Larry Thompson, DTCC Managing Director and General Counsel, and Chairman of the Board of DTCC Deriv/SERV LLC
The role of market infrastructures in enabling global financial market reforms has become more pivotal than ever. However, without cross-border collaboration there is a danger that these reforms may not deliver the transparency needed to properly identify and manage future risks.
Five years ago, the Group of Twenty (G20) gathered in Pittsburgh to set a new framework for the reform of the global financial markets. A commitment was made to promote the integrity of the global financial system by bringing more transparency to the derivatives markets. This commitment was followed by a host of reforms in the U.S., Europe and all the major jurisdictions in the Asia-Pacific region.
These reforms, some wider in scope than others, have centred around three key pillars aimed at improving the stability of the derivatives markets, namely: ensuring that all standardized derivatives are traded on regulated exchanges, that they are centrally cleared and that they are reported to trade repositories. The role of market infrastructures in enabling these reforms has therefore become fundamental.
While the trading and clearing mandates are yet to be fully implemented across all major derivatives jurisdictions, legislation mandating derivatives reporting is already in place in Europe, the U.S. and throughout several jurisdictions in Asia. A number of trade repositories are already collecting vast amounts of derivatives transaction data.
Challenges to global transparency efforts
Policymakers and regulators deserve credit for their efforts over the past five years, mobilising resources, passing legislation as well as writing detailed rules in a relatively short time. Today, regulators have access to more transactional data than ever before, and this should go a long way to avoiding market panics like those witnessed in the 2008 crisis. They have also developed macro prudential toolkits which enable them to create buffers against market shocks in the form of greater capital and liquidity requirements.
Notwithstanding the amount of data collected, significant challenges remain before regulators are able to transform it into information capable of assisting them in their quest to identify and mitigate systemic risks. These challenges are both structural and legal in nature.
The first threat to transparency is the existence of divergent reporting requirements. The global regime we have today developed along regional lines, which ignore the borderless nature of the OTC derivatives markets. These risks create an environment troubled by overlapping or duplicative regulatory requirements, or omissions in terms of the data being reported. Moreover, it is driving up the cost of compliance and making it more difficult for market participants to satisfy multi-jurisdictional reporting requirements with single solutions.
The second challenge to transparency is the lack of globally agreed standards. Although trade reporting has emerged as one of the most important risk management tools available to regulators since the onset of the global financial crisis, for these infrastructures to achieve their full potential, a system of global reporting standards is essential. This will enable policymakers and market participants to more easily aggregate and interpret the data available to them.
Last but not least are the legal challenges to transparency, including privacy laws and indemnification clauses put in place by some jurisdictions. The U.S. Dodd-Frank Act, for example, includes an indemnification provision which de facto prevents non-U.S. regulators accessing data held by U.S. trade repositories. Given the global nature of the derivatives markets, if, for instance, European regulators cannot have a full picture of European banks’ cross-border exposures, then the ability of regulators to understand, identify and mitigate possible risks is significantly compromised. The removal of legal roadblocks would go a long way to ensuring transparency efforts.
Time for greater collaboration is now
We are now entering an important stage in which regulators face the challenge of aggregating the derivatives data and transforming that data into meaningful information.
For the data to be useful to regulators it needs to be timely, accurate and aggregated on a global basis. The latter is essential: derivatives markets are some of the most globally interlinked, with the potential for chain effect reactions - thus making the effective monitoring of those chains critical to achieving financial stability.
The key challenge for cross border cooperation is to balance national regulatory interests with the need to monitor risks throughout a global marketplace. National regulators have the responsibility to protect investors and markets in their jurisdiction, but they must also recognise that they operate in a wider, global framework.
The Financial Stability Board, which is leading the efforts towards data aggregation, can play a key role in this regard. DTCC believes that the process needs to begin with identifying what data is needed to meet the G20 transparency goals, understanding what regulatory agreements are already in place that would govern information sharing among regulators and address any data privacy issues, and lastly, implement data aggregation where infrastructures, such as DTCC, can play an active role.
Mandating trade reporting was an important step towards transparency, but it is increasingly evident that the regime that has emerged, with data fragmented along regional lines, denies the level of transparency that was deemed essential by the G20 to ensure financial stability. For the trade repository to achieve its full potential as a risk mitigation tool, collaboration among the regulators and the industry groups will be critical to ensuring that the greater good of market transparency and integrity is achieved and that the regulators have the tools to identify and mitigate causes of financial instability.
This article first appeared in the Boersen Zeitung (Rules & Regulations Newsletter) on August 12, 2014