Tuesday, October 6, 2009

Move afoot to store OTC derivatives data

Posted in the Financial Times by Jeremy Woolfe:

The European Union could follow the US in adopting the system of trade repositories for registering trades in credit default swaps. This move “could cast light on over-the-counter markets in these derivatives”, says Eddy Wymeersch, head of Cesr, the Paris-based Committee of European Securities Regulators.

“The set of the European version of the repository [data warehouse] and the type of services provided will depend on the market participants,” he adds.

Cesr, which currently has an advisory role, is set to be upgraded under plans announced by the European Commission. It will gain a new name, becoming the European Securities and Markets Authority (Esma), and binding powers as a senior financial regulator.

Mr Wymeersch says a Cesr expert group has been studying the usefulness of trade repositories to strengthen the post-trading infrastructure of OTC derivatives, notably markets in credit default swaps, since late last year. The initiative for the present study follows calls by regulators in the EU for more public information about OTC derivatives. EU finance ministers in December 2008 asked explicitly for the risks to be looked into.

In July, the European Commission adopted a communication that looks at the role played by derivatives in the financial crisis. It seeks steps to reduce risks, and ensure efficient, safe derivatives markets.

Mr Wymeersch says the Cesr investigation, published as a consultation paper last week, aims to tackle the lack of transparency in the CDS market, which has an estimated global notional gross value of about $30,000bn (£18,657bn, €20,541bn).

Central banks and regulators are concerned about the risks that may derive from this market, he says, referring to the near collapse of AIG, which had to be propped up with $180bn of state support. To reduce risks, initiatives have been supported to create central clearing houses.

The central repository will come on top of this, says Mr Wymeersch, functioning as a warehouse for the electronic storage of trades done by dealers and others in OTC derivatives. It will create transparency and reliability, and will allow banks to reconcile their positions. It will also feed supervisors with much needed detailed data about transactions and positions.

This information will help both macro prudential supervision and micro supervision, and perhaps avoid the accumulation of risk that was known in the recent past. It would also provide supervisors mandated to ensure market integrity with reliable data for investigating market abuse cases.

As for a third possible regulatory step, that is, bringing CDS trading onto a regulated market, such as a stock exchange, Mr Wymeersch is cautious. “This is a decision for market participants. If the US will mandate this type of trading, Europe is likely to follow, to avoid regulatory arbitrage,” he says.

In a recent letter from Cesr to the European Commission, Mr Wymeersch justifies the Cesr study on an EU repository by noting the large number of European entities active in derivatives markets. He notes the European origin of many underlying instruments, and the high proportion of contracts denominated in euros.

Options open to the Cesr expert group include doing nothing. But it could also suggest setting up some kind of collaboration with the existing trade repository for CDSs, the Trade Information Warehouse, although sufficient guarantees for the European market operations would have to be secured.

Set up in 2006 by the Depository Trust & Clearing Corporation in the US, the warehouse holds transaction details on CDS contracts traded by market participants in 35 countries. It played an important role in bolstering the teetering financial system last year.

Last October, after Lehman Brothers collapsed, the DTCC informed the market that, based on its warehouse records, the exposure to Lehman’s was a net notional value of about $6bn. This was done to stem speculation that the credit derivative exposure was $400bn. When the Lehman exposure was closed out, the actual value was $5.2bn.

Given the complexity of CDS contracts, “having all of this information residing in a single place is a crucial contribution to reducing risk and promoting market efficiency”, says Donald Donahue, DTCC chairman and chief executive.

Cesr itself takes a neutral stand as to who should be in charge of organising a European trade repository, says Mr Wymeersch. “However, it [Cesr] will lay down rules to ensure safety and efficiency. Such rules will cover open access to any proposal for a repository.”

He adds: “European operators may come forward with proposals.”

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