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Regulators Weigh In on Indemnification

In an unequivocal show of support for proposed legislation that would help ensure transparency in the over-thecounter (OTC) derivatives markets globally, two senior DTCC executives testified in March before key House subcommittees.

The legislation DTCC supports would remove provisions from the Dodd-Frank Act that require U.S.-based swap data repositories (SDRs) to receive a written indemnification agreement from non-U.S. regulators before sharing critical market data with them. Regulators outside the U.S. have said they would be unable or unwilling to provide an indemnity agreement because the concept is unfamiliar to them and inconsistent with their traditions and legal structures.

DTCC testified that passage of the legislation is critical to prevent the fragmentation of swaps data. Fragmentation could undermine the ability of regulators to obtain a comprehensive view of the global marketplace, which would impact their ability to see risk building up in the system and provide adequate market surveillance and oversight. Removing these provisions would therefore help ensure that regulators around the world continue to have the highest degree of transparency into OTC derivatives markets.

The proposed legislation, The Swap Data Repository and Clearinghouse Indemnification Correction Act (H.R. 4235), was approved by the House Financial Services Committee on March 27 and with a March 28 hearing in the Committee on Agriculture, it continues to move through the legislative process.

One-two punch: Donahue and Bodson

On March 21, in testimony before the House Capital Markets and Government Sponsored Enterprises Subcommittee, Donald F. Donahue, DTCC’s President and CEO, strongly endorsed the proposed legislation.

"Dodd-Frank may legally preclude U.S.-based repositories from providing regulators outside the U.S. with market data on transactions that are under their jurisdiction without an indemnity agreement," Donahue said. "The clear risk is that global supervisors will have no viable option other than to create local repositories to avoid indemnification, which will fragment data globally. While each jurisdiction would have an SDR for its local information, it would be extremely difficult and time consuming to effectively share information between regulators."

One week later, on March 28, Michael C. Bodson, DTCC’s COO, reinforced the company’s position in testimony before the House General Farm Commodities and Risk Management Subcommittee.

"This bill would send a strong message to the international community that the United States is strongly committed to global data sharing and determined to avoid fragmenting the current global data set for OTC derivatives," Bodson said. "If a regulator can only ‘see’ data from the SDR in its jurisdiction, then that regulator cannot get a fully aggregated and netted position of the entire market as a whole. In short, regulators will be blind to market conditions as a direct result of the indemnification provision."

Bodson also stated that, if data fragmentation occurs, U.S. regulators, including the Securities and Exchange Commission (SEC), the Commodity Futures Trading Commission (CFTC) and the Office of Financial Research, would face the daunting and time-consuming challenge of having to aggregate data from multiple repositories for purposes of market oversight and systemic risk mitigation

Donahue noted that removing the indemnification provision from Dodd- Frank would also bring U.S. law into closer alignment with international data-sharing protocols developed through the cooperative efforts of more than 50 regulators worldwide, including the CFTC, SEC and Federal Reserve, under the auspices of the OTC Derivatives Regulators’ Forum (ODRF).

Another threat: plenary access

Both DTCC executives stressed that indemnification and a second issue, known as "plenary access," need to be addressed concurrently, otherwise data fragmentation is likely to occur.

Dodd-Frank gives U.S. regulators "direct electronic access" to data held by an SDR, a provision intended to ensure immediate access to swap data in machine readable form. Non-U.S. regulators are concerned that "direct electronic access" has already been interpreted too broadly by the U.S. agencies to gain plenary access to all swap data held – including data for transactions with no identifiable nexus to U.S. regulation.

DTCC is urging Congress to amend the indemnification legislation to include clarifying language stating that regulators have access to data in which the regulator has a material interest.

"Plenary access is unworkable because the scope of an SDR can be broader than just U.S. data – and regulators should have access to only that data in which they have a material interest," Bodson said. "DTCC fully supports regulators having plenary access for SDR supervision activities related to the operation of the SDR and transactions held within it with a U.S. nexus. However, we oppose plenary access for other purposes because non-U.S. financial firms executing transactions without a U.S. nexus will avoid reporting their trade data to a global repository if that data could become subject to U.S. regulatory access."

Call to action

"By amending and passing this legislation to address both indemnification and plenary access, Congress will help create the proper environment for the development of a global trade repository system to support systemic risk management and oversight," Donahue said.

"While the legislative calendar remains tight, due to the overarching influence of U.S. presidential elections, passage of the legislation remains challenging this year," added Dan Cohen, DTCC Managing Director and Head of Global Government Relations. "However, these hearings have moved the process forward and changed the way both domestic and global regulators view this issue. Because of these hearings, this legislation has a chance." @