Why regulatory transparency doesn’t get the “all-clear”

A recent speech by Benoit Coeuré, a member of the ECB Board of Executives, sheds some light on a key issue in the OTC derivatives markets: regulatory transparency.

It’s an issue on which ISDA and market participants have spent a lot of time and resources – largely to good effect, as the trade repositories we helped establish gave policymakers a clear view of risk in the system.

Recent developments, though, threaten to undermine progress that has been made.

Mr. Coeuré asks an important question about transparency in his speech: “Does…the supervisor responsible for the supervision of a large cross-border financial institution at a consolidated level have direct and immediate access to information on OTC derivatives transaction that encompass all transactions entered into by all entities of this group? Is the information accessible, in other words can it be easily aggregated across trade repositories and jurisdictions?”

He then goes on to say: “My answer would be a clear no!”

And we agree.

Mr. Coeuré went on to discuss privacy laws, blocking statutes and indemnification clauses in several jurisdictions which restrict access to the detail of OTC derivatives transactions; the inability to aggregate data across trade repositories and jurisdictions; and differences in the type and level of information required for reports across jurisdictions. He ultimately broke the problem into three main issues: information gaps, data fragmentation across trade repositories and jurisdictions and obstacles impeding authorities’ access to data.

As the ECB official points out, the Financial Stability Board, assisted by the CPSS and IOSCO, has only very recently begun a feasibility study on various approaches to address shortcomings in the global regulatory reporting landscape (a global repository aggregator being one approach).

These problems were predictable, and were predicted. The OTC derivatives market has been a global one from its inception. The only way to capture this activity is single centralized trade repositories by asset class. Proliferation of trade repositories – within different regions and globally – leads to fragmentation and possible duplication of the information gathered. As such it undermines the very efforts of the regulators to capture and comprehend the risk exposures that market participants want to provide and that regulators want to get.

We believe there is a lesson here. Regulators will have heard ISDA and various market participants ask “What is it you want to achieve?” when addressing regulatory proposals and wishes. This is not a rhetorical question. Regulatory (or quasi-regulatory) processes where there is a real, interactive debate with industry and other interested parties – such as those which first enabled development of trade repositories – are healthy, and achieve results. They create shared understanding of regulators’ goals, and help everyone to build towards them.

There’s still a lot of work to be done on derivatives regulation – on global reporting taxonomy, for example (which must involve an open and interactive dialogue between regulators and industry). We want to solve these problems too, and want to be able to help regulators to do so.

A Debut in D.C.

There was a premiere in Washington on October 14, though you might not have read about it in the arts and entertainment pages. Connie made his first appearance on the Congressional hearing stage, representing ISDA and its members before the Capital Markets and Government Sponsored Enterprises Subcommittee of the House Committee on Financial Services.

The script for the Subcommittee hearing was taken from a series of bills that have been introduced in the House of Representatives to address several troubling aspects of the Dodd-Frank Act (DFA) and the subsequent rulemaking. Among the bills discussed in the hearing were ones addressing swap execution facilities, inter-affiliate trades, pension plans’ usage of swaps and the so-called push-out provision of Section 716. Subcommittee chairman Scott Garrett should be commended for providing the stage to debate these important issues.

Our theme was the timeless one of delivering safe, efficient markets. We reiterated our support for the G20’s efforts to reduce systemic risk by focusing on improving counterparty credit risk management and transparency in the OTC derivatives markets. ISDA lent its backing to each of the bills under consideration, as did other individuals and organizations testifying. Our written testimony is available on the ISDA website.

As with any production in Congress, however, not everyone is reading from the same script. From the line of questioning of some members of the subcommittee, it is clear that financial regulatory reform is a play with two acts. Act One, AIG. Act Two, DFA.

This is misguided. Much of DFA has nothing to do with preventing another AIG.  The part that does – improved regulatory transparency – is already in place as a result of the CDS Trade Information Warehouse. It is hard to conceive that AIG-type trades could achieve a level of standardization that would lend themselves to clearing or SEF execution.

In addition, it is not clear to us that there is sufficient appreciation for the range of swaps that are used day in and day out to manage risk. Representatives from pension funds and end-users, in particular, spoke at the hearing of the need to make sure that we are not throwing the baby out with the bathwater. The swap world is one of many characters and scenes.

We will continue to play our part in debates like these, providing information that helps inform decision making. A perfect example of this was Connie’s response to a question regarding transaction costs for users of derivatives trades. One witness asserted that such costs total $50 billion annually. We await the study that demonstrates those costs, but in the meantime, Connie walked through some quick analysis based on straightforward assumptions that made the assertion seem unlikely. We like plots that are based on true stories.