Frank Dodd Regulatory Reforms and its implications on Global Derivative Trading -- an executive summary

1. Frank/Dodd compliant Derivative Trading
Birds Eye View - 2nd
June 2013
raman@assetcorporation.net
Introduction
2013 is a make or break year for any
organization participating in the global
derivative markets. Title VII of the Dodd-Frank
Wall Street Reform and Consumer Protection
Act (“Dodd-Frank”) [D/F][1] requires all trades
on qualifying derivative instruments to be
exchange traded, cleared and reported to
public utilities known as data repositories.
Exchange traded implies fungible assets with
standard contracts, terms and procedures.
Clearing and Reporting a trade requires
standardization at every level of a trade. We
will run into mayhem if trading parties and
traded securities are not denoted by standard
references.
Staus Quo
Prior to D/F, derivative trades were not
cleared and firms assumed all the
responsibility, from trading through
settlement, including book keeping,
valuation, risk management and
execution, over the life of the
derivative trade, resulting in significant
moral hazard, lacking --transparency,
price discovery and fungibility--. Each
firm had their own set of counterparty
mnemonics, security identifiers and
custom valuations – making
reconciliation amongst firms
impossible.
Roles defined
The D/F act defines specific roles. Derivative Market
Participants have to be registered as either Dealers
(SD), Participants (MSP) and transact through venues
such as SEF and DCMs and the D/F act assigns
particular responsibilities and obligations associated
with each role. Registration procedures are
described in [4]. Firms may register with either NFA
or CFTC.
Abbreviations
Swap Dealers (SDs);
Major Swap Participants (MSPs);
Future Commission Merchant (FCM);
Derivative Clearing Organizations (DCO);
Swap Execution Facilities (SEF);
Designated Contract Market (DCM);
Central Clearing Party (CCP);
Swap Data Repositories (SDR);
Eligible Contract Participant (ECP)
Unique Swap Identifier (USI) (aka UTI)
Unique Trade Identifier (UTI) (aka USI)
Unique Counterparty Identifier (UCI) (aka LEI)
Legal Entity Identifier (aka UCI)
Unique Product Identifier (UPI)
The D/F Act defines the following roles:
Trading entities (MSP, ECP);
intermediaries (SD, FCM,MSP);
Trading Venues (SEF/DCM);
Clearing (CCP,DCO,FCM); and
Repositories (SDR).
Many basic questions come to mind, such as:
What trades are qualifying?
Who can trade?
What assets are qualifying?
Who must report?
Are there exceptions to the rule?
What are the time limits to report a qualifying trade?
Where does one report the trade?
What happens to reported trades?
Who can access those trade records ?
Without basic definitions and clarifications to these,
trading over exchanges, clearing and reporting are just
not possible!

2. Processes Defined
Under D/F, qualifying derivatives may be
traded only over execution facilities
(SEF/DCM) and have to be cleared through
designated clearing entities known as
Derivative Clearing Organizations (DCO).
Derivative transactions are to be submitted
to 3rd
party repositories, SDR [2], so that all
trades are centrally available for
comprehensive oversight. Thus, in addition
to imposing clearing and execution
requirements, the D/F Act creates robust
recordkeeping and real-time reporting
regimes. Defines Product Eligibility –
Securities that are subject to D/F act; and
Participant criteria including the so called End User Exemption as to who is subject to these
regulations [3].
Standard Reference
To ensure uniform and universal counterparty identifiers, industry has adopted LEI framework.
Trading parties must report trades using Legal Entity Identifiers not proprietary mnemonics
companies had used. There are vendors providing LEI services. Adopting LEI and using those
standard identifiers to denote trading partners industry wide and through the entire trade life
cycle will eliminate the usual problems faced when firms failed, such as LTCM in 1998, Lehman
in 2008, AIG-2008 and MFG in 2012. Under D/F, all counterparties in the OTC derivatives market
must be self-registered as only trades between registered parties will be cleared by the DCO.
DTCC launched the first LEI Solution on CICI Utility, accessible here www.ciciutility.org.
Reflection
While D/F Act requires derivative trading firms to undertake major technology initiatives to be
compliant, in the event of another failure in the derivative markets the world can anticipate an
orderly cleanup and recovery due to these sweeping regulatory requirements. The world will
not be faced with such questions as: Who is this trade with? Or what is this instrument?. At the
least, that is the stated objective of the regulators behind these reforms. As a matter of fact,
Title II of the Act, provides for orderly liquidation of firms when necessary. At an abstract level,
as a result of the D/F Act, derivative trading becomes operationally and structurally similar to
the proven equity markets. Notwithstanding the growing pains, that is a good thing!
References
[1] http://www.charlierose.com/view/interview/12953
[2] https://www.federalregister.gov/articles/2011/09/01/2011-20817/swap-data-repositories-
registration-standards-duties-and-core-principles
[3] https://www.federalregister.gov/articles/2010/12/23/2010-31133/swap-data-
repositories#h-17
[4] http://www.cftc.gov/IndustryOversight/IndustryFilings/index.htm
Acknowledgements
This brief is part 1 of our series on technology strategy and realization plan for trading derivative
securities worldwide. The research and writing is subsidized in part by ClearTrack LLC, a leader in
helping major MNC implement Dodd/Frank compliant trading systems. Author acknowledges
valuable insight and editorial input from Dhiren Rawal and William j Sweeney (risk, data, and
analytics LLC) . However, author is solely responsible for the content.