Regulators have already said that they will not take a “Big Bang” approach. Rather, they will phase in the rules over a period of time that could span several weeks or months. At DTCC, we’ve been focused on this issue because as the operator of the centralized global repository for credit default swaps (CDS), we have a particular insight into how swap data repositories (SDRs) will play a fundamental role in helping to achieve the transparency and risk mitigation goals of Congress and regulators.
Some quick background first: SDRs are an essential part of Dodd-Frank. They’ll hold the trade and position data on all OTC derivatives trades. When this data is consolidated in a centralized repository, such as DTCC’s Trade Information Warehouse (TIW), market positions and concentration of risk are fully transparent to regulators worldwide. It allows regulators to monitor global trading activity, view extensive details about a particular trade within its jurisdiction and evaluate risk concentrations – all of which are designed to help avoid another financial crisis.
Based on our experience, we believe the new OTC derivatives rules should be implemented in three waves, beginning with establishing the necessary infrastructure to support the new regulatory regime. Wave one would require comprehensive trade reporting to SDRs to bring transparency to the market. After that would be mandatory clearing of OTC derivatives trades and then mandatory trade execution on exchanges or swap execution facilities (SEFs).
Trade reporting is the critical first step because regulators will depend on current and accurate trade information to make decisions related to other parts of Dodd-Frank, including clearing and trade execution. This will allow regulators to think about whether they want to put some restrictions on markets or certain market functions. It will also assist them in appropriately defining large block trades.
Within each of these waves, it makes sense to sequence the implementation by asset class, focusing first on the products with the greatest automation because they will be the most capable of providing the highest quality data to SDRs. Under this scenario, credit and interest rate derivatives should be at the front of the line because the overwhelming majority of trades in these markets are already confirmed electronically. Next would be FX derivatives….and then equity and commodity derivatives together.
While the order of implementation is vital to the success of the new rules, the proper implementation of Dodd-Frank requires more than just appropriate phasing and sequencing of rules. It is equally as important to focus on the degree of coordination among the three pillars of the Dodd-Frank infrastructure — the trading platforms, the clearing agencies and the swap data repositories.
For starters, we believe that the twin principles of open access and user choice, which are deeply imbedded in both the letter and the spirit of Dodd-Frank and the proposed rules, should be made explicit. In other words, trading platforms and SDRs must maintain strict open access to all market participants – and not impose artificial barriers to access or anti-competitive burdens on the trading, clearing or reporting of transactions. In addition, reporting counterparties should have the right to dictate where their transaction data is reported. To protect the integrity of the trade reporting process, vertical bundling and cross-subsidization of services should be explicitly disallowed.
These policies will ensure that SDRs are able to fulfill their mission of providing record keeping services for the benefit of regulators and the general public.
As regulators begin the transition from writing rules to implementing them, we believe that appropriate sequencing will help promote more transparent markets for global regulatory oversight and systemic risk mitigation. We also believe that it will help protect the public and ensure liquid and efficient capital markets.
Larry Thompson is managing director and general counsel of The Depository Trust & Clearing Corporation (DTCC), a non-commercial market utility that serves as the primary post-trade infrastructure organization for the U.S. capital markets.