Aggregating Swaps Data: Putting the Cart Before the Horse?

How can we effectively monitor systemic risk in the swaps market?

That is the question now facing regulators around the world, and if financial firms were to have their way a federated approach to aggregating data would be the best option, they tell FinOps Report.

Whether this scenario — one of the options now under review by the Financial Stability Board (FSB) — is feasible without harmonized data standards and reporting rules is a multi-trillion dollar question now under debate. Regulators can’t afford to rush in without careful planning and may need to do a lot more work before any new technology infrastructure is created, say some.

With swap trades now captured in multiple geographically dispersed trade repositories in multiple formats and content, regulators are understandably having a hard time connecting the dots to come up with a complete picture of just how many swap transactions each firm is executing with which counterparty nd for how much value. Without such a global view they cannot correctly measure systemic risk — the potential that one firm’s financial woes will spread to others as occurred with Lehman Brothers’ bankruptcy in September 2009.

The FSB has suggested it wants to further study the cost and benefits of three alternative methodologies, of which the first reflects a centralized physical model or one database where all data would be collected and stored from multiple repositories around the world. The second is a “logically centralized” or federated approach where regulators could access data at will from any repository through a middleware hub, and the third option would put the onus on regulators to collect raw data from local repositories and aggregate it themselves. Although the third version is the only one practically feasible today, both regulators and market participants clearly prefer either a centralized physical model or logically centralized model, if technical and operational barriers could be overcome.

In speaking at the association’s recent annual meeting in London, Scott O’Malia, the chief executive of the influential trade group International Swaps and Derivatives Association (ISDA), appeared to scoff at the viability of a global data repository, calling it a “dream.” Yet in a separate interview with FinOps, Karl Engelen, head of data reporting and the FpML message protocol at ISDA insists such a characterization is misleading. “We have no preference regarding the data aggregation models. The FSB raises the right questions in is feasibility study and the answers to its questions will help further evaluate the options,” he says. He also emphasizes that the immediate regulatory focus should be on standardization and harmonization in different jurisdictions irrespective of the data aggregation model chosen.

An example how different regulations affect the transaction data available to regulators can be found in the discrepancies between the US and European mandates for reporting the economic details of swap trades. Under both the US Dodd-Frank Wall Street Reform Act and its European counterpart European Market in Financial Instrument Directive (EMIR), financial firms must submit information about the transactions they execute to an accredited trade repository. However, EMIR requires financial firms to provide far more details about the collateral backing a deal than their US counterparts under the Dodd-Frank legislation. As the parties responsible for executing trades on behalf of fund manager clients only broker-dealers and banks must typically comply with swap reporting requirements under Dodd-Frank. EMIR adds fund managers to the lot.

The harmonization challenge goes far beyond the obvious issue of creating a common data language, content or even reporting requirements. Specific codes also need to be used some of which depend on the global uptake of legal entity identifiers, new unique transaction identifiers (UTI) and new product identifiers. Financial firms must report on their swap deals using legal entity identifiers, but the construction of the UTI may be different from one nation to another, which could lead to difficulties in risk analysis.

In Europe the LEI is used as the prefix for the UTI to ease matching of two halves of a transactions that may be reported to different data depositories. In the US the prefix of the UTI cannot be an LEI, explains Allan Grody, president of risk management consultancy Financial InterGroup Advisors in New York. Instead, the prefix must contain a “name-space identifier” which futures commission merchants, swap dealers and major swap participants must obtain from the National Futures Association.

Industry Feedback

While the FSB also agrees on the need for uniform data standards, identifiers and reporting formats, its decision to float alternative architectures for discussion is fueling internal debates at the financial firms responsible for complying with regulatory reporting requirements. Given that they have already spent plenty of time and money in fulfilling current rules, they are hard-pressed to plan ahead for changes that are yet to be announced.

None of the ten operations managers in the US and London contacted by FinOps wanted to voice their opinions publicly for fear of attracting regulatory attention to their own firms. However, they didn’t hesitate to express their frustrations on condition of anonymity. “If regulators can’t compare apples with apples data, we have really stressed ourselves unnecessarily in rejiggering all of our systems and procedures to provide regulators with the data,” says one broker-dealer operations manager. “They should have done a better job at harmonization before the rules were implemented, so we don’t have to start all over again.” His stance was shared by nine others, of which three worked for UK fund management shops.

When asked which of the three data aggregation models regulators should use, all of the operations managers said they favored what the FSB has called a “logical” database where information could be accessed by regulators at will from any trade repository they want anywhere in the world at any time. However, they were uncertain how much data harmonization would be necessary accomplish such a scenario and how it could operate given local data privacy rules.

National swap trade repositories which will have to adapt to any regulatory changes appear to support  harmonization of  standards before any global swap data repository can be created. Yet, they don’t appear eager to give up their vested interest at becoming the dominant player. Officials at DTCC, owner of a network of repositories around the world, were unavailable for comment at press time, but have consistently touted their trade repository business as a global solution.

So does European data repository REGIS-TR in Madrid. “Our clients expect us to be a one-stop shop for their reporting, because having to interface to different repositories including a global swap repository is not efficient,” says John Kernan, senior vice president of product management at REGIS-TR in response to e-mailed questions. “While it is likely possible to create a global swap data repository, there is the the question of necessity and practicality with very different standards and processes operationally. Technically and legally there would be many challenges regarding the efficient access and interoperability that market participants expect.”