Since the financial crisis, 25 repositories have begun listing so-called over-the-counter derivatives trades, securities transactions which are not carried out on stock exchanges. But the number of such warehouses is beginning to work against transparency and effective risk avoidance, according to Larry Thompson.
Larry Thompson is Vice Chairman and General Counsel with The Depository Trust & Clearing Corporation (DTCC), a global post-trade services provider based in the US. As a user owned and industry governed entity, DTCC simplifies the complexities of clearing, settlement, reporting, data management and information services across asset classes. In 2013, DTCC’s subsidiaries processed US securities transactions valued at approximately $1.6 quadrillion.
What do you think of the Commission’s green paper on a Capital Markets Union?
Europe is key to our operations and, as a result, we are fully engaged with any developments that could have an impact on the region’s market structure. We are currently studying the consultation paper and will provide a response in due course. Generally, we are supportive of initiatives that promote harmonised capital markets and robust financial systems. We supported US Dodd-Frank rules [the sweeping overhaul of the US financial regulatory system in the wake of the financial crisis] and, to the extent that the Capital Markets Union promotes these objectives, the initiative will likely be positive for our clients, for banks and for brokers.
You and others within the regulatory sector, such as David Wright and Elke König, have called for more transparency in the over the counter sector. Why?
Markets need look no further than the Lehman Brothers’ bankruptcy to understand the need for greater transparency across the derivatives markets and the value of trade repositories. At the peak of the financial crisis, market rumours suggested credit default swap trades (CDS) exposures to Lehman could be in excess of $400 billion. If this figure had been accurate, it could have threatened the stability of the global financial system much more severely.
DTCC had already developed a Trade Information Warehouse in the US for CDS trades, a precursor to trade repositories. It was built for two reasons: first, to handle confirmation and affirmation of CDS trades, and second, in the event of a bankruptcy, to use that information to run the credit advance off.
We had a record of 98%-99% of all CDS traded at the time of Lehman’s collapse.
As a result, we were able to provide greater certainty to the public by releasing data from the Warehouse showing that the actual exposure was, in fact, no more than $6 billion.
That led directly to calls by the G20 in 2009 for the introduction of trade repositories to bring transparency to the over-the-counter (OTC) derivatives marketplace. [OTC trading is done directly between two parties, without any supervision of a stock exchange, by contrast with exchange trading. Stock exchanges facilitate liquidity, help mitigate risk concerning the default of one party in the transaction, provide transparency and maintain a current market price. In an OTC trade, the price is not necessarily available to the public.] While such repositories existed for CDS trades at the time of the Lehman collapse, they were not available for swaps in rates, equities and other asset classes.
To meet the G20 objective, DTCC suggested the optimal model would be to establish one trade repository per asset class, providing a centralised point of access for regulators around the world.
But what has happened, unfortunately, is that instead of one trade repository per asset class, 25 trade repositories have sprung up around the world.
DTCC operates the largest trade repository in the world, but there are many others around the world, several which entered the market looking to leverage data as a commercial opportunity.
We’ve always said that trade repositories and their data should not be used for commercial purposes. Data should be collected and shared for public good, aiding market transparency and reducing risk.
Why does it matter?
If regulators do not have access to a consistent data set across jurisdictions, and are prevented from accessing data due to legal barriers that limit data sharing, it becomes impossible to monitor international exposure of derivatives and compare risk across borders.
We agree with David Wright that there needs to be some rationalisation of the market in order to achieve the transparency goals set out by the G20.
How serious an issue is this?
In order for regulators and market participants to see what is going on in the marketplace, there must be transparency. It is essential to monitoring the build-up of risks and to preventing those risks from posing a threat to the overall financial system. The financial system is hugely interconnected and, without this transparency at a global level, risk originating in one jurisdiction could have significant impact on the financial stability across other jurisdictions.
Why do you think that the DTCC is best positioned to offer trade repository services?
DTCC’s representation within the various segments of the financial industry is strong, and we have a 40 year track record in making the markets more efficient and safe. We are a trusted partner to both clients and regulators globally, with oversight in the US by the Securities and Exchange Commission and the Board of the New York Federal Reserve, as well as regulators around the world, such as ESMA in Europe.
It is important to note that DTCC is not only making the financial markets more efficient, but – as an industry utility – we are contributing to greater transparency and reduced risk around the world. Because we operate trade repositories in several jurisdictions, we can provide a truly global picture of activity across asset classes. We make a great deal of information available to regulators, bringing increased insight into critical areas. In fact, we view regulators as one of our key stakeholders, and we have a dedicated group that works to provide them with data in a timely fashion.
What would you think of introducing a financial services element or chapter within TTIP?
We are broadly in favour. We don’t see how a trade agreement can be reached without addressing a number of regulatory issues concerning financial services. The concept of the independence of market regulators is a challenge, given that regulators would likely not want to give away their ability to regulate financial activity in their jurisdiction.