Issues and questions relating to the location of payment systems and market infrastructures are also gaining in importance for central banks. •  Central banks have started interacting and cooperating with new interlocutors and partners outside the banking area. Many new players and providers in the field of payment, clearing and settlement services are indeed non-banks with which central banks traditionally had little – if any – direct interaction. •  Central banks are increasingly concerned with the division of responsibilities and the allocation of risks between infrastructure providers and their clients. The responsibility for the safety of a payment, clearing or settlement system rests largely with the system operator. However, to the extent that participants in the system can take action to reduce risks that may have a bearing on the system as a whole, they should be given incentives to do so. For example, the margining systems of central counterparties should give incentives to participants to trade prudently. •  Central banks are increasingly involved in cross-border cooperation and information exchange with other central banks and authorities contributing to financial stability in order to obtain a comprehensive picture of risks and vulnerabilities and to identify appropriate and effective mitigating policy actions. •  Central banks have been intensifying their efforts to produce consistent regulatory and oversight standards on a cross-border basis. The Core Principles for Systemically Important Payment Systems and the CPSS-IOSCO Recommendations for Securities Settlement Systems and Central Counterparties have been important steps in this direction.

Against the backdrop of an apparently healthy financial system, market participants report a substantial rise in transactions leverage, erosion in the use of loan covenants, more favorable financing terms for hedge fund counterparties, and especially a pressure to reduce initial margin against OTC derivatives exposure to hedge funds. But the concern is that this sustained period of very low credit losses and low volatility works to hold down measures of the underlying economic risk in these exposures. This combined with the range of factors I just discussed, raises the odds that market participants will be faced with negative surprises in the event of a more adverse macroeconomic  2  BIS Review 55/2006  environment. And this could have more negative implications for market dynamics and liquidity as market participants react to those losses and attempt to reduce their exposure to future losses. These concerns are not particularly new, and my sense is that they are widely shared among the people and institutions that are closest to these markets. They do not, in my view, challenge the overall judgment that these changes in the credit markets on balance are likely to make the financial system more resilient rather than more fragile. But they do suggest the need for greater caution by financial institutions in several important areas. First, it is very important that the major dealers make the investments necessary to improve the operational infrastructure that underpins the credit derivatives and broader OTC derivatives market.