Speaking the Same Language

Much has been written about the OTC derivatives clearing obligation, which is due by end-2012. However, what is perhaps less transparent is that the clearing mandate is about much more than clearing.

One of its primary features, for example, is reporting. The CFTC has issued a number of rules in this regard (Parts 43 and 45) which prescribe detailed reporting requirements. CFTC rules call for the electronic reporting of all swap data to Swap Data Repositories (SDRs) following execution of trades. Potential reporting entities are SEFs (Swap Execution Facilities), DCMs (Designated Contract Markets), DCOs (Derivatives Clearing Organizations), SDs (Swap Dealers), MSPs (Major Swap Participants) and swap counterparties who are neither swap dealers nor major swap participants (non-SD/MSP counterparties) including counterparties exempt from the clearing requirement.

SDRs must maintain all swap data reported to them in a format acceptable to the regulators. The CFTC has even specified the format in which such data will be reported. In order to enhance its ability to conduct effective market surveillance (and thus mitigate systemic risk and prevent market manipulation), the CFTC has specified data conventions such as Unique Swap Identifiers (USI), Legal Entity Identifiers (LEI) and Unique Product Identifiers (UPI). These unique identifiers are crucial for linking data together and enabling data aggregation across counterparties, asset classes and trades.

The industry welcomes all these regulatory initiatives. We have stated repeatedly that we fully support complete regulatory transparency. At the same time, we have expressed our reservations with respect to the interaction between public transparency and liquidity.

Regarding the data initiatives specifically: We welcome the CFTC’s efforts to provide more structure to the reported data through the introduction of USIs, LEIs and UPIs. As the Bank of England’s Andrew Haldane put it in his March 2012 speech, “Today’s financial chains mimic product supply chains of the 1980s and the information chains of the 1990s. For global supply chains and the internet, their fortunes were transformed by a common language… They are astonishing success stories…. A common financial language has the potential to transform risk management at both the individual-firm and system-wide level.”

Equally, we see a number of useful applications that could come out of the creation of this unique identifiers infrastructure. Apart from enhancing the ability of regulators to monitor activity and risk in the system, these developments are likely to revolutionalize the financial services industry and will, most likely, lead to the creation of another cottage industry specializing in applications from these data.

There are, though, some troubling aspects of the reporting requirement that could lead to potential issues for all involved, including the CFTC itself, let alone the industry which is working diligently to meet the July 16 date on which reporting becomes effective in the US.

• First, the CFTC, in order to prevent data fragmentation, requires that all data for a swap must be reported to a single SDR. Yet, the CFTC allows for the creation of several SDRs per asset class, creating the potential for faulty double reporting, overlapping of data, and most importantly, the potential need for an SDR for SDRs per asset class;

• Second, there are similar reporting initiatives in other jurisdictions, creating again the possibility for the requirement that the same transaction has to be reported to two different trade repositories in two different jurisdictions. This has to be avoided at all costs;

• Third, the data structure proposed by CFTC is a US regulatory initiative. It is hoped that it will be accepted by other jurisdictions around the world. Establishment of parallel data structures by other regulatory authorities would be an expensive calamity and would create a significant hurdle to achieving greater transparency.

We will be watching with interest developments in this regard as they promise to be exciting and potentially transforming for the industry.

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