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CESR Releases Consultation Paper on Trade Repositories in the Derivatives Market: Data Standards on the Regulatory Agenda Again

Echoing the discussions going on over the pond on the subject, the Committee of European Securities Regulators (CESR) has just released a new consultation paper examining the need for a trade repository for OTC derivatives data. The US Securities and Exchange Commission (SEC) chairman Mary Schapiro has been talking about the need for a greater ability to track derivatives data in the changing marketplace for some time and the CESR paper is in accordance with that goal.

The issue has been raised in light of the collapse of Lehman Brothers and its impact on the market post-trading infrastructure. Regulators are keen to ensure there is more transparency on exposures generated by the OTC market, in particular for derivatives. Obviously, regulatory proposals are already in the works to move a lot of these OTC flows on to regulated exchanges and clearing central counterparties (CCPs), but CESR and the SEC are keen to go one step further.

The CESR paper, Trade Repositories in the European Union, is also in response to a request from Ecofin and is therefore in keeping with the European Commission’s proposals to move credit default swaps (CDSs) and other OTC derivatives onto CCPs. According to CESR, it is part of the goal to explore what further improvements can be made in order to enhance risk mitigation and to improve the transparency and efficiency of the post-trading process as a whole.

By placing this data into a centralised registry that maintains an authoritative electronic database of all open OTC derivative transactions, CESR hopes to gain a better handle on the flows and risk exposures within the market. The core functionality of such a repository is its record keeping and reconciliation function of definitive copies of trade data, says the regulator. Much like the function of a centralised EDM data store within a financial institution, the repository is able to retain a golden copy of transaction data.

In order for such a repository to function effectively, it will need to be connected to all market participants, service providers and market infrastructures, which could prove to be a hefty task to achieve in a relatively short space of time. CESR reckons this work will be worth the effort, however, and indicates that the repository would provide “risk reduction, operational efficiency and cost saving benefits to individual participants and the market as a whole”.

The data contained within the repository would be used by various regulatory bodies and other parties involved in the oversight process in order to ensure market integrity and to promote financial stability, says the report. Regulators would likely need a high level of granularity with regards to being able to drill down into this data in order to closely track risk exposure on the entity and instrument level.

This data would also be required for use by market players such as CCPs and specialised post-trading service providers, such as those involved in reconciliations. “Regulators should receive all the information required to fulfill their respective public mandates. Market infrastructure and service providers as well as market participants should have access to relevant information on a non-discriminatory basis, subject to relevant confidentiality provisions. The public may have a need for aggregate information on size, structure and major participants of OTC derivative markets,” says the report. The very fact that the data would need to be appropriately formatted for so many differing downstream uses could also pose a challenge during its set up.

“Data reported by trade repositories should at least include matched and confirmed trades. Trade repositories should provide adequate processes to ensure that the data on these trades is reliable and not duplicated. Work is ongoing in the international OTC Regulators Forum, which is in the process of defining both data input and output of trade repositories,” says CESR.

It defines the basic level of data detail that should be provided by the repository as including: product type; type of underlying, category of buyers and sellers; maturity; currency; top single names by gross and net notional; top indices and tranches by gross and net notional; product data by sector; position data by counterparty upon request by the appropriate regulatory authority; and position data for the main counterparties by gross and notional upon request by the appropriate regulatory authority.

The regulator is not necessarily keen to build such a repository from the ground up. In the paper, CESR highlights the Depository Trust & Clearing Corporation’s (DTCC) Trade Information Warehouse (TIW) as an example (well actually, the only current example) of a trade repository in existence that is being used by the market. Derivatives dealers in the US have already committed to using the repository, which is subject to joint supervision by the Federal Reserve Bank of New York and the New York State Banking Department, for CDS trades. They have also promised to use it for interest rate derivative trades by 31 December 2009 and of OTC equity derivative trades by 31 July 2010.

Although it is the only currently functioning repository, CESR also contends that other potential entities exist in the market that could be adapted to operate as a repository in the future. This would likely be the route used for the establishment of a European-based repository. As has been demonstrated on the CCP front, Europe is not keen to rely on US-based entities due to fears about legal (and most certainly political) control being ceded.

However, the paper does note the duplicative nature of establishing more than one entity that functions in the same manner. Multiple trade repository facilities could lead to a fragmentation of data, making efficient and effective supervision of OTC markets even more difficult, warns CESR. Opponents against a European solution have also argued that the costs for the industry to set up an additional site in Europe would outweigh the benefits to be gained from the establishment of such a site.

“The supervisory needs of European regulators could be satisfied by establishing a supervisory framework with regard to the TIW and by giving European regulators access to the data provided by the TIW (in this respect a process is already underway in the OTC Regulators Forum to define the data access by European and other regulators). Business continuity would be no less endangered by setting up an additional European facility unless such a facility would be limited to mirroring the trades registered in the TIW and to providing a back-up for the data on these trades,” says the report.

In order to function effectively, however, such an entity would likely require new regulation to be introduced at a European level and filtered down into each country’s legislation, notes CESR. Given the market’s reticence with regards to facing yet more regulatory compulsion this will likely prove unpopular.

Moreover, the regulatory community may be keen for greater transparency around OTC derivatives data, but the market is concerned about regulators going a step too far. Last month, the International Swaps and Derivatives Association (ISDA), the Securities Industry and Financial Markets Association (Sifma), and the London Investment Banking Association (Liba) published a joint response to the European Commission’s CCP proposals, warning that derivatives standardisation should be balanced by market innovation.

Industry participants are wary of the use of centralised data repositories for these instruments because they feel this may hamper attempts to innovate in the market. The statement warns that it is “critical that their usage does not curtail the flow of new products to the market and fully respects the global basis on which these products trade”.

Data standardisation in the derivatives market is certainly on the cards, regardless of where such a repository is based and how much concern the industry displays. Regulators will not likely be dissuaded from setting up entities such as this to gain more insight into market practices. Perhaps this initiative will also help to breathe life into the European Central Bank’s (ECB) reference data utility proposals? Interested parties have until 6 November 2009 to provide comment on this consultation paper.

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