Political leaders concluded that the scale and systemic impact of these derivatives had been obscured from regulatory oversight until the threat they posed crystallized with disastrous results. In response, in 2009, the G20 Pittsburgh summit asserted that:
"All standardized OTC derivative contracts should be traded on exchanges or electronic trading platforms, where appropriate, and cleared through central counter-parties by end-2012 at the latest. OTC derivative contracts should be reported to trade repositories."
The strategy was, therefore, two-pronged: to exert pressure for as much as possible of the derivatives market to migrate to open exchanges and to ensure that relevant data on the remaining contracts would be reported to the authorities, allowing their potential risk to be monitored.
Since 2009, regulators have been developing rules to implement the G20 commitment
in practice, most notably in the context of the European Market Infrastructure Regulation (EMIR) in the European Union and requirements of the US Dodd-Frank Act for reporting swap transaction and pricing data. Other jurisdictions are developing similar requirements. For example, in October 2011, the Hong Kong Monetary Authority (HKMA) and Securities and Futures Commission (SFC) published a joint proposal on a framework for the trading, central clearing and reporting of OTC derivatives. These new regulations will be introduced progressively, in the US from the end of 2012 and in Europe later in 2013.
Significant uncertainties remain. For example, in order to track and monitor trades, a system of universal identifiers for legal identities needs to be developed, with transaction and product identifiers unambiguously cross-referenced to them. In the US, the requirements published by the Commodity Futures Trading Commission (CFTC) call for the use of a Unique Swap Identifier (USI), a legal Entity Identifier (lEI) and a Unique Product Identifier (UPI). These identifiers are described as crucial regulatory tools for linking data together and enabling data aggregation by regulators across counter- parties, asset classes and transactions. However, such a system is still under development.
Significant challenges have also arisen in reconciling the new reporting requirements with data protection legislation and with the manner in which this varies between jurisdictions. In Hong Kong, for example, one of the major concerns raised by the industry was the potential extraterritorial impact of the proposed Hong Kong regulations and their compatibility with confidentiality requirements in certain overseas jurisdictions. In response, regulators have agreed that the mandatory reporting obligation may not apply where it would bring market participants into conflict with confidentiality requirements.
Michel Barnier, EU Commissioner for Internal Market and Services
Despite the uncertainties, deadlines for compliance are looming. Given the broad consensus on what the reporting requirements are intended to achieve, most firms appear to be preparing for the implementation of the Dodd-Frank Act regulations and assuming that they will be broadly sufficient to satisfy requirements elsewhere.
Swap data record-keeping and reporting under Dodd-Frank
Under the CFTC final rules on swap data record- keeping and reporting, published in January 2012, swap dealers, major swap participants, swap execution facilities, designated contract markets and derivatives-clearing organizations must keep records throughout the existence of a swap and for five years following termination of the swap. The records must be readily accessible to the entity or counter-party throughout the life of a swap and for two years following its termination. For the remainder of the retention period, the records must be retrievable within three business days. Similar rules apply to other counter-parties.
Data on each individual swap has to be reported electronically to a swap data repository (SDR) at the creation of the swap and during the continuing life of the swap until its final termination or expiration. The data required includes "all primary economic terms data and all confirmation data." SDRs must keep records that are readily available throughout the existence of each swap and for 15 years following termination of the swap.
The final rules adopt a streamlined reporting regime that call for reporting by the entity or reporting counter-party the commission believes has the easiest, fastest and less expensive access to the data: either the swap execution facility, designated contract market or the derivatives-clearing organization for off-facility swaps accepted for clearing. In relation to back-book contracts, the rules apply to all derivatives that are entered into before and are still in place at the time of passage of the Dodd-Frank Act.
Swap data reporting regulations being developed in other jurisdictions will differ in detail. In Europe, for example, the EMIR casts its net more widely than Dodd-Frank and requires all derivatives contracts, whether traded on an exchange or OTC, to be reported to what it terms 'trade repositories'. In relation to pre-existing derivatives, it applies to all contracts that were entered into before enactment of EMIR and which remain outstanding on that date. However, the core implementation issues faced by the industry will remain common.
Key areas which banks, investment managers and others now need to review include:
- Which contracts are within the scope of the different reporting requirements?
- What information needs to be reported?
- Where should it be reported? Perhaps in multiple jurisdictions?
- How should the different requirements of different regulators be satisfied?
Once the scope and broad outlines of the compliance regime have been determined, an implementation strategy will need to encompass:
- data collection, collation and cleansing
- systems design, specification and commissioning
- processes and responsibilities for continuing management
- audit and review.
Despite appearances, it may not all be bad news: like many new regulatory requirements emerging in the wake of the crisis, there is an opportunity here for far-seeing companies to take advantage of the need to review and revamp data, systems and operations in this way. They could end up with more efficient and insightful business processes.
- Tom Jenkins, KPMG in China
- Isabel Zisselberger, KPMG in China
- Kara Cauter, KPMG in the UK