Regulations

senior vice president, Astec Analytics, SunGard’s capital markets business

Regulatory Alphabet Soup: ESMA, UCITS and ETFs

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A certain excitement spread through the securities lending market during August 2012. A new set of guidelines from ESMA (European Securities and Markets Authority) that govern securities lending for UCITS (Undertakings for Collective Investments in Transferable Securities) and ETFs (Exchange-Traded Funds) were published. These guidelines, due to come into force in February 2013, had the laudable objective of strengthening and harmonizing regulatory practices, but one particular aspect was jumped on and, unfortunately, misinterpreted.

It is entirely appropriate for ESMA to underline that any investment vehicle is run for the benefit of the investor, but this was interpreted by some as guidance over how services are provided to those funds and how they pay for them. Those misinterpreting the guidance hailed the end of payments to agent lenders for providing securities lending services, whereas it seems the focus was intended to be on the third-party splits that fund managers themselves take from the lending revenue.

The International Securities Lending Association stepped quickly into the breach and gave a clear message about just what ESMA had intended. But is ESMA right? Or is there a place for a third split paid to the fund manager? HSBC Asset Management does not seem to think so, announcing on August 23 that it would be “returning all profits from securities lending operations” across its UCITS range.

Many asset managers, including those managing ETFs, are believed to charge some level of “oversight” or management charge for stock lending, and it is rumored that in some cases these are as much as 70 percent of lending revenue. If so, once the agent lenders’ fee split has been taken out, there would be precious little left for the fund. While it is clear that some charges can be excessive, if the manager is providing an actual oversight function for their clients, then there is an argument for charging a fee of some sort. Such fees should, of course, be proportionate and transparent, allowing the investor to make an informed decision as to what service provider he or she selects.

Returning more of the securities lending revenues directly to the funds will no doubt improve their overall performance and returns, which will in turn benefit the fund and its managers. However, using legislation to cut off another source of revenue for banks and asset managers will place yet more strain on a system that is already under pressure. To be clear, there is no room and no defense for inflated fees that do not pass “the blush test” in terms of value for money. But investors can make their own choice between high and low cost providers without the help of a regulator.

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product manager, Valdi, SunGard's capital markets business

Consolidated Audit Trail: More than One Way to Skin this CAT

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This  blog post originally appeared on Advanced Trading.

The Securities Exchange Commission voted in July 2012 to require exchanges and broker oversight groups to have a single system to monitor and analyze trading activity across U.S. equity and options trading venues. This Consolidated Audit Trail (CAT) will be designed to help enhance the surveillance of the equities markets by establishing a centralized database that can track and store order information throughout its entire lifecycle, including every trade order, execution and cancellation.

Why is CAT necessary?

Regulators are currently on a different playing field than market participants. They’re not able to keep up with the technology and data improvements in the marketplace. Regulators currently oversee trading activity by observing data collected in various formats from various systems. CAT would provide a centralized data store, capturing all relevant information throughout the lifecycle of a transaction. The CAT system would begin the process of “calling up” the regulators to the major leagues.

CAT has spurred various opinions on the impact and effectiveness of the rule. Proponents of the rule argue that CAT will increase the ability of regulators to monitor the overall market structure, ensuring better understanding of rules and the effect on trading. They believe data will provide better insight into patterns, helping to assess the quality and fairness in the markets. Critics of CAT say the SEC has not considered the cost benefit analysis of the rule, in that it will be too costly to implement and won’t provide any significant benefit to regulators and the marketplace as a whole.

Implementing CAT

A system and data warehouse of the size and scope of CAT is a complex and timely effort. A system will have to provide firms with the data warehouse framework and reporting capabilities to be able to respond to CAT. Ideally, this should include cloud-based surveillance, supervision, and management reporting to provide a complete view of an order’s lifecycle. A best-practice CAT system must allow regulators, exchanges and broker-dealers to implement a cost-effective solution in a timely fashion.

For instance, if a broker-dealer seeks to establish a system to capture the elements of CAT in order to display the routing information associated with a specific trade order exception, the firm would need:

A proactive approach

The passage of CAT by the SEC shows once again that firms need to stay diligent and proactive in today’s regulatory environment.  Firms can no longer be reactive to changes.  In fact, SEC Chairman Mary Schapiro said, “A consolidated audit trail will reduce the regulatory data production burdens on SROs and broker-dealers by reducing the number and types of ad hoc requests that regulators submit today.” This is just a first step in a broader change that will affect all market participants.  There may be more than one way to skin a CAT, but behooves these various firms to be prepared to tackle these new requirements now and in the future.

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senior product specialist, SunGard's capital markets business

3 Key Facets of Market Monitoring and Surveillance

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One aspect of the current market situation is rather ironic: “fat fingers.” When equity markets moved from floors and hand signal-based trading onto screens, a big fear was fat finger errors. Traders not used to screen-based trading accidently entered orders with very low prices and/or ridiculously high volumes, rendering huge losses unless they managed to bust the resulting trade. These fat finger errors also caused temporary confusion in the markets. As a consequence, screen-based order entry systems introduced simple fat finger checks to block outlying orders from entering the market, not only to avoid trading losses, but also to ensure orderly markets, as required by authorities.

We’re now experiencing a new technology shift. Algorithmic trading, employed using advanced trading strategies based on data requires very little to no human intervention during the trading day. With this, we now see an increased occurrence of a new version of fat finger errors causing havoc in the markets – computers entering outlying orders. Not only are firms getting hit by trading losses — sometimes of sizes that force them to seek additional capital to avoid going bankrupt — but the consequences to the very interlinked and fast-moving markets are widespread disorder and prolonged confusion.

It’s no wonder, then, that there is an increased focus from regulators on market monitoring and surveillance tools, and their use among market participants. These can roughly be divided into three areas: pre-trade checks, real-time monitoring, and post-trade surveillance.

Pre-trade checks

Pre-trade checks are part of the transaction chain, and add latency. Therefore, these need to be automatic and trigger blocking of orders to enter the market automatically, as any manual review and intervention would simply add too much latency to the transaction chain. They also need to be simple and implemented in a way that they minimize any latency added to the transaction chain.

These checks need to include order flows from clients that access markets via DMA, client child orders entered onto markets via in-house OMS, and house orders.  Inevitably, they add a layer of complexity and therefore surveillance officers need to have the capability and systems to manage parameters and checks to ensure they are efficient and at the same time do not block legitimate orders.

These systems also need to monitor for trading limits, positions limits, short sell rules and credit limits, as part of any trading desk’s normal risk processes.

There is also potential for systems to start doing pre-checks, looking for potentially abusive patterns and incorrectly configured algorithms. Perhaps these would not trigger an active intervention, but would simply alert surveillance officers and traders to potential issues. They can then focus their efforts and be prepared to intervene and halt an algorithm if necessary before it can create a problem in the markets.

Real-time monitoring

Real-time monitoring is done at order and trade level, typically focusing on child orders and active trading, overlaying the order flow on top of market information and news items. Real-time monitoring does not form part of the transaction chain, but rather listens, records and analyzes trading and market data. Triggered alerts are analyzed by surveillance staff as they become available, and findings may lead to interventions and actions on the spot, depending on their severity.

Typical patterns included are: rapid price movements, ramping the close (both morning and close of play), unusual activity, layering, spoofing bait and switch, and pinging.

Post-trade surveillance

Post-trade surveillance can be done intraday or T+1 depending on the compliance department’s focus and resources.

The post-trade surveillance function focuses on more complex and long-term suspected abuse patterns, such as insider trading, front running, cornering, and repeated patterns over extended periods of time. Triggered alerts are analyzed, and more advanced analysis is done using reporting engines.

Examples are profit-and-loss analysis, analysis of trading patterns over longer periods (such as ramping or capping at month’s end), systematically changing sides in the books after opening auctions, etc.

Case management forms an important part of the post-trade surveillance function, supporting the collection of data and reporting of suspicious behavior to the business and DMA customers. Short selling reporting, transaction and position reporting, and other regulatory reporting requirements also fall under post-trade surveillance tasks.

A compliance solution that is flexible, fast and fit for purpose is more important than ever in order to avoid the algorithmic equivalent to a fat finger error. Market participants need to look at the entire order and trade life cycle and employ compliance solutions that are suitable for each stage in the cycle to be effective and provide value.

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vice president, SunGard’s capital markets business

How Should Broker-Dealers Leverage FINRA Rule 2111?

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This blog post originally appeared on TabbFORUM.

Regulatory changes are among the most challenging events taking place in the financial industry today.

The Dodd-Frank Act, as statutory authority, continues to demand a significant data process and collection re-engineering effort. For example, the newly adopted FINRA Rule 2111 which governs customer suitability for brokerage customers is applicable to all broker-dealers. Additionally, many firms subject to FINRA Rule 2111 are concurrently subject to certain business conduct rule provisions under Dodd-Frank which demand new onboarding and data acquisition requirements for transactional counterparties – based on an identical dataset. The question is whether this identical onboarding and continuation data is being (or will be) leveraged across the enterprise to support ancillary activities ranging from compliance to product cross-selling.

The new FINRA Rule 2111 stipulates that a firm or advisor must “have a reasonable basis to believe that a recommended transaction or investment strategy involving a security or securities is suitable for the customer, based on the information obtained through the reasonable diligence.” The new rule makes it clear that a broker-dealer lacking a complete understanding of both the product and the customer is in violation of the rule. FINRA Rule 2111 therefore drastically changes the brokerage onboarding process to a more dynamic and perpetual “know-your-customer” experience.  The reasonable basis analysis for concluding that a given strategy or product recommendation is suitable will likely be a collaborative data process which is a substantial shift from the traditional account opening process.

Because FINRA Rule 2111 and the related Dodd-Frank provisions require a significant process reformation and data collaboration, the model should be rules-driven and flexible to optimize the inherent cross business-line data while contemporaneously leveraging any applicable safe harbor provision.

Safe harbors, which constitute a legal provision to reduce or eliminate liability, are often used as a part of a compliance strategy. For example, FINRA Rule 2111 requires broker-dealers and associated persons, for both retail and institutional accounts, to document with specificity their reasonable basis for believing that a given profile data element is either not relevant, or alternatively, customer-provided with a reliance on the accuracy of the customer’s submission. The reliance on the submission as part of a rules-based collaborative onboarding process constitutes reasonable basis, provided no red flag or suspicious activity is detected. Because of the ongoing and perpetual suitability requirement, the collaboration feature is likely the next generation of onboarding intelligence.

FINRA Rule 2111, in part, is comprised of reasonable-basis suitability. The reasonable-basis obligation requires a broker-dealer or associated person to have a reasonable basis to believe that the product or strategy recommendation is suitable for at least some investors.  FINRA, through its guidance, stated that “[b]rokers cannot fulfill their suitability responsibilities … when they fail to understand the securities and investment strategies they recommend.” Where the broker-dealer’s repository already contains product and strategy data, the rules-based query engine could easily harmonize the data (for cross-selling purposes), and/or evaluate profile suitability (for compliance purposes). The collaboration rules are necessary to allow for any after-the-fact determination that may narrow or widen the customer/counterparty risk tolerance, time perspective, or other data element.

Suitability is an often misunderstood concept. Many misapply the suitability test as a subjective determination and attribute the analysis to a single customer and an anticipated product. This oversimplification effectively wastes useful aggregated customer profile data by failing to leverage system-based profile range analysis.

FINRA Rule 2111 has made customer onboarding more complex. First, the data must be more time-sensitive and dynamic to account for changes in customer risk tolerance, circumstance, or investment strategies. Second, FINRA Rule 2111 expands the scope of customer recommendation. The suitability rule applies to any recommendation to a customer. “Customer” is defined broadly as anyone who is not a “broker or dealer” and includes an individual or entity (including institutional customers) with whom a broker-dealer has a business relationship related to brokerage services. Even a non-transactional business relationship where no account was opened, nor any transaction effectuated, under the rules, will constitute a broker-customer relationship.

A rules-based processing engine is necessary to account for changes in customer risk tolerance, circumstance, or investment strategies as required by FINRA Rule 2111. Data elements that contribute to customer profiles should be leveraged in advance, while the onboarding solution proactively aligns customers with strategies and simultaneously measures real-time suitability. The collaboration feature must be flexible and rules-based to account for individual circumstances and proprietary business methods.

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senior product specialist, SunGard's capital markets business

The New Role of the Compliance Officer

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This blog post originally appeared on Markets Media.

With the unprecedented rate of change in the financial markets, and with regulators across the board stepping up the enforcement of existing regulation, one can’t help but wonder: what does this mean for the compliance officer?

Compliance officers are facing a deluge of new regulations on top of an existing heap of rules and requirements which makes oversight of all compliance consequences difficult to gain. Compliance officers need to spend increasing amounts of time reading consultation papers, providing feedback, and then reading new guidelines and regulations as they become available. They then need to ensure that systems and processes are updated to match new requirements, often to very tight deadlines imposed by regulators. They should also not underestimate the risk of accidental breaches, even if one has the best intentions in mind. Ultimately, the compliance officer today needs to focus on convincing internal stakeholders and budget keepers to spend money and increase headcount – a tall order in today’s regulatory climate.

At the same time, new trading structures and advanced trading strategies coupled with huge data sets makes the task to monitor trading activities and markets a very interesting challenge today. If monitoring is executed properly, it can provide useful feedback to business functions on its performance, and early detection of misconfigured OMS/algo systems can be vital to avoiding mistakes and poor trading results, or even accidental market abuse.

Within all of this, compliance officers are finding they must manage a delicate balance between business interests, culture, increasing cost pressures and heightened regulatory demands on reporting, due diligence monitoring, and surveillance. To add even more pressure, the compliance officer is now taking on increased personal risk. If major misconduct is revealed within an organization, the compliance staff can be held personally accountable.

If this doesn’t put the compliance officer between a rock and a hard place, I don’t know what does. Why would anyone in his right mind want to find himself in this position? Is there an upside to the story, or should a compliance officer just cut his losses and run?

The flip side of the new world for the compliance staff is the ability to create a platform for increased job satisfaction. Because of the increased focus on rules enforcement, a compliance officer is gaining increased authority and clout to do a thorough job. And since that is the case, it is now gradually becoming more likely for a head of compliance to secure budgets and resources to deploy systems and processes that are up to the task.

As the global trading environment gets more and more complex, the compliance function is getting the ears of senior management and is now forming part of corporate risk thinking. A strong compliance and trading monitoring function coupled with the right systems and strategies have become critical, and say to the outside world: “We are a firm that takes fair and orderly trading and transparency seriously. You can trust your transactions to be safe with us.” Who wouldn’t want to be a key part of fulfilling that message?

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vice president, SunGard’s capital markets business

Finding Hidden Opportunity in the Dodd-Frank External Business Conduct Rules

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This blog post originally appeared on FOW. It also appeared on ATMonitor.

The Dodd-Frank Act (DFA) final rules require extensive systematic changes to pre-trade swap documentation and the adoption of comprehensive external business conduct processes – as early as October 14, 2012.

External business conduct compliance and institutional onboarding

Among other provisions, external business conduct compliance constitutes (i) standard format disclosure; (ii) suitability monitoring; and. (iii) reasonable basis analysis. The rules apply to swap dealings with all counterparties, including an enhanced duty to “special entities.”

It is therefore critical that an external business conduct data system design consider all applicable variations of trade participation status with applicable exemptions, including the codification of prescribed safe harbors. For instance, according the CFTC and SEC, major swap participants (MSPs) are not subject to institutional suitability, “Know Your Counterparty (KYC),” and scenario analysis requirements – but those in a fiduciary capacity are.  An enterprise system should consider varied counterparty-facing statuses.

Among the most pressing issues are the changes in institutional onboarding (IO) requirements. The IO function, in addition to being a pre-trade compliance function, should also serve as an opportunity repository that effectively aggregates or matches business-line level data to leverage the recommendation and suitability provisions as a business driver. In other words, if the data is already being captured for pre-trade compliance purposes, is it possible to re-use the customer/counterparty profile data to increase deal flow, or to create products that match a defined profile, or to match profiles to strategies? Suitability and recommendation data should, and likely will, be used this way as a competitive advantage.

A competitive advantage

For example, the suitability duty is triggered when a swap dealer makes a ‘‘recommendation.” Beginning with the IO process, a counterparty (generally acting in a dealer capacity) must undertake reasonable diligence to understand the potential risks and rewards associated with the recommended product or trading strategy and have a reasonable basis of suitability. This is a product/strategy-facing analysis. So from a business opportunity perspective, the data can reasonably be re-used to calculate a matrix of products that fit a defined profile, or alternatively, determine a suitability range of counterparties for a pre-analyzed product or strategy. These are business opportunities – not compliance functions.

Conversely, the industry has recently considered, and some have apparently endorsed, a master agreement amendment tool that uses a simple check-the-box process that attempts to multi-task as both an addendum and disclosure mechanism for the purpose of DFA-related external business conduct requirements. This check-the-box process seemingly expedites the more tedious process of granular data aggregation as well as the time consuming process of re-drafting master agreements and credit support annexes.

The proposed tool, while sufficient to modify a status, or revise an acceptance of liability, is entirely disconnected from any actual customer or counterparty data, and lacks connectivity to any relevant information necessary to analyze full data-driven compliance with the external business conduct rules or the leveraging of data to create trading business opportunities.

The DFA requires this extensive overhaul of pre-trade documentation, and other regulators and self-regulatory organizations will likely follow suit by imposing similar rule-based requirements. The Dodd-Frank external business conduct rules explicitly mandate a methodology change to documentation as well as an implicit enhancement of market and counterparty data systems that must be more cross-functional to analyze enterprise-wide suitability and dealings.

Firms may give themselves a competitive advantage if they can find tangible business opportunities to re-use IO data while leveraging the counterparty relationship in areas such as collateral optimization, securitized lending, valuation and risk analysis.

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senior vice president, Astec Analytics, SunGard’s capital markets business

No “Silly Season” for Securities Lending

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The time known as the “Silly Season” is upon us. An annual tradition, the Silly Season marks that time in the year where nothing of note is happening. As a result, our newspapers usually contain bizarre stories that would never normally get any airtime and people realize that as our politicians are all on holiday, no one is actually running the country. This year is different of course; with the Queen’s Jubilee and the Olympics in London, there is no shortage of activity.

Similarly, securities lending has much going on. For example, the European Securities and Markets Authority (ESMA) has launched new guidelines on income distribution for securities lending. Of arguably more immediate importance, new short selling bans have also been re-introduced in Italy and Spain. Spain has put a three-month ban on all shares in place from July 23, and Italy mandated a new ban for one week only starting July 29 for insurance and banking shares.

In what some have described as an act of desperation, the short selling bans have been introduced as a result of market volatility even though such bans have been shown in the past to be ineffective and indeed even counter-productive to this aim. Such bans have impaired liquidity and damaged already ailing investor confidence; they have also been seen to drive short selling into other European markets.

While securities lending is not equal to short selling, it is a good proxy for measuring such activity, especially as we are now outside of the main dividend season. While it is a little early to see an impact from these bans on lending activity in these locales, prior evidence shows that such bans raise spreads, drive out liquidity and scare investors – presumably exactly what the regulators do not intend. For Spain and Italy, does this herald the start of their own Silly Season, perhaps?

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senior product specialist, SunGard's capital markets business

Capital Markets Regulatory Compliance: An Olympian Task

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Portions of this blog post originally appeared on Markets Media.

With the London Olympics in full swing, one can’t help but think of the state of our industry and the challenges ahead. When it comes to regulation and compliance for the capital markets, we certainly face an Olympian task.

At present, we aren’t exactly in fighting form. The industry has sustained several serious injuries, hampering its ability to perform well in forthcoming events. Despite the many stumbles and falls along the way, we are forging ahead and becoming stronger.

Our referees, the regulators and politicians, are looking on in dismay and are now busy reviewing rulebooks on how the game is played, judged and monitored. Risk is obvious, and rushed rule changes could in effect alter the sport beyond recognition.

Regulation is brought into place as protection to keep the game and all the players operating safely. But what happens if the regulators force boxers to wear pillow-sized gloves and helmets so big they can’t see clearly? There is risk, too, in over-regulation. However, recent examples in the capital markets world tell a different more balanced story.

Short selling regulation

Regulating short selling (EU Regulation 236/2012, ESMA 2012/228, which takes effect in November 2012), is essentially an attempt protect us from ourselves by controlling short selling of bank shares and sovereign debt. The intention is to ensure a level playing field across member states and to build a new reporting mechanism.

The regulation text is refreshing reading (honestly!) in that it explicitly states the benefits of short selling and the important role it plays in ensuring the proper functioning of financial markets in the context of market liquidity and sufficient price formation, while emphasizing that identified risks should be taken seriously.

This rushed-through regulation is really about reporting and measuring. This is similar to the introduction of electronic censoring of goals and ball positions in sporting events. Was the tennis ball short of the base line or not? Now, we will know the answer.

Of course, this also presents challenges for market participants, such as increased burden of already stretched back office systems and staff; the need for flexible data systems; new reporting obligations, etc.

With the short selling regulation, ESMA is looking for a level playing field and a uniform implementation and enforcement across the union. It is also empowered by the Commission to step in and enforce preventative measures across all member states.

Investor protection

The final report for ESMA Guideline 2012/387 was published on July 6, and we’re now waiting for the clock to start ticking for the guidelines to take effect, approximately four months after the publication of the translated versions.

The guidelines detail to great extent how investment firms should record and monitor sales practices and customer vetting practices, including regular follow-ups, to ensure recommendation of proposed financial products are fit for their purpose, are clearly understood, and match the risk profile of the customer.

They do not make any difference between professional and single individual customers, so the systems the guidelines are asking for are relevant for investment firms focused on professional investors as well as firms focused on retail.

Again, new rules bring new challenges. To comply, firms will need to have systems in place for efficient and easy recording and follow-up. And yet many firms are not yet gold-medal material in this regard.

MiFID and MAD marathon

We mustn’t forget our ongoing regulatory marathon in the background. Between MiFID and MAD, it’s a difficult marathon through London streets, trying to avoid pot holes. Of course, firms are still running while waiting for Commission voting, which has been postponed to mid-September.

Will the industry light its torch and bear its head high, work with politicians and regulators, resist over-regulation and arrive at a state that ensures fair, open markets that will lead to a thriving and healthy industry? There is still judging to be done, but it certainly seems we are running, cycling, and swimming in the right direction.

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senior vice president, Astec Analytics, SunGard’s capital markets business

Trouble Ahead? New Short Selling Regulations from ESMA

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The first half of this year has seen a flurry of activity among regulators as they battle to construct new regulatory regimes that reduce risk, increase efficiency and bring a new level of transparency to volatile markets. Driving this volatility is a series of unknowns, ranging from the longevity and stability of the euro to which country will be next to require a bailout.

I recently attended the annual International Securities Lending Association (ISLA) conference in Madrid, where one of the subjects up for debate was, of course, regulation. Based on the keynote, it seems very clear that increased regulation is coming, whether the industry wants it or not, and it’s coming soon. The keynote opinion stated that the political glue that holds Europe and the single currency together may be more like concrete, and the solution for Europe could be, in fact, “more Europe.”

The new SSR legislation is a prime example of this in the context of the securities lending industry. While its primary aims are to increase market settlement certainty and reduce naked short selling, the original drafts included many potentially serious unintended consequences for securities lending, and by association, the wider financial market itself through reduced liquidity, wider spreads and poorer price discovery. Thankfully, much of this has been avoided through effective use of the short consultation period available, but in the run up to implementation of the new rules in November this year we face a new problem – that of interpretation and application.

At the conference, I co-chaired a well-attended roundtable on SSR. Two aspects of that session raised concerns that are worth further debate. In a room of more than 30 people, there was only one agent lender. He agreed with two senior representatives of two large borrowers present that the lending community were generally taking little action responding to the new SSR regulations, instead expecting their borrower counterparts to create a new one-size-fits-all liquidity measuring and locate recording process for them. While this may sound like a good idea, the two major borrowers then explained that they had totally opposing positions in interpreting the regulations, so how they were going to apply them?

While as an industry, securities lending has an amazing way of finding its way through difficulties, there could be trouble ahead.

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general manager, Stream GMI, SunGard’s capital markets business

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IS PURSUING THE DODD-FRANK END-USER CLEARING EXCEPTION WORTH THE TROUBLE?

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The Commodity Futures Trading Commission (CFTC) and the Securities Exchange Commission, (SEC) in a much anticipated ruling, have approved the final definitions of “swap” and “security-based swap.” In addition, the so-called “end-user” exceptions have been finalized.

Swap participants seeking an end-user exception will generally applaud the decision that exempts them from submitting swaps for central clearing. However, these participants may be surprised to learn that the additional burdens of noticing, documenting, and reporting, may make that decision more burdensome than beneficial.

For instance, if a swap participant seeks an exception, it must first file a notice with the CFTC, and additionally provide proof that it is using the noted type of swap to hedge or mitigate qualified commercial risk. The exception-seeking swap participant must then notify the Commission of how it generally meets its financial obligations associated with the swap. And finally, there are ongoing reporting burdens that require an excepted entity to report to the Commission or to a data repository, on a swap-by-swap basis, or annually for reduced activity. If the exception is invoked, each exempted entity is held responsible to hold itself open to the CFTC for any additional information that is required. This information may include trade capture details, position valuation, risk modeling, settlement, or other relevant trade-related data that must be adequately maintained.

Notwithstanding the inherent credit and operational risks that exist in all bilateral non-cleared swaps, resource considerations are necessary prior to seeking approval for a clearing exemption.

The practical implication makes the invocation of an exemption even more uncertain. That is, although the margin rules are not yet finalized, and the proposed rules do not impose margin requirements onto non-financial swap participants, there is a conflicting requirement that certain swap participants must have credit support arrangements in place to govern the rights and obligations of the parties, including margin. And these swap participants have a heightened responsibility to manage their swaps activities.

Logically, these entities are likely the counterparties of those seeking an end-user exception. However, these entities have an independent duty, separate and apart from any exception consideration, to model and manage all swaps. The heightened compliance requirements will likely pass to those swaps entities that seek to qualify for an end-user clearing exception.

One must consider that once these costs, including trade life cycle technologies, are passed on to the exception-seeking swap participant, together with the additional burdens of noticing, documenting, and reporting, is the end-user exception really worth the trouble?

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