The Depository Trust & Clearing Corporation (DTCC) was the obvious candidate to provide trade repository services not just in Europe but throughout the world. After all, the DTCC had already built and been operating a trade repository for credit derivatives for the last six years.
Its Global Trade Repository (GTR) is now operating across multiple jurisdictions and asset classes, and looks in pole position to benefit from the anticipated consolidation of the sector.The DTCC had an unexpectedly bumpy start to European derivative reporting after 12 February 2014. Sandy Broderick, CEO and President at DTCC Deriv/SERV, told reporters the problems were an issue not of technology but of process, which created a backlog in the early days. Such were the problems of success, since DTCC could scarcely be accused of failing to prepare properly.
“We have had over 500 people working on this project,” says Broderick, “Significant investment has gone into building not only a robust infrastructure, but one that was scalable as well.” The fact staff numbers remain well into three digits is a measure of the commitment the DTCC has made to a regulatory reporting project the global infrastructure utility naturally regards as home territory. DTCC was live – in jurisdictions such as the United States more than a year ahead of the European deadline. Operating the trade information warehouse for credit derivatives since 2007 meant an infrastructure was in place already, the organisation was linked to the MarkitSERV confirmation and allocation service, and experienced staff could work on the expansion of the service from credit into other asset classes. DTCC is now covering all reportable asset classes off what is - local variation in the details of reporting apart - a platform whose origins go back more than six years. “Arguably, we have been live since 2007, when we launched the trade information warehouse for credit derivatives,” says Andrew Douglas, head of public affairs at DTCC in London. “This was also the sixth time we have been through a go-live with a local derivatives repository. We anticipated many of the issues as a result. People who had not built a trade repository before were in for a nasty shock.”
One obstacle even DTCC had to overcome in adapting its existing infrastructure to the European marketplace was the insistence by the European Securities and Markets Authority (ESMA) that the European Market Infrastructure Regulation (EMIR) reporting service be operationally separated from the global platform. “It was largely a data security issue,” explains Andrew Douglas. “Authorities’ access to trade repository data is a highly sensitive issue and one that requires an agreement between respective regulators accessing each other’s data. If you look at the two major derivatives jurisdictions, the United States and Europe, such agreement does not currently exist.
So we built a trade repository which collects and reports European data to European regulators only.” The international collaboration which built the trade information warehouse for credit derivatives between 2005 and 2007 has evaporated in the years since the crisis. Europeans are concerned about informational leakage and the extraterritorial reach of US regulators. This has contributed to an environment in which the lack of trust has the potential to undermine the objective of managing systemic risk on a global scale. Sandy Broderick gives an example of one such scenario which could result from the absence of formal data sharing by regulators. “A credit default swap on a German bank executed in London by a French bank with a US bank can be seen by ESMA and other European regulators,” he says. “But if the same trade is done in New York between two US banks, it will be reported to the Commodity Futures Trading Commission (CFTC), and will not be visible to ESMA or European regulators. ESMA will have to make a bi-lateral request to the CFTC to see Germany based underliers in the CFTC database. The way things are structured at the moment, the regulators will not be able to spot cross-border positions which could lead to huge losses and/or systemic risk.”
Nevertheless, DTCC has to be mindful of its American heritage. To be doubly sure of avoiding any leakage of data across the Atlantic, it has designated Singapore as the backup site for its Netherlands-based European hub, rather than either of its two sites in the United States. Global users of the DTCC trade repository reporting services can still report to the separate platforms via a single portal, and DTCC will also deliver information onwards to multiple regulators with the correct information in the correct format. “We are the only trade repository where, if you do a trade that is reportable in more than one jurisdiction, we will take care of that for you automatically,” says Douglas. “If you do a trade which is reportable under the rules of the Financial Services Authority (FSA) in Japan, and to ESMA under EMIR, you only have to report it once to us instead of twice to different regulators with the correct information in each.” At present, DTCC is also the only trade repository to be live and supporting clients in all three major regions. “We are the only trade repository that is actually global,” says Broderick. “We are the only one trying, as far as possible, to provide a global solution.” In addition to the United States and Europe, DTCC is currently the sole provider of services in Singapore, Japan and Australia, and enjoys a very high market share of non-cleared trades regulated by the CFTC, and is already live in every case. DTCC also secured authorisation to provide trade repository services as an agent in Hong Kong, where the service went live late last year.
The upcoming targets include the remaining states that belong to the G20, such as Brazil, Indonesia and Malaysia. Andrew Douglas says smaller derivatives markets often demand a ‘‘One physical presence in the local marketplace, even where the investment cannot be justified by the amount of business being done. “Unfortunately, people who have never done this before do not understand the cost,” he says. At present, DTCC is looking to service all markets from its data centres in Singapore, the Netherlands and the two sites in the United States. “Trade repositories are expensive businesses to run.” Irrespective of costs, nationalistic sentiment is driving the establishment and appointment of repositories in some jurisdictions, but global fund managers are taking a more rational view. Being a global trade repository is certainly helping DTCC attract their business. A little-noticed influence on their decision-making is the belief that Europe is a good place from which to master two-sided reporting, with some predicting the United States will eventually follow the European example and adopt two-sided reporting as well.
Some Asian jurisdictions are already demanding two-sided reporting and, for now, they are markets in which DTCC has an established leadership position. It has secured the sole repository licences issued in Japan and Singapore (and authorisation as agent in Hong Kong) and, although the Australian regulator says the local market is open to all-comers, DTCC has yet to encounter a competitor there.However, the global market infrastructure utility looked at one stage to have captured an even stronger position due to client demand than it currently enjoys. When EMIR was first agreed in 2010, the Association for Financial Markets inEurope (AFME) and the International Swaps and Derivatives Association (ISDA) hosted requests for proposal (RFPs) that aimed to identify the provider of choice of repository services across foreign exchange (AFME) and credit, rates, equity and commodities (ISDA) derivatives. The DTCC won the vote of the panel in every one. The preference of the trade bodies was understandable, given the experience of DTCC with the Trade Information Warehouse and its neutral character, but regulators preferred to establish a framework for competing trade repositories. “It was not a `mandate’ from AFME and ISDA to their members to use DTCC.“ recalls Andrew Douglas.
But it was a statement that they had looked at all the potential providers, and concluded the DTCC was the best option of choice across all five asset classes. “That recommendation was superseded by the ESMA authorisation process.’’ One reason the 12 February 2014 deadline ambushed so many market participants, prompting a last minute rush in January and February this year to select a trade repository, was the fact that ESMA did not actually authorise any trade repositories at all until 7 November 2013.
Nevertheless, the DTCC experience of the American and Asian markets meant it entered the frantic weeks ahead of the 12 February 2014 deadline with an advantage. “The advantage we had is that we had done it somewhere before,” says Broderick. ESMA wants to see data at least once a day but, by the time the EMIR regime went live on 12 February, DTCC was already sending on to the regulators real-time data from swap execution facilities (SEFs) and swap dealers in the US market. By the time repository was already devouring 65 million new data points a week, meaning the amount of data it was handling was two to three times more data every day than Twitter. This put DTCC in a good position to gauge the differences between Dodd Frank and the EMIR reporting regime, which was expected to double the data volume. “Logistically, EMIR is huge,” says Broderick.
He reckons the United States has proved more complex in terms of what has to be reported, while Europe is made more complex by two-sided reporting and the inclusion of exchange-traded derivatives, which do not have to be reported anywhere else as yet. “The amount of detail we have to deliver to regulators is much smaller under EMIR than under Dodd Frank,” says Sandy Broderick. “ESMA has created a much more `absolute’ data set, while the CFTC was much looser, and wanted to capture much more breadth and depth than ESMA has asked for. As a result, EMIR reporting is less complex to implement. There are just 85 fields, against up to 1,200 to fully describe all the asset classes under the American model.
You can describe an FX swap in ten fields, and an interest rate swap in less than 85, but if you want to describe an amortising swap, each one of up to 20 amortisations is a separate reporting field under Dodd Frank. Commodities are also incredibly complex to report, because there is such a large range of underlying commodities, and each one requires a separate description. One reason why there is so much competition between trade repositories in Europe is that the implementation of reporting under EMIR is so much simpler than the implementation of reporting under Dodd Frank.”
In fact, DTCC was able to create an “OTC Lite” reporting template for users with straightforward swap portfolios that covers all the data demanded by EMIR in far fewer than 85 fields. “The repositories that operate in Europe only have had to focus on a single set of rules; on the other hand, our experience in other markets means we have been able to apply our depth of experience into our product offering,” adds Broderick. “As a result, our product may be richer in functionality which is something the larger and global derivatives players are interested in; however we have also produced a slimmed down version as `OTC lite’ to help smaller firms cope with the onerous burden of reporting.” Provided clients adopt a DTCC template, they can deliver reports via spreadsheets, CSV files or in the FpML format, and transmit over private lines, by secure file transfers or even via the Internet. Broderick says DTCC is exploring whether to support XML submissions as well, and the CPML protocol preferred by commodity market participants. (Regulators, incidentally, have told trade repositories they expect to see the data in CSV or XML only.)
The DTCC pricing model is also geared to take account of size and sophistication. Smaller users (less than 200 open positions) pay a lower annual membership fee per jurisdiction (€800) than larger users (€3,800) but the biggest users get volume discounts, and per month transaction fees are capped at $500,000 a year for OTC derivatives and $300,000 a year for exchange-traded derivatives. “Our basic model is cost-plus, as it always is at the DTCC,” explains Broderick. “We need some return to maintain the infrastructure, and sufficient regulatory capital. In this case, we have to file the fee structure with the local regulator in each jurisdiction.
We cannot charge a small corporate that trades very few derivatives the same as a bank that trades in large volume. The numbers of open positions and transactions are different, and costs per ticket are different, and even the cost per asset class is not necessarily consistent either, because there are different ways of charging within each asset class.” “The global investment banks were ready in good time, and their process was relatively seamless,” says Sandy Broderick. “But the other banks, the corporates and the fund managers all had to put their foot flat to the floor in the run-up to 12 February.
DTCC had no difficulty in attracting a lot of business. The fact that the major investment banks all opted to report to DTCC helped persuade fund managers in particular that they should do the same. “We had a regular stream of buy-side clients on-boarding with us prior to the 12 February deadline,” explains Sandy Broderick. “The big firms were well ahead of the game, but the smaller firms ran fast and caught up. “He adds that for fund managers who do not use advanced technology, tactical solutions, such as relying on spreadsheet submissions or appointing a third party service provider, have proved useful.
DTCC is demonstrably happy to work with any provider a potential client wants to use. The list of service providers to the DTCC global trade repository runs to 100 names. It includes MarkitSERV (which has expanded its longstanding confirmation service to encompass almost all asset classes), a variety of swap execution facilities (such as 360 Trading Networks, BGC, Thomson Reuters and Tradeweb), suppliers of existing regulatory reporting (such as UnaVista), post trade processing services (such as Traiana), reconciliation services (such as Tri-Optima) and suppliers of technology to participants in the exchange-traded derivatives market (such as Markit SERV, Abide Financial, Bloomberg, Misys and Murex). “We give them our specifications, and they work out how to interface with us,” says Broderick. “Our technical support and liaison groups are pretty large for this project.”
He says they did encounter “structural” challenges with some end-investors - such as multi-manager funds using multiple execution and clearing brokers – but nothing a buy-side user group was unable to engage with quickly. The one group that proved conspicuously behind schedule as the 12 February deadline approached was corporates. DTCC could measure this because it had formed with SWIFT the market-leading pre-Local Operating Unit (pre-LOU) to issue the Legal Entity Identifiers (LEIs) that are an essential prerequisite to reporting derivatives to a repository (see“LEIs: what they are, who needs one, and where to get one,” page 18). Estimates suggest there is somewhere between 1 and 1½ million corporates that are supposed to report under EMIR. “Corporate uptake was relatively slower ahead of the deadline,” says Sandy Broderick. “But then who was going to enforce it? Financial regulators do not have oversight of corporates.” However, as Broderick points out, the Bundesanstalt für Finanzdienstleistungsaufsicht (BaFin) has taken a harder line on this regulation, warning German firms that the auditors would not be permitted to sign off their accounts if they were not ready to report derivatives on time.
“It was quite a clever approach, and one that will no doubt be adopted by other jurisdictions, once they establish how they can do it, legally speaking,” predicts Broderick. Until they do, regulators can be expected to continue to adopt a pragmatic approach to the post-12 February implementation, including the all-important reconciliation of trades within and between repositories. After all, one effect of the last minute authorisation of trade repositories by ESMA was a predictable delay in working out how, in an environment where both sides of a trade are obliged to report, one-sided reports could be reconciled. Until authorisation, no repository knew what other repositories it would have to reconcile with, so little work was done. In the 90 days that remained between 7 November 2013 and 12 February 2014, DTCC participated in regular meetings with the five other authorised repositories to agree procedures to find the other half of one-sided trade reports. “Some trades will always be one-sided, because supranational organisations and debt management offices are not obliged to report,” says Broderick. “Though we think some may end up reporting, as a matter of good practice.”
One complication in tracking down the other half of one-sided trades is the lack of agreement on Unique Trade Identifiers (UTIs) (see “UTIs: what they are, who needs one, and where to get one,” page 22) and Unique Product Identifiers (UPIs) (see “UPIs: what they are, who needs one, and where to get one,” page 26), where the marketplace was still awaiting guidance from ESMA on content and issuance as the 12 February deadline passed. Andrew Douglas points out that the delay reflected a collision between regulatory objectives and market realities. ESMA’s suggestion that a UTI persist throughout the life of the trade, for example, was understandable – it creates a clear audit trail throughout the life of a trade – but ignored the fact that every novation is a new trade.
However, with the exception of the FX market, lack of agreement also owed something to lack of any standards in the other four derivative asset classes. “Regulators tend to be reluctant to commit themselves to a particular standard because they fear that might not be the `right’ standard,” says Douglas. “Unfortunately, the reality is that solutions such as the UTI and the UPI are impossible to implement without the regulators being prescriptive. Regulators saying, `This is what the standard is,’ can actually give a standard some legs, and help it become a commonly used standard. Far from a standard failing if a regulator endorses it, it is more likely to succeed.”
Reconciling individual trades without UTIs and UPIs is a live business issue for DTCC, which is not only receiving a large number of one-sided trade reports, but also has a number of clients reporting at least some asset classes to other trade repositories. This has put to the test the individual trade and portfolio reconciliation processes DTCC and the other repositories agreed ahead of 12 February 2014. Similar work has been done between trade repositories in the United States. DTCC likes to argue that it is good at it. “Our remit is very much to be collaborative and co-operative with everybody on this,” says Broderick. “We have played a leading part in setting up the mechanisms for reconciliations between repositories, and we were also the driving force behind the creation of the procedures for matching of individual trades.”
He argues that the collaborative personality of DTCC makes it easier for the organisation to get a hearing at ESMA and the CFTC. “Our advantage is that we are utility – a user-owned, usergoverned co-operative,” says Broderick. “It is an advantage with the regulators too, because we do not have any commercial skin in the game.” Andrew Douglas adds that “one of our differentiators is that we spend as much time with the regulators as we do with the clients, making sure they are comfortable, and that they get the information they need, and understand how repositories work.” In fact, DTCC has a fully staffed regulator engagement team that is constantly on the road visiting regulators such as CFTC, ESMA, BaFIN and Autorité des marches financiers (AMF), and DTCC executives are also a familiar sight at the FSA in Japan and the Financial Conduct Authority (FCA) in London.
Broderick says DTCC engages regularly with 70 regulators around the world, and he expects that to rise to more than 100 by the end of 2014 as market surveillance and competition authorities start to use the data. “Most regulators will use this data to detect market abuse as much as systemic risk,” predicts Douglas. No less than 50 regulators are accessing DTCC’s regulatory portal. The organisation is already helping to analyse the data on behalf of the regulators, “They are looking to us to help them understand what steps they need to take,” explains Andrew Douglas. “We act almost as a mechanism for transferring knowledge and best practice between regulators.” Of course, its effectiveness in analysing the data is dependent on its ability to collaborate with the other repositories to gain access to the data they control.
As Andrew Douglas points out, the data is fragmented not only between North America, Europe and Asia but within Europe, where six trade repositories are collecting it. “The trade repository solutions we have devised do not help the regulators meet the Group of 20 (G20) agenda, which is to use the data to manage systemic risk,” he says. “Systemic risk requires you to look by definition at the complete ‘system.’”
Broderick believes that regulators are happy to re-examine what they do with the data once the implementation phase is over, but will never make public any of the data except at the aggregate level. “Some data will be made available at the aggregate level, because it will be regarded as a public good for the public to understand what is out there,” he says. “But you will not be able to see what bank A has alleged against bank B, or what the total risk in the system is. The regulators might look at that, but it will not be published. However, it is an evolving process. At this stage, we do not know how the data will be aggregated.”
What Broderick is certain about is that by February 2015 there will no longer be six trade repositories in Europe. He reckons that what will guarantee the survival of DTCC despite of its difficult start in Europe, is the fact the organisation is providing a service at the behest of its clients, while competitors are seeking to protect their data franchises. “Logistically, and economically, this is not a high return business,” says Broderick. “It is a low return business, which is why it suits our cost-plus model, but does not necessarily suit a publicly listed company driven by shareholder value.” Andrew Douglas agrees, predicting that “a number of people out there will realise that this is not a business they should have got into.”
Before the shake-out occurs, however, the Financial Stability Board (FSB) will report on how the trade repositories of the world should aggregate their data for the benefit of regulators looking to manage systemic risk and – if Andrew Douglas is right – market abuse. The solutions the FSB can offer are limited. One is to build a super-repository to float above the various existing repositories. A second is to create a federation of trade repositories. But if Sandy Broderick and Andrew Douglas are right, market forces will solve the problem of data aggregation long before either of these answers can be put into practice. They will achieve it by the consolidation, for entirely commercial reasons, of the competing providers of today.