December 04, 2013

While the Obama Care fiasco has reached out to all Americans, the Dodd-Frank derivatives implementations are similarly ‘problematic’ but not understood enough to touch the lives of everyday people… yet. After all it’s just the ‘plumbing’, the backend ‘stuff’ left to others, left as an afterthought in fact, even though it will power, in the first instance the website and in financial reform make the American economy work. Most do not understand that today’s diverse capital markets cannot function without equivalent risk shifting markets.

Laying out and then pouring the foundation of a building before we know its height is not the way architects and engineers build buildings. Nor should we be doing the same in building global information systems of such significance. That is why the FSB has taken up global swaps data aggregation as an issue. The results are to be publicaly made available in June 2014. Policy people are listening now. Derivatives regulation was troubled from the start when the DFA’s newly empowered Office of Financial Research punted the technology data standardization of counterparty identification (who is trading with whom) to a global regulator, the Financial Stability Board. The FSB itself was a creation of the G20, reacting to the financial crisis by empowering a new global institution for stabilizing the global economy.

However, in the US the Commodity Futures Trading Commission chose to proceed with its own version of counterparty identifiers even while the FSB was deciding on a global standard. That standard still has not been finalized. In its haste, the CFTC, assuming a race to be the first to check off an ‘I implemented Dodd-Frank rules first’ box stumbled badly.

Passing framework rules and leaving technology implementation as an afterthought has proven disastrous. Like the website debacle of Obama Care it has brought to the fore big data issues yet to be resolved.

The LEI is, in its first use, a pillar for transacting swaps in a computerized transaction environment. It is the glue that will make this possible, yet very few understand its significance. That is because it is the plumbing, and the C-suite are not inclined to go rummaging into the basement, hence reporters who write for influential publications like the WSJ don’t get too close to the LEI.

However, there are many hints that further improvements are warranted. In March of this year the CFTC asked for data on the newly regulated swaps derivatives markets. The CFTC was unprepared for the data deluge that followed. Their systems were overwhelmed by non-standardized data, brought about by their failing to provide guidance on data standards. At the time there were about 80 swaps dealers registering for a LEI and sending data. Instead of pausing, in July they commanded the remaining counterparties in swaps trades, thousands of other market participants, to send in data.

There is no way the CFTC could have aggregated this data in any timely fashion. The problem has again been punted up to the Financial Stability Board. This time not only to resolve the counterparty identifier issue and nonstandard data in the US but how data can be aggregated across the many new global derivatives infrastructure entities that have been put in place anticipating regulatory initiatives in their own countries.

The FSB has called for a coordinated approach to how newly mandated facilities like Swaps Execution Facilities (aka swaps exchanges) and Swaps Data Repositories will interoperate. Most importantly, these new facilities must be capable of providing a systemic view of their data to regulators across multiple sovereign regulatory jurisdictions.

Without this capability, a technical issue of major importance, we have simply created another version of a shadow derivatives market, this one an electronic version that neither regulators nor industry members can observe transactions in.

Lest we suffer again the lesson of unintended consequences, best we stop checking off nonsensical boxes that attest to ‘I completed’ this or that regulation. It only signifies the rule was written. Instead we need to check off the ‘I implemented the solution and it is working’ box. That is where the rubber hits the technology road.

—Allan D. Grody is President of Financial Intergroup Holdings Ltd; Chairman of the Advisory Board of the Financial Industry Ontology, Risk and Data consortium; an advisor to the Regulatory Oversight Committee of the Financial Stability Board and to the FSB. Allan is a retired partner and founder of Coopers & Lybrand’s (now PWC’s) Financial Service Consulting Practice; a former adjunct professor at NYU’s Stern Graduate School of Business. He writes, speaks and advises on issues where data management, risk management and technology converge.