Trade Repository Regulation and Framework Introduction As current regulatory discussions focus on central clearing and trade repositories, this white paper will focus on the possible approach and set up of reporting to the Global Trade Repository (as offered by The Depository Trust & Clearing Corporation, DTCC). The paper will also address some of the challenges faced by financial institutions to keep systems and resources aligned with the changing regulatory environment. After the recent credit crisis and the collapse of several financial institutions around the world, regulators concluded that increased central clearing could potentially lessen the impact of the economic downturn and could have averted the sudden collapse of financial institutions entirely. The argument has been made that the separation of market and credit risk into silos led to skewed global exposure measurements across entire institutions. This separation has been recognized as a contributing factor in these financial institutions demise. Risk management has now become the top concern of many, if not all, financial institutions, as well as of the regulators of financial markets. What is a Trade Repository and what are CCPs? A trade repository, sometimes referred to as a Swap Data Repository (SDR), is mandated by the Dodd-Frank Act (In the US) and European Market Infrastructure Regulation (EMIR) (In the EU) and is in essence a data storage warehouse for trade details and daily valuations. The creation of these repositories and the reporting requirement for swap traders/financial institutions is intended to increase transparency for both regulators and for market participants. Ideally, this transparency would allow the market and regulators to anticipate a buildup in exposures. Currently, the two main trade repositories that have pending provisional registration with CFTC 1 are DTCC s Global Trade Repository and ICE s Trade Vault Swap Data Repository. See below for coverage of asset classes. Chicago Mercantile Exchange is currently in the process of getting approval to become an official SDR as well.
Provider of SDR DTCC Global Trade Repository ICE Trade Vault Swap Data Repository Asset class Interest Rate, equity, credit, foreign exchange and other commodity classes Commodity, credit and foreign exchange A Central Counterparty (CCP) is a central clearing house which provides clearing and settlement services. A CCP might clear trades across multiple trading platforms (Exchanges and/or OTC) and asset classes or it might just clear one set of products. The basic purpose of a central clearing party is to reduce the risk of counterparty credit risk and settlement risk. Instead of having multiple trading counterparties with different credit limits, the institution can trade against one CCP (netting offsetting transactions) and would only need to post margin towards that CCP. The CCP also provides daily valuation of trades and posted collateral. There are currently many companies offering clearing with a focus on particular products or a regional focus. Some examples are found in the following table. Provider Geographic Coverage Products Centrally Cleared Currently Products to cover in the future ICE Clear US & Canada, Europe CDS, CDX, ITraxx CME US & Canada, Europe LCH.Clearnet Europe IRS, CDS, Itraxx IRS, CDX, Some FX, CDS, ITraxx, CDX (For Europe), Trade repository Eurex Europe CDS, Itraxx IRS Shanghai Clearinghouse Asia IRS and CDS
Current regulation and regulation under consideration The motivation of this increased focus on OTC derivatives was caused by several factors. After the financial crisis that occurred over the last few years and culminated with the collapse of Lehman Brothers in mid-september of 2008, international regulators decided to coordinate efforts to shore up the stability in the financial markets. G-20 leaders agreed in September of 2009 that, All standardized OTC derivative contracts should be traded on exchanges or electronic trading platforms, where appropriate, and cleared through central counterparties by end 2012 at the latest. OTC derivative contracts should be reported to trade repositories. Non-centrally cleared contracts should be subject to higher capital requirements. The objectives in establishing the new rules are to increase transparency (price and volume information publicly available), reduce counterparty credit risk, and reduce operational risk through central clearing and enhanced capital/margining constraints. Regulation in the USA Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank) This bill became law on July 21, 2010, and is composed of 848 pages. Out of these pages, regulators have created about 9,000 pages of rules and regulations; this represents only about 30% of the rules and regulations as required by the final act, most of which pertain to derivatives and trading of derivatives. In particular scope for this paper is Title VII, which details the mandatory clearing requirement for a majority of OTC derivative transactions while exempting FX swaps and forwards. This section also covers the trade repository requirement. The rules drafted under the Title VII are promulgated by the US Securities and Exchange Commission (SEC) as it concerns security based swaps and with the US Commodities Futures Trading Commission (CFTC) as it relates to all other swaps such as energy and agricultural swaps with shared authority over mixed swaps with a commodity component. Currently there is not much guidance on the geographical reach of the rules and regulations coming out of Dodd-Frank. In the CFTC End-User Rule there is a statement that excludes foreign governments, central banks, and international financial institutions while it indicates that Title VII does not apply to non US activities unless those activities have a direct and significant connection to the US.
Regulation in Europe and UK As the Dodd-Frank Act was passed in the US, the European Commission presented a similar regulation on OTC derivatives, central counterparties and trade repositories called the European Market Infrastructure Regulation (EMIR). Per the commission s website, The Regulation introduces a reporting obligation for OTC derivatives, a clearing obligation for eligible OTC derivatives, measures to reduce counterparty credit risk and operational risk for bilaterally cleared OTC derivatives, common rules for central counterparties (CCPs) and for trade repositories, and rules on the establishment of interoperability between CCPs. Under EMIR, the obligation to clear OTC derivatives applies to transactions where one or both of the counterparties are non EU entities and where they would be subject to the clearing obligation if they were in fact EU entities and if the contract has a direct, likely effect within the EU. A quick note on the Asia-Pacific: financial markets are also coming under increased scrutiny and similar regulatory initiatives are being implemented, but they will not be covered in this paper. Dodd-Frank vs. EMIR regarding Trade Repository There are three types of counterparties that can enter into a swap transaction under the Dodd-Frank Act: Security based swap users (i.e. end users ): These are entities that include insurance companies whose main use of swaps is to hedge risk or companies using swaps to hedge their commercial risk. Major swap participants: There are three parts to the Dodd-Frank Act definition here; an entity that satisfies any of them is a Major Swap participant, 1. An entity that maintains a substantial position in any of the major swap categories after excluding the hedging or commercial risk mitigating positions
2. An entity with outstanding swaps that create substantial counterparty exposure that could have detrimental effects on the financial stability of the United States Banking or financial systems. 3. Any financial entity that has high leverage relative to the amount of capital of such entity and is not regulated by an Federal Banking Agency or is subject to capital requirements and maintains a substantial position in any of the major swap categories. Swap dealers: Is any entity that holds itself as a dealer in swaps, makes markets in swaps, regularly trades swaps with counterparties as normal course of business for its own accounts and engages in trading which causes it to be known in the market as a dealer or market maker in swaps. The threshold here is $8 Billon aggregate gross notional value for the prior 12 months. Under EMIR there are two types of counterparties: Financial counterparty which includes banks, insurers, fund and investment managers, pension plans/funds Non-Financial counterparty, which is any counterparty not classified as a financial counterparty As the regulators are in the process of interpreting the legislations, these differences remain fluid and are subject to change. Below are some of the current differences and similarities. Clearing exemption for participants: The Dodd-Frank Act excludes certain market participants based on trading behavior or needs, while EMIR disregards behavior and permits exclusion of derivatives which can be objectively viewed as diversifying risk related to the non-financial market participants commercial activities. EMIR also allows for exclusion thresholds for non-financial market participants. Clearing exemption based on asset classes: The Dodd-Frank Act exempts FX trades while EMIR remains undecided whether it will exclude this asset class.
Reporting requirements to the Trade Repository under EMIR requires counterparties (all market participants) and CCPs to report trade details of all centrally cleared, noncleared and exchange traded derivative contracts. The accuracy of the details and avoidance of duplicate records falls upon the counterparties and CCPs, but the actual reporting may be delegated to a third party. Under Dodd-Frank Act, there is a reporting hierarchy established: Swap Dealers, Major Swap Participants, End users, which will be discussed in more detail later in the paper. Reporting under Dodd-Frank Act is similar to that of EMIR with the major differences being that entities that are required to report must also report more detailed transaction data to the registered repositories; this data will only be used by the regulators and will not be publicly distributed. Under both EMIR and Dodd-Frank Act, all derivative contracts must be entered into a Trade Repository (Internal trades, trader to trader, inter/intra entity are excluded) Under Dodd-Frank Act, there is a mandatory Swap Execution Facility, while EMIR currently does not prescribe this. As defined in Dodd-Frank Act, this is "a facility, trading system or platform in which multiple participants have the ability to execute or trade swaps by accepting bids and offers made by other participants that are open to multiple participants in the facility or system, through any means of interstate commerce." Recent developments The SEC and CFTC recently publicly defined what constitutes a swap; this new definition triggered about 20 Dodd-Frank rules to become effective for reporting, clearing and trade repository reporting. It also established the registration deadline for swap dealers and major swap participants to register with the CFTC. Approximately 125 companies are expected to register with the CFTC before the registration deadline. The swap definition also contains exemptions for insurance and retail transactions, and the CFTC also chose to exempt from the law so called end users. These end users are commercial and manufacturing companies that use swaps to hedge their risk of doing business.
Bilateral trade reporting work flow Trade flow reporting Two counterparties enter into a swap trade. If the trade is eligible to be cleared, it will have to do so through a clearing house. Once trade is cleared, the CCP will send the information to the Trade Repository. In the scenario below, ongoing trade life cycle updates are Party A s responsibility with the hierarchy set up under Dodd-Frank Act. Under EMIR, that responsibility can be delegated. If the trade is not available to be centrally cleared, i.e. it is a highly bespoke or an illiquid contract, it is up to Party A in the below scenario to report the trade to the SDR. Also under EMIR, there is no clearing obligation if one of the parties falls under the non-financial counterparty categorization. Party A Dealer, etc No Centrally Cleared? Mandatory if eligible Yes Party B (Buy Side, End user, etc) Trade Repository (SDR) Clearing House (CCP)
Swap execution facility trade reporting work flow Per Dodd Frank, derivatives subject to mandatory clearing will have to be executed on a SEF provided the derivative is available for trading there. Party A Dealer Swap execution facility (SEF) Party B (Buy Side, End user, etc.) Updates / Valuation Initial submission Trade Repository (SDR) Mark to Market Clearing House (CCP) Global Trade Repository by DTCC At the time of the writing of this paper, the Global Trade Repository (GTR) offered by DTCC is poised to become the preferred service provider and will provide the widest coverage of both centrally cleared and non-cleared OTC derivative products. This is, of course, subject to change as other vendors play catch-up and begin to roll out similar products. The core duties of a Trade Repository are, Acceptance and confirmation of data Recordkeeping Real-time reporting Monitoring, screening and analyzing data Maintenance of data privacy and integrity Regulatory access
The GTR will support 100% of products traded in each asset class for both electronically processed and paper confirmed trades. Covered Asset Classes by GTR Interest Rates, Credit, Equities and FX Derivatives (Non-US Reporting and Dodd Frank) Commodity Derivatives (Non-US Reporting and Dodd Frank) DTCC allows firms to elect to use GTR Services for regulatory reporting on any single individual asset class, on a subset of asset classes, or as a full-range solution for all global and domestic reporting on all covered asset classes. This includes bilateral, brokered trades, electronically executed trades as well as paper and electronically confirmed, centrally cleared or non-cleared trades. For firms to connect to the GTR and to use its services, DTCC offers a whole host of various interfaces. Existing clients with connections to DTCC through the Securely Managed and Reliable Technology network (aptly shortened to SMART) will be able to use the existing connection to submit records to the GTR Service. In addition, DTCC offers a direct Message Queue (MQ) Link for FpML messages as well as a web GUI for firms that would like to upload using the.csv format. GTR also permits clients to utilize a Business Intelligence Report web-based Interface, which allows clients to customize reports and view submitted data. The following messages, which are related to the various regulations contained in Dodd-Frank and EMIR, are supported by the GTR: Real Time Price Data - This is to comply with regulations for public reporting. Regulatory submission deadline is 60 minutes after execution. Detail Transaction Data/Confirmation - Basically a trade confirmation in electronic format. Regulatory submission deadline is 30 min after electronic confirmation. Position Updates - On existing trades, trade life cycle changes or EOD reporting. Regulatory submission deadline is 60 minutes after execution. Document - A trade confirmation in PDF or any supporting document to a trade.
Event Processing - Credit Events, Reorganization Events, etc. Regulatory submission deadline is to provide daily updates. To further promote efficient reporting processes, the GTR also provides open access to third-party providers such as CCPs, Custodians, Execution platforms, etc. For contracts cleared by a CCP, mark to market valuations should only be provided by the CCP. The reporting party hierarchy established by the regulators under the Dodd-Frank Act is, 1. Swap Dealers 2. Major Swap Participants 3. End users When submitting data to a swap trade repository, the above hierarchy sets the party responsibility for each swap trade. Any updates to the data of the trade are also that party s ongoing responsibility. In the case of two market participants that are of the same hierarchal level, the regulation stipulates that the two participants will come to an agreement on who will be the responsible reporting party (avoid duplicate submission). Certain transactions will be reported automatically to the Swap Data Repository. Standardized, centrally cleared and executed swaps will be sent straight to the Swap Data Repository as indicated in the workflow above. Framework for set up To minimize testing and development, all CCPs will be using Standard Interest Rate GTR messaging. This standard is FpML 5.3 messaging or CSV files. As Dodd-Frank rules makes all rates trades submitted by CCPs Dodd-Frank eligible. This applies for firms that wish to submit directly to GTR. If the firm wishes to use existing connections, it is free to do so. A current client of MarkitSERV can use it as a third party transaction submitter without needing any additional technical set up in-house.
A simplest solution is to build on existing DTCC connectivity (uploads via csv, web service, FPML depending on volume and current set up) Implementation Challenges for Financial Institutions Having to become a clearing house member or client of a clearing member and which CCP will clear your types of trades Ability to identify eligible trades to report in in-house trading system Identify trade events/changes, when to report and how to reconcile Valuation changes/updates and reconciliation of such changes Back loading functionality Changes of eligibility (non-cleared to cleared trades, change of hierarchy in relation to reporting party) Types of valuation data reporting, pricing models used, external valuations. If not centrally cleared, will have to provide mark to market or mark to model valuations. Having to provide sufficiently liquid margin/collateral for previously uncollateralized transactions. Collateral agreements in place Collateral reconciliation across several CCPs and potentially several trade repositories Which Swap Data Repository to report to Delegate reporting (ex. MarkitServer) vs. report directly About Global Market Solutions Founded in 2010, Global Market Solutions provides expertise in implementation and integration projects around financial software for all activities: * Front Office & Pricing Model Integrations * Risk Management (Market Risk, Credit Risk, Liquidity Risk analysis) and Real-Time Limit Monitoring * Back Office and STP (Straight Through Processing) * Accounting and regulatory reporting Global Market Solutions continuously invests on research and development on the theme of credit risk and clearing. We edit IRIS Software, a complete framework allowing financial institutions to manage their counterparty credit risk. For more information, go to www.globms.com