to the clearing house, which uses multilateral netting to sum up investors’ multiple transactions (Genito, Reference Genito2019, pp. 944–945). CCPs use the ‘matched book’ to offset a position taken on with one counterparty with an opposite position taken on with another counterparty (Rehlon and Nixon, Reference Rehlon and Nixon2013, p. 2). In a word, central counterparty clearing replaces multiple risk exposures among investors with a centralized network in which clearing participants are only individually exposed to the CCP (Domanski, Gambacorta, and Picillo, Reference Domanski, Gambacorta and Picillo2015, p. 60). Thus, clearing houses can reduce market risk by matching all positions and offsetting losses against the buyer with gains from the seller. However, as we show later in this chapter, CCPs are themselves vulnerable to the risk of counterparty default.

Thus, CCPs traditionally exerted infrastructural authority over exchange-traded derivatives through the practices and technologies of central clearing. CCPs replace by means of novation the buyers and the sellers of derivatives contracts in organized exchanges. In so doing, CCPs become legally responsible for all contractual obligations. Furthermore, CCPs both enable the trading of derivatives instruments and constrain it through the imposition of margins and the posting of collateral (Genito, Reference Genito2019, p. 950).

Unlike organized exchanges, OTC markets before 2009 were decentralized networks of financial organizations tailoring derivatives instruments to fit certain requirements of their clients (Schinasi et al., Reference Schinasi, Craig, Drees and Kramer2000). Derivatives were privately negotiated between two parties without using CCPs – for example, a bank selling an interest rate swap to a local authority that wants to optimize liability costs (Hendrikse and Sidaway, Reference Hendrikse and Sidaway2013; Lagna, Reference Lagna2015). Just like derivatives trading on organized exchanges, OTC derivatives markets have a long history. For example, during the 1950s options dealers advertised premiums for equity options in the Wall Street Journal and the New York Times (Options Institute, 1995, pp. 6–7). A turning point in the history of OTC derivatives markets occurred in the 1980s when the growing use of swaps contracts marked the expansion of OTC markets (Bryan and Rafferty, Reference Bryan and Rafferty2006).

One of the first swaps was introduced in 1981 with a famous agreement between IBM (International Business Machines Corporation) and the International Bank for Reconstruction and Development (World Bank Group) (Kapur, Lewis, and Webb, Reference Kapur, Lewis and Webb1997, p. 1035). Initially, a group of big banks structured bilateral swap deals, but soon these banks realized the fee-earning potential and started acting as market makers (Geisst, Reference Geisst2002, p. 250). In 1985, they established the International Swaps and Derivatives Association (ISDA) to represent the swaps industry (ISDA, 2024). From this point onwards, swaps became the fastest growing derivatives sector, with companies using them to hedge the risk exposures to interest rates and exchange rates (Markham, Reference Markham2002, p. 192). Moreover, customized swaps became the perfect unregulated instruments that corporations ‘could use […] to avoid regulation or to hide risks’ (Partnoy, Reference Partnoy2009, p. 47). Governments and local authorities also joined the swaps market for their debt management activities, becoming important clients of major investment banks that were packaging and selling swaps (Hendrikse and Sidaway, Reference Hendrikse and Sidaway2013; Lagna, Reference Lagna2015, Reference Lagna2016).

By the time of the 2008 global financial crisis, OTC derivatives markets had expanded dramatically compared to organized exchanges (see Figure 21.1). Importantly, such expansion was built upon the self-regulation of derivatives dealers (Group of Thirty, 1993; Pagliari, Reference Pagliari2012; Tsingou, Reference Tsingou2015). To be sure, several self-regulatory initiatives were developed to minimize risk. Notably, derivatives contracts were subject to the ISDA Master Agreement, which outlines the terms and conditions for parties engaging in OTC derivatives transactions. The ISDA Master Agreement reduced investors’ concerns with counterparty risk concentration in large financial organizations (Lockwood, Reference Lockwood, Helleiner, Pagliari and Spagna2018). However, despite the ISDA Master Agreement, OTC derivatives markets ultimately functioned in a decentralized manner without CCPs mitigating risk and ensuring transparency. As Schinasi et al. (Reference Schinasi, Craig, Drees and Kramer2000, p. 19) aptly explained:

Eventually, the collapse of Lehman Brothers on 15 September 2008, and the ensuing global financial crisis, dealt a major blow to OTC derivatives markets. Credit derivatives – and OTC derivatives more broadly – were at the root of the crisis and necessitated radical reforms (G20 Leaders Statement, 2008, p. 7). It was clear that the decentralized practices of risk management and the ISDA Master Agreement failed to prevent the accumulation of counterparty risk in large financial organizations like Lehman (Parker and McGarry, Reference Parker and McGarry2009). Soon enough, the attention of policymakers and regulators turned to central clearing as useful to make OTC derivatives markets safer and more transparent. In Section 3, we turn to these regulatory actions and how they augmented the infrastructural authority of CCPs.

3 Augmenting the Infrastructural Authority of CCPs

Following the 2009 G20 Pittsburgh Summit, several crucial reforms were implemented, including: (1) the central clearing of standardized OTC derivatives; (2) organized trading of standardized OTC derivatives (where possible); (3) reporting of OTC derivatives trades to data repositories; and (4) higher capital and minimum margin requirements for non-cleared OTC derivatives (ISDA, 2021, p. 3). In a word, such reforms rethought the historical distinction between organized derivatives markets and OTC derivatives.

CCPs rose to prominence in the aftermath of the 2008 global financial crisis when LCH.Clearnet, which in 2016 renamed itself LCH, successfully handled the default of Lehman Brothers. Lehman Brothers used LCH.Clearnet to clear trades. Lehman’s collapse on 15 September 2008 left a multitrillion-dollar exposure on LCH.Clearnet’s books (De Teran, Reference De Teran2008; Norman, Reference Norman2011, p. 26). By October 2009, LCH.Clearnet settled Lehman’s positions without having to rely on its default fund (Gregory, Reference Gregory2014, p. 43). In other words, LCH.Clearnet prevented any of its clearing members from incurring financial losses stemming from Lehman’s defaulting positions. This specific event helped consolidate the regulatory and policy-making consensus on leveraging the practices and technologies of CCP to make the central clearing of OTC derivatives mandatory – in so doing, improving the transparency and stability of these complex financial markets (Lee, Reference Lee2010; Wendt, Reference Wendt2015).

Mandatory clearing of OTC derivatives was introduced in the USA with the 2010 Dodd-Frank Act and in the European Union (EU) with the 2012 European Market Infrastructure Regulation. The Committee on Payments and Settlements Systems – later renamed the Committee on Payments and Market Infrastructures – and the International Organization for Securities Commission were mandated to establish international standards to supervise and regulate CCPs (Helleiner, Reference Helleiner, Best and Gheciu2014, p. 80; Thiemann, Reference Thiemann, Braun and Koddenbrock2023, p. 139). Following these regulatory actions, by the second quarter of 2017, the portion of interest rate swaps cleared through CCPs represented 88.5% of the traded notional amount for such instruments. Cleared credit default swaps accounted for 79% of the notional amount (ISDA, 2017). As of the first quarter of 2023, cleared interest rate swap transactions comprised 78.4% of the total traded notional amount, while cleared credit derivatives transactions accounted for 87.4% of the traded notional total (ISDA, 2023).

Thus, prompted by G20 leaders and their objective to reduce the risk that OTC derivatives trading posed to financial stability leading up to the 2008 financial crash, policymakers and regulators profoundly reshaped OTC derivatives markets by introducing the system of central clearing (BIS, 2016, p. 5). As a result, CCPs – and particularly the world’s largest clearing houses such as LCH, CME Clearing, and Eurex Clearing – have increased their infrastructural authority considerably, superintending a broad swathe of global derivatives trading through counterparty substitution and margin requirements. Whereas during the self-regulatory era, OTC derivatives users were relatively free to negotiate and customize the terms of contracts, now they must accept standard practices imposed by CCPs – above all, the collateral-based margins (Genito, Reference Genito2019, p. 950).

4 Central Counterparty Clearing and Financial Stability

What are the implications of CCPs’ infrastructural authority for financial stability? Let us focus on two dimensions: risk concentration in CCPs and the impact of CCPs’ margins on market liquidity. Both dimensions have the potential to render the infrastructural authority of CCPs more visible to the wider financial system and economy, in the sense that market participants would become fully aware of CCPs’ operations in the event of a financial meltdown caused by those clearing practices and technologies that are usually hidden in the background (Genito, Reference Genito2019, p. 942). Such CCP-led crises could result in state actors reining in the infrastructural authority of clearing houses.

5 Conclusion

In this chapter, we showed how the regulatory actions following the 2009 G20 Pittsburgh Summit bestowed considerable infrastructural authority on CCPs. First, we analysed how, before 2009, CCPs had limited infrastructural authority on global derivatives trading because they oversaw only exchange-traded derivatives. We then examined how policymakers and regulators enabled the expansion of CCPs’ infrastructural authority following the post-2009 reforms. Such authority hinges on the mandatory clearing of OTC derivatives, counterparty substitution by means of novation, and CCPs’ use of collateral-based margins. Finally, we delved into the implications of CCPs’ increased infrastructural authority for financial stability, specifically regarding the concentration of systemic risk in a limited group of CCPs and the potential impact of CCPs’ margin calls on market liquidity.

The post-2009 reforms of OTC derivatives markets were a double-edged sword. On one hand, they placated political pressure to reform global finance after the 2008 great crash by increasing the infrastructural authority of CCPs in global derivatives markets. On the other hand, such reforms concentrated risk in CCPs and did not consider the negative impact that CCPs’ margins may have on market liquidity. Policymakers and regulators have tried to address the structural problem of CCPs’ risk concentration – for example, through the recovery and resolution of failing CCPs (Regulation (EU) 2021/23, 2020). However, these regulatory actions ‘stand in for a solution which de facto cannot be found’ (Thiemann, Reference Thiemann, Braun and Koddenbrock2023, p. 141). In case of a low-probability/high-impact market event, CCPs would require state intervention in the form of liquidity injection by central banks (Thiemann, Reference Thiemann, Braun and Koddenbrock2023, p. 141). Furthermore, while the systemic risk of a failing CCP has been at least considered, policymakers and regulators have not significantly explored the negative impact that CCPs’ margins can have on market liquidity (Genito, Reference Genito2019, p. 955; Genito and Lagna, Reference Genito and Lagna2024).

The debate on CCPs’ growing centrality in global finance and their impact on financial stability continues. We can only hope that viable solutions will be found before we are confronted with another tail event in global financial markets. Finding viable solutions requires thinking carefully about the ‘infrastructural properties’ (Campbell-Verduyn, Goguen, and Porter, Reference Campbell-Verduyn, Goguen and Porter2019, p. 928) of CCPs to avoid ending up in a game of Whac-A-Mole, in which regulatory actions unintentionally create new systemic risks.

1 Introduction

During the 2021 United Nations (UN) Climate Change Conference (COP26) in Glasgow, US Treasury Secretary Janet Yellen (Reference Yellen2021, para. 2) in her keynote speech remarked that addressing climate change will require nothing less than “the wholesale transformation of our carbon-intensive economies,” estimating the costs for this transition “between $100 and $150 trillion over the next three decades.” Mitigating climate change will thus require “making finance flows consistent with a pathway towards low greenhouse gas emissions and climate-resilient development,” as stated in the Paris Agreement (UN, 2015). As a result, various kinds of sustainable finance have grown rapidly after 2015. But whether this allegedly “sustainable” way of investing can actually fulfill this monumental task depends very much on the concrete business schemes and investment practices that are adopted. As this chapter illustrates, this is ultimately determined by the specific infrastructural arrangements – notably environmental, social, and governance (ESG) data, ratings, and indices – that underpin sustainable finance.

According to the European Union (EU) (2023, para. 1), sustainable finance, in its very broad sense, “refers to the process of taking environmental, social and governance (ESG) considerations into account when making investment decisions in the financial sector, leading to more long-term investments in sustainable economic activities and projects.”¹ From its beginnings as a niche phenomenon at the beginning of the 2000s, ESG has turned into a much-debated trend in recent years (Pollman, Reference Pollman2022). However, ESG is both highly contested and its true size is unclear, with estimates ranging from about $700 billion to $30,000 billion (Fichtner, Jaspert, and Petry, Reference Fichtner, Jaspert and Petry2023b). This astounding disorientation regarding the actual structure of the business field creates a sphere of confusion that makes ESG prone to greenwashing.²

In this chapter, we conceptualize ESG as the infrastructure that underpins “sustainable” investing.³ We argue that ESG constitutes a particular set of market devices – data, ratings, and indices – that define the logic, structure, and outcomes of sustainable investing. Having historically emerged as market-driven private standards for governing how to invest “sustainably,” we demonstrate how a small set of private actors defines the infrastructural arrangements that guide ESG investing. As a consequence, a preference for a market-friendly and one-sided conception of sustainability exclusively focused on risks to investors’ portfolios (“single materiality”) was implemented by the actors that defined standards. This setup of ESG creates what we call an “infrastructural lock-in,” whereby this particular conception of “sustainable” investing – which is not utilizing all available transmission mechanisms to actively advance sustainability (Fichtner, Jaspert, and Petry, Reference Fichtner, Jaspert and Petry2023a) – becomes the baseline and the common standard for “sustainable” finance. Market-driven standards of private governance, we argue, ultimately shaped supposedly sustainable investment practices into a form that is inherently not significantly advancing sustainability. By investigating the infrastructure of ESG, we shed light on the crucial question to what extent ESG can play a meaningful role in the much-needed green transition (see also Seabrooke and Stenström, this volume) – and how regulation could remedy some of the crucial shortcomings of ESG investing.

This chapter is structured as follows. Section 2 discusses ESG in terms of a sociotechnical infrastructure for sustainable investing as well as its potential (non)impacts for sustainability. Section 3 then provides a brief historical overview how ESG investing developed, illustrating its emergence as market-driven private standards for defining sustainable investing. Section 4 discusses the resulting structure of the market for ESG which is highly concentrated among a few firms. Drawing on the distinction between single- and double-materiality conceptions of ESG, Section 5 then illustrates how this setup creates an “infrastructural lock-in” as ESG in its contemporary form does not seek to create positive sustainable impact. Section 6 concludes and highlights further avenues of research.

2 ESG as the Sociotechnical Infrastructure of Sustainable Investing

For every market, certain sociotechnical infrastructures need to be in place to enable transactions in the first place (Bowker and Star, Reference Bowker and Star1999). In other words, particular “social, cultural, and technical conditions” make markets possible (MacKenzie, Reference MacKenzie2006, p. 13). But while infrastructures are an enabling factor, they also determine constraints and mark the boundaries of what is possible. As Caliskan (Reference Caliskan2020, p. 542) has stressed, “the study of socio-technical infrastructures plays a crucial role in making sense of economic action and agency, because they structure possible fields of action in identifiable ways.” Infrastructures are not necessarily deterministic but generally shape the room for what is possible – and what is not. Infrastructures therefore potentially lock-in certain practices and courses of action while making the pursuit of alternatives less likely.⁴ In the case of sustainable finance, the infrastructure that underlies ESG investing defines how “sustainable” investing is being conducted and what counts as such. ESG data, ratings, and indices – in this very sense – function both as important market devices that enable sustainable investing while simultaneously determining the limits of what sustainability impact ESG can achieve.

Importantly, these financial infrastructures are inherently political as they modify the distribution of power and capabilities within marketplaces (Pardo-Guerra, Reference Pardo-Guerra2019). Bernards and Campbell-Verduyn (Reference Bernards and Campbell-Verduyn2019, p. 783), for instance, argue that financial infrastructures “can confer, extend and enable new forms of governance” and that “contemporary forms of hybrid public/private governance and corporate power often depend on control over key financial infrastructures.” Similarly, Pinzur (this volume) notes that financial infrastructures are always embedded in asymmetric relations of dependency and discretion which exist between the operators of infrastructures and their users. Whoever controls financial infrastructures therefore has significant power to shape markets and their socioeconomic outcomes. It is thus important to analyze “the hard-wiring of technical operations into financial practices and regulations” (Dimmelmeier, Reference Dimmelmeier2020, p. 2). As a result, by setting the rules of the game for sustainable investing the operators of financial infrastructures have a large degree of power to shape financial markets, their dynamics, and outcomes (Genito, Reference Genito2019; Petry, Reference Petry2021). Who defines ESG – the data, ratings, and indices that set the parameters for sustainable investing – hence matters for what the material impact of these investments actually is.

Thus, in order to better understand the impact that ESG has as the sociotechnical infrastructure for sustainable finance, we need to analyze how its particular characteristics have emerged. As we illustrate in the following sections, ESG has developed as market-driven standards for the private governance of investment practices. This genesis of ESG has given rise to the implementation of a very narrow understanding of sustainability into financial market practices shaped by the notion of single materiality (see Section 5). Importantly, by setting the de facto standards for sustainable investing, ESG data, ratings, and indices thus created an infrastructural lock-in that has established a persistent benchmark for practitioners, investors, and regulators about how “sustainable” investing should be conducted. Crucially, this market-driven approach to ESG does not effectively utilize potential transmission mechanisms to create sustainable impact in the “real” economy.

3 A Short History of ESG

While ESG has become mostly synonymous with “sustainable” investing, its importance as a financial infrastructural device for facilitating sustainable investing is a relatively recent phenomenon. The historical development from a niche phenomenon to the de facto standard for sustainable investing can be divided into three stages (see Busch et al., Reference Busch, Bruce-Clark, Derwall, Eccles, Hebb, Hoepner, Klein, Krueger, Paetzold and Scholtens2021).

The earliest precursors of ESG investing are found in attempts by religious groups, including Quakers and Methodists, to avoid investing in “sin stocks” such as gambling and tobacco (Liu, Reference Liu2020). Similarly, in the 1970s and 1980s, investors from Europe and North America sought to avoid investment in companies active in South Africa to support the anti-apartheid movement – marking the first sequence of modern ESG investment approaches. In the United States, that is, proponents of “socially responsible investing” excluded producers of chemical weapons used in the Vietnam War from their portfolios (Liu, Reference Liu2020). The full or partial exclusion of specific firms or whole industries (e.g., coal or tar sands) is one key origin of ESG. Referred to as “negative screening,” this practice is still an integral part of ESG (Deutsche Bundesbank, 2019; Kölbel et al., Reference Kölbel, Heeb, Paetzold and Busch2020). This phase of “sustainable” investing, which relies exclusively on avoiding exposure to unethical firms, has been labeled “Sustainable Finance 1.0” (Busch et al., Reference Busch, Bruce-Clark, Derwall, Eccles, Hebb, Hoepner, Klein, Krueger, Paetzold and Scholtens2021).

In 2004, the term ESG itself was introduced in a report by the UN Global Compact (Pollman, Reference Pollman2022). This first notion was followed by the development of the UN Principles for Responsible Investment (PRI) in 2006. Arguably, these roots mark the beginning of the “Sustainable Finance 2.0” era which was characterized by the development of ESG investing from a niche phenomenon into a mainstream investment approach (Busch et al., Reference Busch, Bruce-Clark, Derwall, Eccles, Hebb, Hoepner, Klein, Krueger, Paetzold and Scholtens2021). The first creation of ESG exchange traded funds (ETFs) in the early 2000s signaled the start of this new phase.⁵ The UNPRI established a framework defining some basic requirements, particularly regarding transparency. They did not, however, provide specific standards. As a result, a number of private firms developed a plethora of ESG ratings, data, and indices as tools for asset owners and asset managers seeking to pursue “sustainable” investment approaches. As has been repeatedly observed in market-driven processes, the ESG industry began to consolidate into a small group of big firms with high market power (Escrig-Olmedo et al., Reference Escrig-Olmedo, Fernández-Izquierdo, Ferrero-Ferrero, Rivera-Lirio and Muñoz-Torres2019; Dimmelmeier, Reference Dimmelmeier2020). The so-called Sustainable Finance 2.0 period was characterized by the primary aim to manage the financial risks of investors’ portfolios. These risks were understood as stemming from ESG factors. The ultimate goal was to avoid these risks, protecting investor portfolios in order to maximize financial gains. Retail investors and institutional asset owners alike increasingly invested in “mass market” ESG funds reallocating ever-larger amounts of capital. Between 2006 and 2015, the PRI-linked investments of asset owners grew from $2 trillion to $13.2 trillion.⁶

According to Busch et al. (Reference Busch, Bruce-Clark, Derwall, Eccles, Hebb, Hoepner, Klein, Krueger, Paetzold and Scholtens2021), the 2015 Paris Agreement marks the transition toward “Sustainable Finance 3.0.” The advent of the UN Sustainable Development Goals and the increasingly discussed urgency to keep global warming below +2.0°C induced a stronger focus on the real-world impact of sustainable finance.⁷ “Impact” can be defined as positive effects on the ESG practices of firms in the portfolios of ESG funds. Since the Paris Agreement, PRI-linked investments surged even further to $29.2 trillion (2021) – “sustainable” investing driven by the ESG infrastructure became an important force within the global financial system.

However, as the following sections demonstrate, the emergence of ESG as private standards for financial governance has resulted in a configuration through which a particularly narrow understanding of sustainability was locked into the infrastructural devices that inform “sustainable” investment.

4 Resulting Market Structures and ESG’s Impact Potential

If we want to assess the impact of ESG we need to look at the potential channels of impact the funds may exercise and understand which actors actually decide which channels are being used. In essence, there are two mechanisms ESG funds can use in order to exert influence on corporations and create impact: capital allocation (i.e., which companies to include in or exclude, also known as divestment or “exit”), created through the steering capacities of their portfolio (Rohleder, Wilkens, and Zink, Reference Rohleder, Wilkens and Zink2022), and shareholder engagement (also referred to as “voice”), which consists of direct engagements with the top management of investee firms as well as the shareholder voting behavior of funds at the annual general meetings of the portfolio companies. So far, the vast majority of ESG funds have not systemically adopted these potential mechanisms to create an impact regarding sustainability issues (see Griffin, Reference Griffin2021; de Groot, Koning, and van Winkel, 2021; Golland et al., Reference Golland, Galaz, Engstrom and Fichtner2022).

We argue that this is the case because, since the early 2000s, ESG investing was shaped by a burgeoning private industry for ESG market tools which consolidated into a handful of globally dominant firms (European Commission, 2020; Harty and Tor, Reference Harty and Tor2020; ESMA, 2022). They provide quintessential information (data) on the ESG performance of individual firms (ratings) and define groups or “baskets” of firms that are considered “sustainable” (indices). These assessments and categorizations have become authoritative to every market participant navigating the world of ESG investing. They have become a taken for granted baseline that informs how actors calculate, act, and trade (see Pinzur, this volume).

The ESG index industry is characterized by a particularly concentrated market structure, where one firm – MSCI – has emerged as the dominant provider of ESG indices. Partially, this is because MSCI is one of the very few fully integrated firms providing ESG ratings and data as well as indices. As Simpson, Rathi, and Kishan (Reference Simpson, Rathi and Kishan2021, para. 4) noted, “no single company is more critical to Wall Street’s new profit engine [i.e., ESG investments] than MSCI, which dominates a foundational yet unregulated piece of the business.” This business model creates strong synergistic network effects through its provision of complementary infrastructural devices necessary for ESG investing to function (Petry, Reference Petry2021). First-mover advantage via acquisitions, combined with large economies of scale and scope and a market-compatible approach paved the way for MSCI’s success. By deciding which stocks and bonds are included in ESG funds via its indices, MSCI effectively defines what counts as ESG investing and thus emerged as a new kind of “focal institution” in this issue area (Büthe and Mattli, Reference Büthe and Mattli2011). According to JP Morgan, “MSCI has earned its position because they have become a proven compounder with leading offerings in indexing and unmatched scale and longevity in ESG data.” Commenting on MSCI’s role in ESG, the investment bank further argued: “we are not aware of any businesses with data assets that can match MSCI’s combination of history and scale in research, data, and analytics or in indices” (Gordon, Reference Gordon2023). More than merely leading the market, MSCI is de facto setting global ESG investing standards.

This standard, however, does not endorse “additionality” (see Serafeim, Reference Serafeim2023) – which means that no (or only very little) capital actually flows to “green” or “sustainable” projects that would not otherwise have been financed. This is the case because the vast majority of ESG funds are not active on the primary markets – where new capital is raised via the issuance of shares or bonds. Like conventional investment funds, ESG funds are predominantly active on the secondary market, where only already issued securities are traded. In essence, the majority of ESG funds today invest in a very similar way to conventional funds.

ESG investing as currently practiced by most asset managers is almost exclusively focused on managing ESG risks to investor portfolios and to achieve financial gains – but does not seriously engage with the corporations owned by the funds in order to enhance the sustainability of their business practices (Crona, Folke, and Galaz, Reference Crona, Folke and Galaz2021). ESG funds are situated at a prominent market position which could – in theory – be used to influence fossil fuel firms to change their business model and refrain from harmful environmental practices like fracking. They mostly refrain from doing so, however, as neither the forceful use of shareholder voting nor engagement with company management to advance sustainability are considered necessary elements of ESG and neither is capital allocation properly utilized in the majority of ESG funds.

For most lay observers this is probably very counterintuitive. We argue that this is the case because ESG funds mostly follow existing market patterns guided by the sociotechnical infrastructure provided by index providers, which results in an infrastructural lock-in. The underlying understanding of sustainability (or materiality) that was baked into investment decisions based on these ESG infrastructures is discussed in the following section.

5 Materiality of ESG Devices: Data, Ratings, and Indices

One consequence of the adoption of the market-driven and product-focused approach toward sustainable investing described in Section 3, is that ESG infrastructures have endorsed “single materiality” as the concept guiding their premises and understanding of sustainability. Single materiality is an accounting approach that aims to measure how climate change and other “market externalities” create risks that potentially influence the financial value of a corporation. In concrete terms, a single-materiality approach could consist of quantifying the water use of soft-drink makers or chemical companies and the risk they run because of potential water shortages – but only insofar as it poses a risk to their operating profit. It does not explicitly aim to account whether a corporations business practices create risks for the environment. In a similar vein, the environmental footprint (waste, etc.) of fast-food vendors could be assessed quantitatively – however, again, exclusively as a potentially material financial business risk. Single materiality is thus an approach that only accounts for how sustainability factors affect the financial value of a company. As Buller (Reference Buller2022, p. 166) put it, the primary question for single-materiality-oriented finance is “not what your portfolio can do for the climate crisis, but what the climate crisis will do to your portfolio.”

In contrast, double materiality considers how companies affect societies and the environment. In doing so, this concept sets the ambitious aim to move beyond a pure market orientation and internalize nature and society into economic thinking and practices. This approach poses a fundamental rupture with current market (infra)structures and interests. Using a double-materiality approach would imply measuring all greenhouse gas emissions and other harmful business practices of a company and engaging the firm to adopt a path of reducing emissions and put a halt to harmful business practices in general. In other words, double-materiality-focused ESG investing would ask what fund portfolios can do to mitigate climate change and contribute to sustainability.

Consequently, we need to distinguish between ESG investing approaches that seek to create a positive sustainability impact by adopting and following a double-materiality approach and ESG as a profit-driven investment scheme informed by a single-materiality approach. In the former, the focus is shifted to the question of how individual firms can create significant positive impact with regard to sustainability issues; the latter entrenches financial risk and profitability as the driving motives for companies’ actions. As ESG ratings and indices effectively steer sustainable investing (Fichtner, Jaspert, and Petry, Reference Fichtner, Jaspert and Petry2023a), we need to scrutinize the dominant actors in the field and whether they adopt single- or double-materiality approaches.

The case of MSCI’s ESG methodology approach is very instructive in this regard. Eccles, Lee, and Stroehle (Reference Eccles, Lee and Stroehle2020) have conducted a historical case study of KLD and Innovest, two major ESG firms bought by MSCI in 2010. KLD pursued a values-driven approach to “sustainable” investing that scored companies on a five-point scale from “major strength” to “major weakness” in the categories of community relations, employee relations, the environment, the product, and treatment of women and marginalized groups. In the words of Eccles, Lee, and Stroehle (Reference Eccles, Lee and Stroehle2020, p. 580), “KLD focused its ESG assessment specifically on the benefit or harm to the wider society and not on the financial benefit for investors.” In other words, ESG data by KLD sought to capture what is referred to as double materiality. Crucially, KLD did not provide an aggregate quantitative score for rated corporations, which meant that users of its ESG data had to do their own final assessment and could not simply use the KLD data to “automatically” construct investment products. Innovest, in contrast, tried to develop a methodology “as quantitative as possible” by assessing over fifty individual performance indicators in five areas: strategic governance, emerging markets, products and services, human capital, and stakeholder capital (Eccles, Lee, and Stroehle, Reference Eccles, Lee and Stroehle2020, p. 581). Innovest’s ESG assessments were relative and meant to be directly comparable with other firms (to produce “best-in-class” comparisons), the assessments by KLD were absolute (and thus arguably better at creating sustainability impact in the outside world). MSCI chose to continue with the financial value-oriented methodology of Innovest, while discontinuing the KLD approach that captured double materiality to a much greater extent.

The rationale was that the approach by Innovest was better suited to build products that could be sold to financial actors and, crucially, was also much easier to scale (Eccles, Lee, and Stroehle, Reference Eccles, Lee and Stroehle2020). Scaling is pivotal for financial firms as it allows them to spend money on creating an ESG rating, an ETF, or a stock index only once, and subsequently sell it to a potentially unlimited number of clients without incurring substantial additional costs. These considerations and processes within MSCI shape the current market structure for ESG ratings and effectively erase qualitative approaches seeking to adopt double-materiality conceptions. ESG ratings in their current form primarily capture single-materiality risk and largely fail to account for double materiality.

This leads to confusing, even misleading, results. In MSCI’s ESG rating methodology, for instance, “water stress” is an important metric to calculate the environmental dimension of a company’s ESG rating. In this category, Nestlé, the world’s largest food and beverage company, is categorized as an ESG leader⁸ – notwithstanding the fact that the company has been involved in countless scandals where it extracted, bottled, and sold drinking water for a huge profit while depriving local communities from Canada to Pakistan. In the apt words of Simpson, Rathi, and Krishan:

Next to ESG ratings, ESG indices play an important role as infrastructural devices in ESG investing (Fichtner, Jaspert, and Petry, Reference Fichtner, Jaspert and Petry2023b). Since the 2008 financial crisis, stock indices (e.g., the S&P 500) have become much more important in global finance as they are effectively “steering capital” (Petry, Fichtner, and Heemskerk, Reference Petry, Fichtner and Heemskerk2021). Indices occupy a dominant position in the investment chain (see Arjaliès et al., 2017) of ESG, too: a small group of firms is crucial for the provision of relevant ESG indices. These include S&P Dow Jones Indices (part of S&P Global), FTSE Russell (part of the LSE Group), and Bloomberg. But one firm in particular dominates the market for ESG indices as well as for ESG ratings:⁹ MSCI. Recent research found that MSCI has an astounding market share of 56% in ESG-relevant indices (Fichtner, Jaspert, and Petry, Reference Fichtner, Jaspert and Petry2023a).

Thereby, ESG investing has been facilitated and “standardized” by this group of key ESG index providers. While ESG firms have not formally agreed to any market standards, as Fichtner, Jaspert, and Petry (Reference Fichtner, Jaspert and Petry2023a) have shown the majority of large ESG funds today nevertheless do not substantially deviate from conventional investment funds in regard of their capital allocation. A comparison of the holdings of the largest ESG ETF and the largest conventional ETF by BlackRock (the largest asset manager in ESG) provides an example of the striking similarities. Table 22.1 shows the ten largest firms in the portfolio of the (conventional) iShares Core S&P 500 ETF and the iShares ESG Aware MSCI USA ETF. In both funds, Apple, Microsoft, Amazon, Nvidia, and Alphabet (Google) constitute the largest constituents in the portfolio (with together well over 20%). The only top-ten firm from the conventional fund that is not also a top-ten holding in the ESG fund is Berkshire Hathaway. There is almost no difference between how conventional and ESG funds allocate capital.

From a climate-change mitigation perspective, large fossil fuel firms are particularly relevant to consider. If we examine the iShares Core S&P 500 ETF, from the example in Table 22.1 more closely, we see that 4.17% of its portfolio is invested in oil and gas companies. In the allegedly “sustainable” ESG Aware MSCI USA ETF fund, the share of investment into fossil fuel companies is only marginally reduced to 4.14%. It hardly deviates. ExxonMobil has a portfolio weight of 1.23% in the conventional iShares fund and 1.01% in the ESG fund; for Chevron, the respective weightings are 0.77% and 0.70%, respectively.

This is because the iShares ESG Aware MSCI USA ETF applies the so-called Broad ESG approach. Funds adopting this approach, generally speaking, hardly deviate from conventional, non-ESG funds in how they construct their portfolio and consequently are particularly prone to greenwashing. In contrast, so-called Light Green and Dark Green ESG funds, which tend more toward impact-generating approaches (“double materiality”), diverge from conventional funds to some degree. These, however, only account for a tiny share of the overall market. In 2021, 88% out of the 500 ESG largest funds marked can be classified as Broad ESG funds, whereas Light Green and Dark Green funds only accounted for 7% and 5% of the overall market (Fichtner, Jaspert, and Petry, Reference Fichtner, Jaspert and Petry2023a). Thus, most ESG funds do not substantially deviate from conventional investment funds in their capital allocation. Moreover, the vast majority of ESG funds do not utilize the potential mechanisms of private engagements and shareholder voting to push for sustainability in the corporations in which they hold shares.

This is because – like ESG ratings – ESG index methodologies are based on a “single-materiality” conception of sustainability. Having emerged as market-driven, financial value-oriented standards for financial governance, ESG as the sociotechnical infrastructure that enables but simultaneously constrains what is considered “sustainable” investment has locked in a particular narrow conception of sustainability that informs the majority of current investment practices.

6 Conclusion

In this chapter we have argued that ESG is a privately developed sociotechnical financial infrastructure that underpins the functioning of “sustainable” investing. While primarily created for private investors, policymakers and regulators often attribute a central steering role and capacity to ESG investing in efforts to mitigate climate change. ESG funds manage large amounts of capital, thus having the potential to trigger far-reaching changes in the economy and push toward decarbonization. However, this potential is currently not utilized, because very few ESG funds are systematically utilizing potential transmission mechanisms to facilitate sustainable impacts. Neither do they use private engagements with management or shareholder voting to push for sustainable business practices; nor do most ESG funds substantially differ from conventional funds in their capital allocation. What we observe instead is an infrastructural lock-in of a particular understanding of sustainability that is based on a single-materiality approach. ESG investing in its current form, based on single materiality, is specifically not designed to manage broader societal and environmental risks, and definitely not to mitigate the climate crisis. Arguably, ESG has gained increasing acceptance among financial analysts and other financial practitioners because it offers them a powerful tool capable of integrating social and environmental developments into their calculations merely as market signals, while refraining from any normative attempt to influence ESG issues (Leins, Reference Leins2020). In other words, the current form of ESG investing is convenient for investors and asset managers because it takes conventional investing as its baseline and only “tweaks” the capital allocation.

Only a small number of financial firms have shaped the historical development of ESG investing. Arguably the most important firm has been MSCI, whose dominant market position in ESG data, ratings, and indices has enabled it to shape the underlying infrastructure of ESG. This has resulted in de facto market standards that define what is considered as sustainable investing based exclusively on single-materiality risk assessments. These ESG standards are an example of “market-based” private regulation, in which firms “establish their preferred technologies or practices as the de facto standard through market dominance or other strategies” (Büthe and Mattli, Reference Büthe and Mattli2011, p. 14; see also Green, Reference Green2010, Reference Green2014). The outcome of this constellation is, as we have shown, an infrastructural lock-in of single-materiality sustainability conceptions into investment practices.

Analyzing sustainable finance through the lens of a sociotechnical infrastructure bears the advantage of making the possible long-term consequences of the current lock-in visible. If an approach to “sustainable” investment which hardly has any effect of steering capital into decarbonization is getting locked in, it significantly reduces the role of private financial markets to advance the green transition. While others have focused on the lock-in through carbon-emitting infrastructures (Seto et al., Reference Seto, Davis, Mitchell, Stokes, Unruh and Ürge-Vorsatz2016), our focus on carbon-financing infrastructures adds a novel perspective for analyzing potential pathways toward a sustainable future.

Based on our analysis in this chapter, we argue that if ESG is supposed to play any meaningful role in the “the wholesale transformation of our carbon-intensive economies,” as demanded by US Treasury Secretary Janet Yellen, regulators have to make sure that ESG funds follow a double-materiality logic that actually creates a positive sustainable impact. Defining the use of capital allocation, private engagements, and shareholder voting to advance sustainability as essential elements of all ESG funds could potentially overcome the lock-in of the current form of ESG investing, which has very little impact and thus is not making finance flows consistent with a pathway toward a decarbonized economy.

Our claim in this chapter is that green financial infrastructures are spaces for professional coordination and competition to exert claims at “issue control” over how green finance is treated. What professionals want, above all else, is to determine the content of green finance to reflect their varying interests. While they may seek environmental progress or financial profits – or some combination thereof – they are primarily interested in determining how green finance works and who is permitted to work on it.

One more general strategy to achieve control is to align professional “jurisdictional” control (Abbott, Reference Abbott1988) with the establishment of technical infrastructures. Establishing who is allowed to diagnose and treat an issue, who is permitted to be present in the room, and who judges what is appropriate is of utmost importance. Both professional jurisdictional control – ensuring that only certain actors are permitted to work in an area and contribute to its knowledge development – and infrastructures seek a common aim: to streamline and depoliticize behavior. The study of infrastructures is often equated with the study of “boring things” (Star, Reference Star1999, p. 377). Professionals can affirm their jurisdictional prowess, which we refer to as “issue control” (Henriksen and Seabrooke, Reference Henriksen, Seabrooke, Wood, Eberlein, Meidinger, Schmidt and Abbott2019; Seabrooke and Stenström, Reference Seabrooke and Stenström2023), by crafting infrastructures that become unquestioned and boring.

Piecing together these infrastructures involves a few different steps, and invokes different politics, which we depict in Figure 23.1. These steps have been amply demonstrated in the extensive work on how finance is undergirded by technical infrastructure (Knorr Cetina and Bruegger, Reference Knorr Cetina and Bruegger2002; MacKenzie, Reference MacKenzie2006; Tischer, Maurer, and Leaver, Reference Tischer, Maurer and Leaver2019).

Figure 23.1 Linking issue control to new infrastructures.

Source: Authors’ elaboration.

First, there is professional contestation over who is permitted to work on an issue, with rival groups, strongly or weakly tied to professional associations, seeking influence (Abbott, Reference Abbott1988). Second, a boundary object must be formed, including who and what is included or excluded and the creation of shared language. Once the casting has been whittled down, a boundary object can be created, which permits cooperation even in the absence of consensus (Star, Reference Star2010). Third is the forging of a governance object. This involves a forward step from cooperation into contestation over what can be measured and valued, a phenomenon sometimes referred to as “trials of strength” (Callon, Reference Callon, Schwartz, Knorr, Krohn and Whitley1980). These trials can result in a governance object with more permanence than a boundary object and which is put to task in regulating behavior (Latour, Reference Latour, Dodge, Kitchin and Perkins2011; Allan, Reference Allan2017). Should all of this proceed without ongoing contestation, the governance objects and the professionals controlling how to govern issues can enable technical automaticity. At that stage, the socio-technical relations will be automated and only really visible when they malfunction or fail (Anand, Gupta, and Appel, Reference Anand, Appel, Gupta, Anand, Gupta and Appel2018). While unpacking and unsettling infrastructures is difficult, these stages are reversible.

In this chapter, we walk through the elements linking professionals’ attempts at issue control over how green finance is treated, to the establishment of boundary objects, governance objects, and fully articulated infrastructures with technical automaticity. Our examples draw on the world of green finance, where there are multiple trials of strength and contests to create and inscribe governance objects. As political economists, we hasten to add that these processes reflect power asymmetries and distribute assets and resources unevenly (Colgan, Green, and Hale, Reference Colgan, Green and Hale2021; Paterson, Reference Paterson2021). We stress that the lens of issue control is important in revealing conflicts among those making claims to knowledge and influence. Those controlling issues have a vested interest in automating the infrastructure in their favor. In short, remaking a “black box” on how to make finance green empowers particular groups and not others (Bernards and Campbell-Verduyn, Reference Bernards and Campbell-Verduyn2019), often compounding “microgeographies” of information inequality (Zook and Grote, Reference Zook and Grote2016). Our empirical illustrations draw on the European Union (EU) taxonomy for green finance (Seabrooke and Stenström, Reference Seabrooke and Stenström2023), as well as the “materiality” – what should be explicitly reported as material to shareholder and stakeholder interests – debate in green accounting linked to assurance services.

1 Green Transition as Professional Jurisdictional Battles

Research on professional jurisdiction battles typically focuses on how established groups, with strong professional associations, contest each other to determine who has the upper hand in deciding not only how an issue should be treated, but who is allowed to treat it. A classic example here is conflict between accountants and engineers in the early twentieth century over what should predominate for US industrial firms: knowledge over production processes or knowledge on cost allocation? Accountants won the fight over labeling with the emergence of “factory accounting,” which then became known as cost accounting. They were also successful in reproducing themselves by spreading accounting training as part of general management education, in contrast to the engineers who remained as creative specialists (Abbott, Reference Abbott1988, pp. 230–232). The point being that whoever can best label tasks, provide staff, and educate future professionals has a strong claim over jurisdiction. Cementing a relationship with a formal authority to license only particular professionals to work in an area is a way to secure a professional hierarchy of who is allowed to work on what, allowing those selected to focus on how they choose to control their tasks. Prominent examples include economists (Fourcade, Ollion, and Algan, Reference Fourcade, Ollion and Algan2015), lawyers (Liu, Reference Liu2013), and doctors (Freidson, Reference Freidson1988). Recent research has also pointed to how professionals engage in alliance formation with professionals from other groups, as well as embedding “avatars” to infiltrate their own practices (Abbott, Reference Abbott2005), to form “linked ecologies” that have a greater capacity to assert control over issues (Fourcade and Khurana, Reference Fourcade and Khurana2013; Seabrooke, Reference Seabrooke2014; Seabrooke and Tsingou, Reference Seabrooke and Tsingou2015).

Professional contestation and jostling for hierarchy can also be found in the establishment of green financial infrastructures. The establishment of carbon emissions trading systems, between 1990 and 2007, relied on multiprofessional cooperation among economists and lawyers, as well as policy analysts, directors, and consultants (Paterson et al., Reference Paterson, Hoffmann, Betsill and Bernstein2014). It is these professionals who articulated emissions trading through early policy venues from the US and United Nations (UN)-based working groups prior to the Kyoto Protocol in 1997, and then in regional operational venues (Paterson et al., Reference Paterson, Hoffmann, Betsill, Bernstein, Seabrooke and Henriksen2017). Economists led this “pseudo-epistemic community dedicated to ET [emissions trading] for climate change … [and] provided intellectual foundations for a global ET system” (Paterson et al., Reference Paterson, Hoffmann, Betsill, Bernstein, Seabrooke and Henriksen2017, p. 186). Differences between the US and European/intergovernmental approaches to the design of emissions trading centered around the relative presence of economists. In the USA, they dominated with a focus on pro-market efficiency, while the European/intergovernmental approach, where policy analysts dominated more than economists, favored political compromises to get more organizations involved. The professionalization of emissions trading from 2007 onwards led to the development of a carbon market profession through the formation of trading associations, expos, and expansion of graduate training programs specialized in “carbon management” and carbon finance (Paterson et al., Reference Paterson, Hoffmann, Betsill, Bernstein, Seabrooke and Henriksen2017, pp. 198–200). The point here being that jurisdictional claims from the economics professions underpin the formation of the market. Thereafter the market developed its own institutional project that includes new conceptions of professionalism. This process relied on the establishment of boundary objects, what is included in carbon trading and what is excluded, which were then cemented into governance objects. At that point “carbon market professionals” could dominate the system, with the infrastructure largely unquestioned.

2 Green Transition as Boundary Object

An important aspect of issue control in green infrastructure is determining what is to be included for discussion and what is not. Within the sociology of professions, the demarcation of boundaries is an important element of maintaining a jurisdiction. The development of diagnosis, inference, and treatment – the classic conceptual triptych (Abbott, Reference Abbott1988) – involves boundary work from professionals as they seek to create internal and external networks to affirm their position and power (Liu, Reference Liu2018). Such dynamics are essentially turf battles over who is allowed to treat an issue. Once these basic scuffles have been sorted, the boundary object is then up for debate. Boundary objects afford “interpretive flexibility” from different viewers (Star, Reference Star2010), which can lead to claims over how the same object can have multiple uses, as well as “trials of strength” over what the object should really become and how it should be measured (Callon, Reference Callon, Schwartz, Knorr, Krohn and Whitley1980).

An example can be found in how to determine what companies should include in environmental and social governance (ESG) disclosures within the EU regulatory space. Here the boundary object is the standard for disclosures, which reflect a financial instrument, a legal contract, and part of a chain of investments that are linked to scope 1, scope 2, and scope 3 conditions of environmental harm (from the immediate responsible entity, from input/output sources, and from total chain environmental costs). As a “networked product” created by actors and infrastructures (Beaverstock, Leaver, and Tischer, Reference Beaverstock, Leaver and Tischer2023), disclosures are a boundary object that allow multiple interpretations.

Our own research on European sustainable finance provides an example of how ESG disclosures reveal differing treatments of boundary objects and can lead to contestation between professionals (Seabrooke and Stenström, Reference Seabrooke and Stenström2023). Within the European Commission’s High-Level Expert Group (HLEG) and Technical Expert Group (TEG) the issue of what ESG disclosures should reflect was a point of contention. Professionals within the HLEG, which ran from 2016 to 2018 and provided content to the EU Action Plan on Sustainable Finance, and TEG, which ran until late 2020 to work on technical considerations, strongly differed.

A key difference in the treatment of the boundary object here was over whether company disclosures should favor an established “impact” policy established by an official authority, or whether a trial-and-error “process” approach that empowered companies was better. The issue here was both one of control – who is empowered, the regulator (EU) or the companies – and one of interpretation, as in what should count within ESG disclosures. From our interviews we know that the European Commission’s view is that the “impact” framing for responsible finance is important and that “reporting on processes is a thing of the past” (Seabrooke and Stenström, Reference Seabrooke and Stenström2023, p. 1285). Finance professionals involved in the expert groups had a different opinion; that without a reasonable boundary infrastructure that could allow flexibility in ESG disclosures supported by a robust accounting framework (see Section 3 on materiality as a governance object), an “impact” approach to disclosures was impractical. Rather, ESG disclosures should evolve as companies understand the system better. Rather than companies bending to an imposed external standard they should develop “best practices” (Seabrooke and Stenström, Reference Seabrooke and Stenström2023, p. 1285). In the end, the HLEG recommended the approach favored by finance professionals, endorsing “trial and error by companies” and “promoting of best practices” (EU HLEG on Sustainable Finance, 2018).

ESG disclosures within the HLEG and TEG reflected a “trial of strength” between different professional interests and credible interpretations (Callon, Reference Callon, Schwartz, Knorr, Krohn and Whitley1980). To assess how such trials are linked to professional networks, we mapped the composition of expert networks and their professional affiliations. Figure 23.2 shows this network and applies a community detection algorithm to detect who belongs to what groups. In the figure we can see a tightly knit cluster of policymakers (the small cluster in the center), a cluster of finance professionals (the large oblong-shaped cluster to the right), and a cluster of consultants and activists (the oval cluster to the bottom-left). Importantly, we can also see some brokers who span two groups, like Christopher Knowles spanning policy and finance and Steve Waygood, who bridges finance and consultancy/activism. In our analysis such actors were especially important in defining how boundary objects like ESG disclosures should be considered by the experts, which then fed into the defining of governance objects in European sustainable finance and their relationship to infrastructure.

Figure 23.2 Top fifty professionals with community detection.

Source: Seabrooke and Stenström, Reference Seabrooke and Stenström2023, p. 1281.

3 Green Transition as Governance Object

In green finance, professionals battle it out over governance objects. Governance objects are “created, designated, translated and problematized” entities or practices, which unlike fully automated technical infrastructures have not yet achieved taken-for-grantedness (Allan, Reference Allan2017, p. 133). The forging of governance objects is a process of multiple trials of strengths over what can be measured and valued in green finance. Once formed, governance objects are crucial to regulating behavior and making green finance governable. Professionals have an interest in achieving issue control over what is yoked together to form the governance object. This can be illustrated by the debate in international accounting standard-setting on what should be seen as material information to include in sustainability reports. Although international accounting standard-setting often is framed as technical, prior research has pointed out that the process rather is characterized by contestation (Botzem and Quack, Reference Botzem, Quack, Djelic and Sahlin-Andersson2006).

Setting standards on sustainability reporting emerged as a strategy in the late 1990s to make corporate impacts visible and to connect sustainability issues to financial decision-making through accounting techniques (Thistlethwaite and Paterson, Reference Thistlethwaite and Paterson2016). Often bringing together coalitions of non-governmental organizations (NGOs), investors, and professional accountants, a multitude of private governance initiatives setting sustainability reporting standards now exists at the transnational level. This includes the Global Reporting Initiative (GRI), Climate Disclosure Standards Board (CDSB), Sustainability Accounting Standards Board (SASB) and the International Integrated Reporting Council (IIRC). Other initiatives, such as the Carbon Disclosure Project (CDP), Accounting for Sustainability, and the Task Force on Climate-Related financial Disclosures (TCFD), have also put forward guidance, frameworks, and platforms connected to sustainability reporting, contributing to the creation of technical automaticity.

In sustainability reporting, materiality is a key concept. It guides accountants in deciding which information is to be included in the reports – and auditors in their assessment of whether or not the information included is sufficient. There is, however, no clear consensus on which definition of materiality should guide sustainability reporting (Eccles et al., Reference Eccles, Krzus, Rogers and Serafeim2012; Adams and Abhayawansa, Reference Adams and Abhayawansa2022; Jørgensen, Mjøs, and Pedersen, Reference Jørgensen, Mjøs and Pedersen2022). The ambiguity has left the concept of “materiality” open for both cooperation and contestation (Cooper and Michelon, Reference Cooper, Michelon and Adams2022) between not only standard-setters, but also accounting professionals, financial regulators, and market participants.

What is measured and valued in green finance depends on which approach to materiality is inscribed as a governance object. In sustainability reporting, a distinction can be made between financial materiality and impact materiality approaches. Financial materiality is judged based on investors being the main stakeholder in need of information. Information on sustainability issues should in this sense be included if it is deemed as financial material, that is, has an impact on corporate value. Does it hurt profit? It is sometimes described as “outside-in” materiality, in the sense that it focuses on how sustainability issues impact the organization – and not the other way around. As a contrast, impact materiality stipulates an inside-out perspective, how organizations impact people and planet in which it operates. Here, reporting should reflect the impact an organization has on the economy, the environment, and society. This builds on the idea that sustainability disclosures are of interest to a wider audience than investors only.

Among the principal standard-setters on sustainability reporting, GRI, which pioneered sustainability reporting in the late 1990s, is the only one taking an impact materiality approach. The financial materiality approach is favored by standard-setters that came later, such as CDSB, SASB, and IIRC. This has been a part of the strategy to align sustainability reporting with the logic of financial disclosures. In doing so, the initiatives have been able to decouple from the distinct civil society and market logics, which created a tension in sustainability reporting initially (Thistlethwaite and Paterson, Reference Thistlethwaite and Paterson2016). This has primarily been driven by professional accountants, key brokers in the network, who have been able to bridge the worlds of accounting and NGOs through the strategic use of accounting expertise (Thistlethwaite, Reference Thistlethwaite, Seabrooke and Henriksen2017).

The tension to settle the governance object of materiality in sustainability accounting has been even more pronounced as pressure on the standard-setters to harmonize the infrastructure of sustainability reporting has grown. As green finance has increased in salience, with initiatives such as the EU Sustainable Finance Action Plan, the TCFD, and the Network for Greening the Financial System, the lack of a coherent corporate reporting structure on sustainability has been pointed out. While the GRI standards have been widely used among corporations, and contributed to an institutionalization of sustainability reporting among multinational corporations (Brown, de Jong, and Lessidrenska, Reference Brown, de Jong and Lessidrenska2009), initiatives taking a financial materiality approach like SASB have received backing from powerful financial market actors like BlackRock (Tett, Reference Tett2020). The standard-setters have sought to bring convergence to the fragmented space, arguing how their different approaches to sustainability reporting in general and materiality in particular caters to the shifting needs of stakeholders (CDP et al., 2020; see also Rowbottom, Reference Rowbottom2023).

Coalescing around materiality as a governance object is also something that new actors seeking control over the infrastructure of sustainability reporting are doing. The IFRS (International Financial Reporting Standards) Foundation, which controls the financial reporting infrastructure through its International Accounting Standards Board, announced its entry to sustainability reporting at the COP26 in 2021 with the creation of the International Sustainability Standards Board (ISSB). At the same time, it was announced that SASB, IIRC, and CDSB were to be consolidated into the ISSB. ISSB takes a financial materiality approach to sustainability reporting and models its standards on its voluntary predecessors – including the TCFD recommendations on climate-related disclosures. Also in 2021, the European Commission announced that the EU would develop its own mandatory sustainability reporting standards. The development of the standard was delegated to the European Financial Reporting Advisory Group, whose prior task mainly has been to advise the Commission on how to implement IFRS standards in the EU. The EU standards take a “double materiality” approach, which sees materiality from both an impact and financial perspective. This means that reporting should include information both on what sustainability impacts an organization has on its environment and disclosures on how sustainability issues impact corporate value. In 2023, both the ISSB and EU’s European Sustainability Reporting Standards adopted their first couple of standards on general sustainability reporting and climate reporting. Additional standards on other sustainability issues, such as biodiversity and social reporting, are also expected to be developed. With this, the two different approaches to materiality are made operable through standardization. While it might be due to fundamentally different visions of green finance and sustainability reporting rather than jurisdictional turf wars (Maechler, Reference Maechler2023), these developments underscore the tension to settle the governance object of materiality in sustainability reporting to exert control over the green finance infrastructure. Thus, while materiality has been forged into a governance object, it has not yet achieved full technical automaticity. Rather, the object is still contested – leaving space for professionals to battle it out in trials of strengths over what is measured and valued in green finance.

4 Green Transition as Technical Automaticity

For professionals competing to exert greater control over green finance, making climate-related issues susceptible to audit and assurance could be a strategy to automate the sociotechnical infrastructures of the green transition in their favor. Examples of this include professional associations’ efforts to position accountants as key experts in governing climate change (Lovell and Mackenzie, Reference Lovell and MacKenzie2011), for example through the issuing of standards on assurance on sustainability reporting (see, e.g., International Federation of Accountants’ (IFAC’s) ISAE (International Standard on Assurance Engagements) 3,000 Assurance Engagements other than Audits or Reviews of Historical Financial Information and ISAE 3,410 Assurance Engagements on Greenhouse Gas Statements). In doing so, they seek to determine who is allowed to work on the issue of the green transition, while at the same time expanding the demand for their professional expertise.

Gaining greater control over green finance can be achieved by controlling the sociotechnical infrastructure that underpins it. Examples include how concepts and processes of financial audit and assurance have been extended to new areas, such as environmental audit and sustainability assurance (Power, Reference Power1997; O’Dwyer, Owen, and Unerman, Reference O’Dwyer, Owen and Unerman2011; Canning, O’Dwyer, and Georgakopoulos, Reference Canning, O’Dwyer and Georgakopoulos2019). For the Big Four accounting and professional service firms (EY, KPMG, Deloitte, and PwC), translating core expertise in financial audit to new areas such as sustainability assurance has been a strategy to expand their professional service to new markets (O’Dwyer, Owen, and Unerman, Reference O’Dwyer, Owen and Unerman2011). This is not unlike the role of global professional service firms – like the Big Four – in controlling the transnational infrastructure of expertise on transfer pricing (Christensen, Reference Christensen2022), and points to the power of private actors over sociotechnical infrastructures (Bernards and Campbell Verduyn, 2019).

However, transferring sociotechnical processes from one area to another is not free from tension. This is pertinent in the case of sustainability assurance. As a practice, assurance seeks to provide assessments on the reliability and completeness of reporting (O’Dwyer, Reference O’Dwyer2011, p. 1231). Early attempts to construct the practice of sustainability assurance and make sustainability reports auditable showed that the financial assurance logic did not necessarily transfer smoothly to sustainability issues (O’Dwyer, Reference O’Dwyer2011; Canning, O’Dwyer, and Georgakopoulos, 2019). This led to professional struggles between accountants and nonaccountant assurors on how to assess the completeness and reliability of sustainability reporting. Entrenched in their own professional logic, accountants struggled with how to assure sustainability information using traditional financial audit techniques and methodologies. Nonaccountant assurors, on the other hand, had a more flexible approach to the assurance engagement (O’Dwyer, Reference O’Dwyer2011). Over time, this tension between accountant and nonaccountant professional expertise on sustainability assurance has decreased (Canning, O’Dwyer, and Georgakopoulos, Reference Canning, O’Dwyer and Georgakopoulos2019), leading to the establishment of a sustainability assurance market underpinned by the blended professional expertise of accountants and nonaccountants. So while assurance has been translated to a new area of sustainability assurance, it has also transformed to accommodate new forms of expertise. This changes the framework of who is allowed to work on the issue and what is included in the process of sustainability assurance.

This can be illustrated by the assurance engagement undertaken by the third-party independent assurance provider Bureau Veritas on Nestlé’s sustainability report “Creating Shared Value and Sustainability Report 2021.” Bureau Veritas is a global professional service provider, and one of the largest assurance providers of ESG data among US S&P 500 companies. In the independent assurance statement from Bureau Veritas to the stakeholders of Nestlé, the process of the assurance engagement is outlined (Bureau Veritas, 2022). Assurance is assessed with the guidance of AccountAbility’s AA1000 assurance standard on the accuracy, reliability, and objectivity of the information contained within Nestlé’s report. This is done based on four principles set out by the AA1000: inclusivity, materiality, responsiveness, and impact. Depending on which assurance standard that is used, different principles would guide the assurance provider’s assessment. Assurance is also provided on different levels, which determine the scope of the assurance engagement. For Nestlé’s sustainability report, assurance is provided on a moderate level of assurance. As such, the assurance engagement included conducting remote interviews with Nestlé’s employees at the head office, reviewing internal systems and samples of selected information, and confirming the accuracy of information with third parties and partners where relevant (Bureau Veritas, 2022). Assurance provided at a higher level of assurance would include a more extensive engagement from Bureau Veritas, meaning a more thorough review and additional steps to assess the information included in the report.

The sustainability market today is open to both accountant and nonaccountant expertise. However, while the expanding sustainability assurance market in Europe has been largely dominated by audit firms, their influence varies widely between jurisdictions. In the USA, China, and the UK for example, nonaudit firms have been successful in establishing their presence as sustainability assurance providers. Here, audit firms only account for around 15% of the sustainability assurance in the USA, 40% in China, and around 35% in the UK (IFAC, 2023). Currently, new standards on sustainability assurance are being developed at the global level by the International Auditing and Assurance Standards Board (IAASB). The IAASB has the support from the International Organization of Securities Commissions (IOSCO) in developing the International Standards on Sustainability Assurance 5000, which is planned to be in place by the end of 2024 (IAASB, 2023). At the same time, the new European directive on Corporate Sustainability Reporting (CSRD) might put audit firms under pressure from other assurance service providers. The new directive will require assurance of sustainability reports, but it also aims to open up the market to new service providers by allowing member states to authorize independent assurance service providers other than statutory auditors and audit firms to carry out the assurance of sustainability reporting. While this could open up the sustainability assurance market for new types of professional expertise, it could also lead to a shift of who has power over the infrastructure of sustainability assurance. This example illustrates how infrastructures, while often taken for granted, are never fully fixed. Rather, they are always in flux.

5 Conclusion

Our aim in this chapter is to illustrate the three key stages through which actors and objects interact on the creation, maintenance, and defense of green financial infrastructures. We have suggested that issue control in green infrastructures is determined by professional battles over who is allowed to work on particular issues, from varying interpretations of what something is – a boundary object, to scuffles over what should be included within governance objects, and, in some cases, systems that normalize activity through technical automaticity. Here we have a scale from expert brawling between humans with clear interests to the concretizing of those interests and asymmetries through “machines.” There are various ways of interpreting issue control along this scale, including work from the sociology of professional on jurisdictional squabbles (Abbott, Reference Abbott1988), to trials over how to value and measure (Callon, Reference Callon, Schwartz, Knorr, Krohn and Whitley1980), to the creation of infrastructures that make what was once contentious “boring” (Bowker and Star, Reference Bowker and Star1999). All of these stages are political and we should put in the analytical work to make struggles within them explicit. This is especially important given that they all have strong redistributive effects on who gets to define what a financial product is, what counts as environmental harm, and who benefits.

Acknowledgments and Funding

Our thanks to the editors for their excellent comments and criticisms on an earlier draft. We acknowledge research support from the Time Mirror project on green accounting, funded by the Independent Research Fund Denmark (#0217-00380B).