Vinod Jain, senior analyst, capital markets, Aite-Novarica Group
A lot has by now been discussed about the recent collapse of a family office fund and the subsequent losses incurred by the investment banks. I’m wondering what the practical aspects of this to the financial industry may possibly could be to strengthen the capital markets.
Surely some of the learnings involve bigger larger regulatory steps leading to more transparency in the information being shared between business and legal teams over a client. But these are still high level, and, in my view, they are more internal to an institution.
So, here’s my attempt to identify some of the possible initiatives which could assist the financial industry.
Identity a swap by its nature: The progress made by taxonomy initiatives is commendable to initiate the standardisation process in over-the-counter derivatives. But it lacks to a certain extent the practical use as not all the trade processing platforms use it. So, we have more than one field to identify the nature of the swap, for example, amortised swap, step up a swap, or for that matter the bullet swap, which was used by the family office fund. If the taxonomy definition could be expanded by such tags it would truly be beneficial for all users looking at the trade information or involved in trade processing. In absence of such a field, there is a continued reliance on more than one data field.
Make ISINs from ANNA DSB more intelligent: Just related to taxonomy is the concept of an ISIN number for OTC derivatives which are issued by ANNA DSB. Again, though remarkable process progress has been made in the number of ISINs created by ANNA DSB across all OTC derivatives asset classes, the true application of these in trade processing is close to negligible. This is because the ISINs numbers though intelligently generated but they cannot identify the nature of the swap product traded. Thus, could the ISIN number may be mode more intelligent like an extension of CFI code so an ISIN for Rates_Swap.Cross_Currency_Fixed_Float can be like RSCCFFXXXXXX. There is a greater need to define the products beyond the current taxonomy definitions and ISINs. On one side the MiFID II regulation mandated the ISIN for otc derivatives but to a surprise, the new CFTC and SEC rules for swap reporting do not mandate the ISIN as a reportable field.
Review cross-product margining: Now let’s look at the cross-product margining. The benefits of cross-product margining are terrific as it reduces the number of collateral exchanges and provides an offset benefit to both parties involved in the margin call. But due to its very nature of cross-product margining the exposure distribution under the trades is not easily available other than the collateral management systems to identify if there is a skewed margin number which is causing a huge deviation in cross-product margin direction flow. Having an identifier of cross-product margin proportion with direction involved could provide the much-needed analytics to identify the relative contribution of trade to the overall cross-product margin number, for example, trade number 123 contributes +30% towards the cross-product margin, trade number 456 contributes -40% towards the cross-product margin and so on.
Okay, moving on to next….
Enhance collateral reporting: This discussion now leads us to enhancement in collateral reporting. The current collateral reporting under various regulations across asset classes does not provide a holistic view of the counterparty exposure to a regulator. It is limited to asset class under the jurisdiction of the regulator. ESMA, the European regulator had a chance to extend the collateral reporting under MiFID II to cover collateral reporting, but the focus was on transaction reporting and not on collateral reporting. Collateral reporting is based on the actual exchange of collateral settlement and does not include details of margin disputed by either counterparty. A feature like a unique trade identifier at the trade level which is a common trade identifier between two counterparties could be extended to collateral portfolio code. This will also eliminate the mapping of multiple collateral portfolio codes which may be created to comply with uncleared margin rules.
Now the last mile…
Link various available data: We are living with a data quality enigma; data quality can quickly change from strength to an issue to resolve based on the context. In a true sense, most of the time the data is available but due to various reasons, the information does not provide intelligence to link the data set and makes it unreliable to make a business decision. One example is reporting of orders quotes and execution data under consolidated audit trail rules to FINRA, reporting of equity derivatives trading activity to trade repositories under Dodd-Frank regulations, and fails-to-deliver data reported by SEC. By linking all the three data sets, it can easily track the activities in the swap market and equity market for the stocks leading to major volatility in the market like GameStop, Viacom CBS, and others. There is a compelling necessity to link all these to achieve a holistic monitoring service.
In the end, like the above five areas, many other use cases make a compelling case to link the data sets and remediate the gaps in the existing trading and trade process. Until then the availability of true counterparty exposure in real-time is at a long distance.