FINANCIAL REGULATION Q&A WITH LARRY THOMPSON, DTCC

This week I took a few minutes to ask Larry Thompson, managing director and general counsel at The Depository Trust & Clearing Corporation, what he is thinking these days regarding financial regulation. I gave Larry a handful of questions to answer, touching on Dodd-Frank implementation, regulatory uncertainty, and preparedness. Take a look at his responses and use the comments section to ask your own questions. What do you want to ask DTCC?

Tony Scianna: Larry, since we spoke earlier this year about financial regulation and the consequences of indemnification, what new developments has DTCC seen with regard to Dodd-Frank implementation, if any?

Larry Thompson: There have been some significant developments in the financial regulatory reform process recently. First, this summer both the CFTC and SEC announced that they were postponing the writing of many new rules so that each rule receives proper consideration and analysis—from both the agencies and the industry itself. I think this was an important step in ensuring that they get these new rules right.

The CFTC did finalize one rule recently that was of particular interest to DTCC, as it will govern trade repositories. Trade repositories are essentially large databases that aggregate and standardize OTC derivatives market data. The rule establishes the registration requirements for trade repositories as well as the core principles of these entities. The final rule provided clarity for market participants on a number of important issues, but at DTCC we’re concerned that certain matters, such as indemnification and the bundling of mandated regulatory services, have the potential to create unintended negative consequences. It’s another indication that for all the work that has been accomplished to date, there’s still a long road ahead for the industry.

Tony Scianna: DTCC currently provides market data to regulators globally. Why is the indemnification provision of Dodd-Frank so problematic to an SDR’s data sharing capabilities?

Larry Thompson: The provision requires third-party regulators, such as those in Europe and Asia, to indemnify U.S.-registered trade repositories before obtaining critical market data from them. This is problematic for several reasons.

Foremost, many foreign regulators will be unable to grant indemnity to U.S. trade repositories. This could prevent repositories from sharing information with global supervisors, which is the objective of these regulatory initiatives. As a result, European and Asian regulators would have little choice but to create their own national or regional repositories – and this will fragment what should be a single global set of data.

The CFTC’s final rule provides several methods for regulators to access data stored in U.S. trade repositories, but it doesn’t adequately address the problem because of the strict letter of the law.  Congress is going to need to address this issue in a technical corrections bill, but in all likelihood that won’t occur until after the 2012 U.S. Presidential elections. In the meantime, we’re working closely with lawmakers in the European Parliament to help develop sound public policy that will harmonize the relevant guidance and practices of U.S. and other nations in the future.

Tony Scianna: DTCC has expressed concern recently about the need to reinforce the principles of “user choice” and “open access” with regard to counterparty selection of a trade repository and data reporting. Can you explain this position?

Larry Thompson: User choice and open access are deeply embedded in both the letter and spirit of Dodd-Frank because these principles are critical to protecting the integrity of the trade reporting process and the quality of the data that’s collected.

Let’s look at the issue of user choice first. Dodd-Frank empowers the parties to a swap to report information from that transaction to a registered trade repository. Unfortunately, the final rule appears to allow the trading platforms and/or clearinghouses to contractually require reporting of data to a particular trade repository. In other words, counterparties will lose their freedom to choose.

In addition, the final rule appears to permit the vertical bundling of mandated regulatory services, such as trade execution, clearing and trade reporting. This is highly problematic because it will frustrate free market competition and create an unlevel playing field, favoring infrastructure providers that offer multiple mandated services over those that offer only one such service.

On the issue of open access, we believe it’s essential that trading platforms, clearinghouses and trade repositories interact with one another on an impartial basis and ensure interoperability. If any party refuses or delays linkages with another provider, even when there is customer demand for it, this lack of connectivity will prevent the free flow of data and result in an incomplete data set, which would paint an inaccurate and potentially distorted picture of the market. We are working with the regulatory agencies to address these issues.

Tony Scianna: From your perspective, has the sense of urgency surrounding regulatory readiness diminished among firms?

Larry Thompson: Quite the contrary. Financial firms realize they need to be ahead of the curve in complying with new regulations to ensure their competitiveness in the new regulatory landscape. However, the extended timeframe for implementing Dodd-Frank has created a level of uncertainty for many market participants.

A large part of this stems from the fact that many of the key terms contained in Dodd-Frank, such as “swap,” for example, have yet to be defined. Additionally, some of the most controversial rules, including the end-user exemption, remain unsettled. Once these and other issues are addressed, firms will be in a better position to respond to and prepare for compliance with the new rules.

Tony Scianna: As the implementation of Dodd-Frank continues, where do you feel financial firms should focus their efforts and budgets in the coming months?

Larry Thompson: The industry needs to remain fully engaged in the rulemaking process so they have the ability to shape the final regulations. Cooperation with our regulators is essential. They have an enormous task ahead of them, and they need input from the industry to avoid unintended consequences. In order to ensure that new rules are properly crafted, regulators and the industry need to continue communicating with one another and market participants need to provide insight on how the new rules will impact the competitiveness and efficiency of our financial markets, capital formation and long-term economic growth and job creation.