RegTech Intelligence

The OTC forest: seeing the wood for the trees

JWG analysis.

“When a tree falls in the woods, does it make a noise?” While some may find the question trivial, it has provided much food for thought for philosophers since it was first raised in the early 1700s. The answer to the question relies on one’s assumptions on whether observation is a necessary condition to knowledge, or even existence, of an event.

On a more practical note, the financial industry may well be posing a similar question of late. “If a trade is reported, does it make the market any safer if regulators can’t process and make sense of that information?”

In a statement of dissent published earlier this week, CFTC Commissioner Scott D. O’Malia bemoaned the lack of resources being allocated to the Commission’s IT budget. In essence, he suggested that the increased trade reporting requirements brought about by Dodd Frank may not actually improve market surveillance or reduce risk, if the CFTC did not have the IT resources to decipher the data.

In particular, O’Malia noted that the current 2015 budget plan was insufficient to support plans to improve the quality of swaps data currently being collected, and to “utilize this data for critical risk analysis and surveillance.” He also suggested that the Commission needed a database that could analyse exposures across different classes of derivatives – including futures, swaps, and options. “This database currently does not exist, and the Commission has not funded one in this budget request,” read the statement. Finally, O’Malia noted a requirement to extend the CFTC’s data collection infrastructure to include order, or quote, messages, which would imply a more than tenfold increase in the volume of data it currently collects.

Without investments in those kinds of IT projects, O’Malia said the Commission would struggle to meet its goals of ensuring market integrity, and protecting the market (and general public) from “fraud, manipulation, abusive practices, and systemic risk.”

And it isn’t just Commissioner O’Malia that is complaining about regulators’ ability to aggregate and make sense of trade data. The Financial Stability Board’s consultation paper on aggregating OTC derivatives data, which closed for comment at the end of February, will look to propose solutions to the challenges currently faced by regulators in aggregating trade data for more meaningful analysis.

Those challenges are likely to be even more evident in Europe. If the CFTC is complaining that it doesn’t have the funds to make sense of its swaps data, you might wonder how well ESMA is deciphering the data it started collecting last month. ESMA’s IT spend is a fraction of the CFTC’s. In 2014 it budgeted €1.4 million for Information and Communication technology spend, with a further €4.75 million set aside for its ‘Collection of information: IT project.’ In comparison, the CFTC’s proposed IT budget for 2015, which Commissioner O’Malia clearly sees as being insufficient, allocates $50 million to IT services and a further $21 million to fund full time IT staff.

Add to that, the fact that ESMA is likely facing even greater challenges with aggregating its swaps data – given the double-sided reporting regime in Europe and the fact there are six trade repositories (TRs) compared to the three swaps data repositories (SDRs) in the US – and it’s difficult to believe the data currently being reported under EMIR is being put to much use. That said, perhaps a like-for-like comparison between ESMA and the CFTC is unfair, as National Competent Authorities will also be helping to police EMIR trade data. But exactly how the collaboration between various NCAs will work and what levels of IT spend each is investing in retrieving, cleansing and analysing trade data, is really not known.

Going back to the tree analogy, regulators are now sitting on a rapidly sprawling forest of data. In fact, if each trade report represented a tree, this forest would be growing by hundreds of acres every week. And without the proper tools, navigating through that forest becomes increasingly difficult.

Whether it means identifying specific trading patterns that need further investigation, or more gradual build-ups of exposure that could prompt systemic risk concerns, it would seem the real question would be: when a tree really does fall, will anybody be there to hear it?

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