CFTC calls for international swaps data sharing deal
Global standards and approaches to regulation need to focus more on removing risk from the financial system rather than just compliance – but to do so international regulators will need to harmonise their efforts and embrace technology to a much greater degree.
That was the message from a trio of speakers at different events in London this week. Speaking at a Swift Standards Forum conference, Commissioner Scott O’Malia said: “Our supervisory mind-set is focused on the filing of forms and compliance checks. This is not an acceptable regulatory paradigm in the post-financial crisis world … the technological landscape is evolving and changing rapidly. We need to leverage this resource and reform our surveillance and oversight mission in a significant and technologically-adept way.”
This was echoed by Professor Randall Kroszner of the University of Chicago Booth School of Business. Kroszner, a former member of the board of governors of the US Federal Reserve System, was in London to talk at an event on transatlantic financial regulatory mechanisms. Speaking on the BBC Radio 4 Today programme, he said that differences in international rules are leading to a culture that addresses compliance rather than addresses risk, in which international banks spent too much effort on ensuring they were compliant with regulators in different jurisdictions.
O’Malia also made this distinction between compliance monitoring and market oversight. The US Dodd-Frank Act, among other things, requires that all swaps be reported to swap data repositories in order to provide the CFTC with the ability to identify and monitor large swap positions that could have a destabilising effect.
This is creating vast databases that the CFTC cannot actually analyse. “Utilising this data to identify risk patterns is a new skill set that we haven’t mastered yet because the data is not in a form and format that is readily usable,” he said, adding that there are “three critical areas where the CFTC needs to make immediate technological improvements” in order to efficiently and cost-effectively monitor the markets to meet its Dodd-Frank mandates:
- improve swaps data quality
- develop additional automated surveillance tools
- develop automated risk analytics
“By developing these technological capabilities, the CFTC can build the infrastructure and tools it needs to perform its fundamental mission: to ensure market integrity and protect market participants and the public from fraud, manipulation, abusive practices, and systemic risk in the futures and swaps markets,” said O’Malia.
To do so will also require global regulators working together. “I am encouraged by the focus and attention that international regulators have devoted to working on the data challenges presented by a global swaps market,” said O’Malia. “These recent developments will forge a coordinated approach and will provide solutions to transform regulatory oversight of OTC derivatives. We can’t miss this opportunity to work together, when the US and the EU are facing the same problems at the same time.”
International Data Sharing Agreement
He said that on Monday he had met European Union officials and “specifically requested that the US and the EU engage in an immediate discussion” to recognise each other’s swap trade repositories and develop a means to share the data and collaborate to harmonise both the form and format of data being reported.
“By accomplishing these two objectives, our two jurisdictions will be able to enhance our cross-border cooperation in carrying out the G20 OTC derivatives reform mandates,” he said. “The urgency for a holistic view of the financial markets, without borders, was underscored by how the financial crisis caught the world by surprise. Data that could have identified systemic risk was fragmented across regulators and nations. Risk knows no boundaries: our ability to monitor it shouldn’t have any either.”
Across London at the TSAM buy-side technology and operations conference, Patrick Pearson, head of financial markets infrastructure at the European Commission, was addressing the same topic, writes Elliott Holley.
“There are several possible approaches [to dealing with rules in different countries], said Pearson. “The first is to accept that their laws are equivalent to ours and we will rely on the regulator in that country to enforce those rules. Under such a scheme, those countries can access our markets with no other restrictions. Another approach is to have qualified equivalence, under which their law applies but only for certain things, such as clearing or registration. In Europe, we haven’t applied equivalence yet but it is coming and it will be introduced this summer.”
Pearson said that there were differences in the legislative mechanisms of different countries that create some obstacles to harmonisation, but international bodies are working to overcome this.
“There is a correction mechanism in place in the European rulemaking process – ESMA has an obligation to protect the consumer, but the Commission can block measures if they are not in line with its original intent,” he said. “In the US, if the CFTC is going to implement something that will cause problems, Congress can’t stop them and say, ‘that’s not what we meant’. In Europe you can.”
Irina Leonova, a member of the secretariat of the Financial Stability Board, pointed out that there is an international dimension to the discussion and that regulators had to be pragmatic: “Besides Europe and US there is the rest of the world. You want the same outcome – how we get there matters, but at the end of the day we want to get to the same place. If regulation is not the same between jurisdictions you have to remember we live in heterogeneous world. An objective-based approach that looks at what we are trying to achieve is best.”
Echoing O’Malia, Pearson said that it there are limitations to collaboration resulting from data quality. “In Korea they want equivalence, but the information available is not granular enough,” he said. “Let’s not cut corners – we have no interest in opening our markets and letting in risk that could damage our system. Firms could no longer hedge risk if they lack the necessary information.”
On the whole, though, he said that international efforts are progressing effectively. “We talk to each other. There’s a group set up between regulators including Japan, the US and Europe, and it’s doing a good job – its first report is being published soon,” he said. “The group meets three or four times a year, and I’ve had weekly phone calls from them. I’m encouraged; I’ve never seen this level of cooperation between different global regulators before. We are ensuring rules around the world match up.”
Back at the Swift Standards Forum, O’Malia told the audience that a standards-based approach could enable “successful cross-border regulation of the derivatives markets through the use of open, transparent, and standardised swaps data” as part of a “coordinated approach to swap data reporting by international regulators in order to comprehensively regulate OTC derivatives and monitor systemic risk”.
“Over a year has passed since swap data reporting began in the United States, yet, the CFTC still cannot crunch the data in SDRs to identify and measure risk exposures in the market. Lack of automation, inconsistent reporting, technical challenges, and poor validation and normalisation have crippled our utilisation of swaps data,” he said. “The technological deficit in our ability to aggregate, search, and navigate through these varied data structures have made our efforts to develop a basic level of analysis unsuccessful. These breakdowns in functionality can be traced in large part to the lack of data standards. The swap data reporting rules failed to provide for standardised data fields or reporting formats. As a result, entities are reporting trades using different message types and in varying record formats.”
Besides improving swaps data quality, the CFTC must have a system that can process and perform analytics on big data, he said: “The CFTC doesn’t have a database that links the futures and swaps markets to aggregate and perform cross-market analytics, horizontal reviews, and surveillance for systemic risk. In fact, we don’t have a single database for all swaps data we have to rely on the four registered SDRs to store the data and perform first-order analysis.”
Taking this to the next logical step is for the CFTC to invest in surveillance tools to oversee the real-time order messages and not rely on stale transaction data. Having the ability to perform market surveillance at this granular level will help the agency understand the behaviour of automated trading systems, including High Frequency Trading and identify suspicious activity.
“I refuse to believe that even a small regulatory agency like the CFTC can’t harness technology to explore the data that we currently receive or can access,” said O’Malia. It is exciting to imagine what our potential can be.
Automation has an even more important role to play in risk analytics, and the CFTC must implement a strategy to integrate swaps, futures, and options data to perform risk analysis and surveillance, he said: “Identifying risk can only be done effectively if we are able to manage our data. The CFTC, however, is struggling to ramp up and meet its new goals and objectives.”