Its objective was to identify issues of legal uncertainty which might give rise to material risks, and to consider how such issues might best be addressed. The Committee seeks to meet this objective, first, via liaison with industry and market participants to identify those areas of legal uncertainty with potentially adverse impacts, and, second, by working with market experts to propose solutions. One area in which the FMLC has been active in recent years is in encouraging the development of a smoothly functioning legal framework for cross-border transfers of intermediated securities. In 2005, the Committee undertook a thorough analysis of the advantages and disadvantages of harmonisation of the private international law in this area, as reflected in the Hague Convention. It was, and still is, widely accepted that such harmonisation would contribute to legal certainty by facilitating a clear identification of the law governing the holding and transfer of indirectly-held securities. This is  BIS Review 77/2007  7  particularly important in the context of the cross-border use of collateral: a key element of banks’ global liquidity management strategies. Early in 2006, the FMLC published a paper that undertook a full analysis of the Convention and expressed strong support for its central propositions. The FMLC’s work in this (and other) areas has been well received and has contributed to the decisionmaking process for government at the national and supra17 national level. Indeed, overall, the Committee has had some notable successes in addressing and ameliorating legal uncertainty in the financial markets context.
Market failures in infrastructure provision and single points of failure It is instructive to consider why providers of the market infrastructure and their members might, left to their own devices, invest too little in resilience and risk-mitigation. The answer lies in the microeconomics of infrastructure provision, and, in particular, the presence of market characteristics such as network externalities, increasing returns to scale and coordination failures. By network externality, I refer to the incremental benefit derived by existing owners of a particular good or service when another party purchases that good or service. For instance, the broader the participation in a particular exchange or trading facility, the more extensive the trading opportunities and the deeper the liquidity; as a result, the greater the potential benefits from membership of that exchange. Equally, in the case of post-trade infrastructure – clearing and settlement systems – the greater the volume of transactions cleared or settled, the greater the potential for netting exposures and/or cash-flows (or in gross payment and settlement systems, the more efficiently liquidity can be recycled). BIS Review 77/2007  3  Increasing returns to scale reflect the fact that infrastructure provision is, by and large, a fixed-cost business: once an investment has been made in the information technology supporting the trade, clearing or settlement of a given volume of transactions, the marginal cost of each transaction up to the capacity of the system is very low.