What was the status of the credit derivatives markets during the financial crisis?
The 2008 global financial crisis (GFC) and the collapse of Lehman Brothers specifically, revealed that regulators and financial institutions were unable to gain an accurate view of market exposure among firms and hence the build-up of systemic risk. At the time of the GFC, DTCC’s Trade Information Warehouse (TIW), which processes approximately 98 percent of all credit derivatives transactions, and the forerunner to DTCC’s Global Trade Repository (GTR), proved to be a vital source of information to market participants and regulators.
In total, the TIW netted $285 billion in credit default swaps (CDS), in terms of gross nominal value, reducing them to an effective payment of $12 billion, less than the amount that was initially referenced.
What regulatory action was taken?
These events triggered a wave of reforms by G20 regulators aimed at increasing the transparency and resilience of global financial markets. It became clear to regulators that the key to understanding the soundness of the financial system would be their ability to quickly and consistently identify parties to financial transactions and obtain an accurate view of their global exposures.
These reforms, agreed at the G20 Pittsburgh Summit in 2009, included the trading of over-the-counter (OTC) derivatives contracts on exchanges or electronic trading platforms, clearing of OTC derivatives through central clearing counterparties (CCPs), and reporting of these trades to trade repositories.
What’s the current state of trade reporting regulations across the world?
Great progress has been made with regards to the implementation of OTC derivatives trade reporting regulations across the world. Domestic compliance with the G20 reporting mandate has been established, a wide range of reporting requirements have been met, and new procedures and processes have been implemented to ensure that derivatives transactions across all asset classes can be reported in an accurate and timely manner.
However, jurisdictions have implemented regulations in very different ways. For example, the Commodity Futures Trading Commission (CFTC) has adopted a ‘catch-all’ approach to the data it has requested from market participants, while the European Securities and Markets Authority (ESMA) has been more prescriptive.
As a result, the current patchwork of reporting rules has lead to greater costs and increased complexity for firms. Furthermore, coverage has been inconsistent with regards to instrument types and market participants, implementation timelines have also varied hugely across jurisdictions.
Even more significant is the fact that prescribed data fields, terms and core elements are extremely diverse across jurisdictions which hampers the objective of data aggregation to monitor systemic risk. Lastly, the sharing of data held by trade repositories has been less than originally intended due to inconsistencies in the data collected and restrictions around legal and structural access.
What progress is being made to create reporting standards?
Standard-setting bodies (SSBs), trade associations, regulators, market participants and infrastructure providers continue to work together to establish data and processing standards for OTC derivatives, refine technical guidelines around data consistency and provide guidance around ways to harmonise reporting practices across jurisdictions.
The International Swaps and Derivatives Association recently launched its first digital-based version of the common domain model, a framework that aims to standardise derivatives-trading processes. Developed in collaboration with the Committee on Payments and Market Infrastructures and board of the International Organisation of Securities Commissions (CPMI-IOSCO), it formulates governance and technical guidance to underpin common data standards for derivatives reporting.
Collaboration among industry stakeholders has also led to the establishment of proposed guidelines for the consistent use and governance of the critical data elements (CDEs) needed to identify, process and report an OTC derivative transaction globally. CDEs include the legal entity identifier (LEI), unique product identifier (UPI) and unique trade identifier (UTI). LEIs are currently embedded in 14 G20 jurisdictions, even though adoption of UPIs and UTIs has been slower.
With regards to access to data, the industry has worked to remove barriers to data sharing. Further methods are being sought to share data more efficiently. Much of this impetus has originated from the efforts of the Financial Stability Board and has seen the US Congress repeal statutory indemnification requirements that had previously limited data exchange with third party trade repositories, while the European Commission proposed an amendment to the European Markets Infrastructure Regulation to provide direct access to data held in European trade repositories by third party jurisdictions with which equivalence has been agreed.
Where and how can DLT be applied in derivatives trade reporting that would have the most impact and which are best addressed through traditional means?
Advances in distributed ledger technology (DLT) have proven its ability to provide a single, immutable and commonly accessible record of transactions among multiple parties, thereby increasing transparency and reducing costs.
The industry is already discussing whether DLT can enable a shift to searchable databases and full regulatory access. DTCC is in the process of re-platforming its TIW for CDS transactions to a DLT system with the aim of enhancing efficiencies and generating new value-added services.
Credit derivatives are an ideal use case given they consist of standardised process flows and data models which allow the technology to be tested with appropriate and meaningful scale.
However, for DLT-based initiatives to be deployed successfully, it is essential that firms learn lessons from the past, ensuring the use of technology, governance and data standards to enable compatibility between ledgers and prevent any customisations that are made during development and implementation from compromising end objectives.
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