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Reval’s Okochi and Trozzo Highlight Valuations and Data Impacts of US Swaps Market Reforms

It seems everyone’s talking about the data impacts of the Dodd Frank reforms at the moment. Last week, the Commodity Futures Trading Commission (CFTC) hosted a public roundtable on the subject of the new recordkeeping requirements and related standards efforts, and derivatives risk and valuations solution provider Reval also hosted its own webinar on the upcoming rule changes and their data impacts. Pat Trozzo, chief compliance officer at Reval, and CEO and co-founder Jiro Okochi discussed the particular impact of swaps reforms on the valuations function and the data challenges underlying the enhanced transparency requirements.

Documentation and recordkeeping requirements are increasing for all parties involved in the swaps markets as a result of Dodd Frank, said Okochi. For example, swaps dealers will likely be compelled to hold Credit Support Annexes for all of the counterparties to a trade in order to provide an audit trail to support margin requirements. Firms must also provide additional documentation around the process of affirmation and confirmation of trades, which, in turn, must all be linked back to “complete, accurate and reliable” reference data.

For un-cleared trades (those that remain off exchange and are not cleared via a central counterparty), there will be much more scrutiny of a data audit trail and timeliness of data will be highlighted due to the need to meet ad hoc regulatory queries. Swap dealers will therefore potentially face an increase in data management costs due to new real-time and snapshot reporting requirements, according to Reval.

However for both cleared and un-cleared trades, more data items must be provided for assessment and reporting purposes, especially when it comes to pricing and valuations and risk management. “If you are a major swaps market participant, you’ll need to go to the extent of measuring potential future exposure under the new requirements, which involves a much more complex process and many more data items,” said Trozzo.

Valuation disputes also need to be settled within five days or reported to the CFTC; therefore more of a spotlight is being placed on accurate valuations, especially for un-cleared derivatives trades. Valuation models or methodologies must be made available in granular detail to the regulatory community, with full transparency into the inputs therein. Trozzo noted that this raises a big question mark about how this data can be provided across all instruments, given that methodologies in particular are not easily standardised.

The driver for this push towards transparency is to avoid repeating the same mistakes made during the financial crisis, where the wide spectrum of valuations for the same instrument escalated market illiquidity. This has led to more scrutiny of the reliability of data inputs to these calculations and the methodologies involved. Other requirements such as those for margin calculations have meant that a valuation of a swap must be based on pricing sources that are “accurate and reliable”, said Trozzo. There is also a degree of pressure being placed on the timeliness of pricing data because of the need for portfolio valuation once a day due to new reconciliation requirements.

In spite of the availability of some exemptions in terms of clearing requirements such as for FX forwards and FX swaps, for example, these instruments must still be reported to swaps data repositories. This has also put pressure on the regulatory community to get the infrastructure right, added Okochi, which will be a particular challenge in terms of monitoring un-cleared trades. Furthermore, once these repositories have collected the required data, there remains an open question of what they will do with that data, he said.

Obviously, one of the priorities for regulators in the interim has been the establishment of basic data standards for the identification of instruments and legal entities. This is a fundamental first step in enabling firms to be able to report this data to regulators, noted Trozzo.

There also remains a great degree of uncertainty overhanging the reforms as a whole that is making many market participants nervous, noted Trozzo and Okochi. “We would urge market participants to engage with and provide feedback about these concerns to the CFTC, as well as discussing the potential impacts of these reforms,” concluded Okochi.

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