To the extent these advantages can be realized, a centralized utility can reduce the risk of damaging contagion from a failure of a financial institution affecting overall market liquidity. By making some types of losses more predictable, they can reduce the incentive for firms to withdraw liquidity from and reduce exposure to other counterparties that they believe might have credit exposures to the failed institution. Global integration of payments systems The increase in cross-border financial activity, the global reach of the largest financial institutions, and as a consequence the greater transnational scope of many payments systems have provided a compelling rationale for cooperation to set a higher level of international standards for payments and settlement systems. These same dynamics may lead eventually to a more uniform international platform for payments and settlement concentrated on a much smaller number of systems. But we are not there yet. The myriad of different systems that make up the global network means that payments now cross a complicated mix of legal, technological, and supervisory borders. And this means banks are exposed to settlement risk in a remarkably large number of different value transfer systems. One large U.S. internationally active financial institution now operates in 400 separate payments systems around the world. Differences in legal regimes mean different netting arrangements, collateral requirements, close-out procedures, and bankruptcy implications. Differences in operating platforms and communications standards can increase operational risks.

Adoption of the Hague Securities Convention by countries around the world will improve legal certainty for cross-border collateral arrangements, which is important for bilateral counterparties, clearing and settlement systems. And there are new market-led initiatives underway to bring some utility-type clearing services to the present bilateral arrangements for OTC derivatives. These efforts to improve the clearing and settlement infrastructure for the OTC derivatives market are important because they help make it easier for firms to understand and manage their bilateral risk exposures. Markets work better, particularly in times of stress, when firms are able to operate with greater certainty about their direct counterparty exposures. In this context, it is worth reflecting on whether it makes sense to build on these efforts by developing and utilizing central counterparty clearing arrangements in the more standardized part of the OTC derivative market. To be sure, poorly designed central counterparties can increase risk, and they necessarily concentrate operational risk. But well designed central counterparties can play an important role in reducing systemic risk in markets. This is a complicated challenge for instruments that are inherently complex and constantly evolving, and for which calculating exposures can be difficult. And attracting a critical mass of strong participants can be daunting. But it makes sense to think about whether use of a centralized clearing utility could provide significant advantages over the present bilateral arrangements by increasing transparency, enabling multilateral netting, and providing centralized risk controls, collateral management, and margin requirements.