Industry Remains in the Dark on Parts of Dodd-Frank but Initial Steps Can Be Taken to Ensure Compliance

By Lisa Iagatta, Director Account Management, Investment Services, Fiserv

Lisa Iagatta

Over three years have now passed since the Dodd-Frank Wall Street Reform and Consumer Protection Act was signed into law, yet many of the act’s requirements are yet to be finalised. A key part of the regulation deals with trading and processing over-the-counter (OTC) derivatives. By changing the way in which OTC derivatives are to be traded, the Dodd-Frank reform aims to address weaknesses in the financial system. The introduction of central clearing counterparties (CCPs) to process and clear OTC trades seeks to address these weaknesses by mitigating counterparty credit and operational risks associated with OTC derivatives.

However, despite the continued lack of clarity the impending deadlines are prompting action. As a result, financial institutions are working with technology providers to reengineer their trading workflows within the limited guidelines received to date.

Based on the existing information available on the Dodd-Frank requirements, there are four main tasks financial institutions should be implementing in order to ensure compliance with the regulation.

• Part of the regulation requires trades to be transmitted electronically, meaning that existing manual practices are no longer an option. Therefore institutions must now put in place electronic data file feeds for trades
• The regulation requires enhanced trading communications from order management systems (OMS) to the CCPs, although there is still ambiguity around the required standard message types
• Because there are different requirements for settling the various asset types, the next phase is to outline the steps for the routing, execution and settlement based on each security type, then capture that information through to client and regulatory reporting
• Institutions must also ensure faster settlement of transactions than previously, due to the new 15-minute deadline from time of trade execution to send data to the appropriate CCPs

As Dodd-Frank becomes the financial law of the land, institutions will have to take additional steps to remain compliant. To ensure compliance, institutions must also provide comprehensive information regarding trade repositories and implement new risk management standards, including operational processes and margining for all bilateral OTC derivatives (for example, trades not cleared by a CCP). It is now a requirement of Dodd-Frank to utilise a message and application-agnostic trade flow solution for all asset types. This is aimed at removing the associated risks of processing OTC securities manually, especially when trading at high volumes.

The complexity and cost of complying with the regulation has led some market participants to turn to the futures market as an alternative to cleared swaps, due to its comparative simplicity and cost effectiveness. Many believe that there will be a continued trend away from OTC instruments and increased exposure to futurised swaps. However, time will tell if this is the case. As a result it could be that some hedge funds could begin executing different transactions and trading alternative products.

Further challenges will arise as a result of the regulations, demanding comprehensive derivative- contract reporting with the final details still forthcoming. The requirement for electronic trade transmissions will also mean that there will need to be increased use of electronic blotters for OTC trades, meaning additional costs for firms.

For global organisations, compliance with the regulation is complicated even further by the European Market Infrastructure Regulation (EMIR). Global organisations struggling to navigate the requirements of Dodd-Frank will also be impacted by parts of EMIR. While the regulators have spent time trying to align the two regulations as much as possible, there are both key overlaps and differences between EMIR and Dodd-Frank, and separate effort will be needed to meet EMIR’s additional requirements.

As firms and financial institutions work to comply with the requirements of Dodd-Frank, despite the regulation’s unclear implementation status, a new set of compliance activities have already emerged. Firms should invest in an application-agnostic technology solution to improve trade processing and remove the risks that accompany manual processing of esoteric securities. Financial institutions are currently developing new workflows and trade processes within the limited guidelines available, but many fear that these efforts may need to be adapted at a later date once the details have been finalised in order to ensure compliance.

By Lisa Iagatta, Director Account Management, Investment Services, Fiserv

Lisa Iagatta

Over three years have now passed since the Dodd-Frank Wall Street Reform and Consumer Protection Act was signed into law, yet many of the act’s requirements are yet to be finalised. A key part of the regulation deals with trading and processing over-the-counter (OTC) derivatives. By changing the way in which OTC derivatives are to be traded, the Dodd-Frank reform aims to address weaknesses in the financial system. The introduction of central clearing counterparties (CCPs) to process and clear OTC trades seeks to address these weaknesses by mitigating counterparty credit and operational risks associated with OTC derivatives.

However, despite the continued lack of clarity the impending deadlines are prompting action. As a result, financial institutions are working with technology providers to reengineer their trading workflows within the limited guidelines received to date.

Based on the existing information available on the Dodd-Frank requirements, there are four main tasks financial institutions should be implementing in order to ensure compliance with the regulation.

• Part of the regulation requires trades to be transmitted electronically, meaning that existing manual practices are no longer an option. Therefore institutions must now put in place electronic data file feeds for trades
• The regulation requires enhanced trading communications from order management systems (OMS) to the CCPs, although there is still ambiguity around the required standard message types
• Because there are different requirements for settling the various asset types, the next phase is to outline the steps for the routing, execution and settlement based on each security type, then capture that information through to client and regulatory reporting
• Institutions must also ensure faster settlement of transactions than previously, due to the new 15-minute deadline from time of trade execution to send data to the appropriate CCPs

As Dodd-Frank becomes the financial law of the land, institutions will have to take additional steps to remain compliant. To ensure compliance, institutions must also provide comprehensive information regarding trade repositories and implement new risk management standards, including operational processes and margining for all bilateral OTC derivatives (for example, trades not cleared by a CCP). It is now a requirement of Dodd-Frank to utilise a message and application-agnostic trade flow solution for all asset types. This is aimed at removing the associated risks of processing OTC securities manually, especially when trading at high volumes.

The complexity and cost of complying with the regulation has led some market participants to turn to the futures market as an alternative to cleared swaps, due to its comparative simplicity and cost effectiveness. Many believe that there will be a continued trend away from OTC instruments and increased exposure to futurised swaps. However, time will tell if this is the case. As a result it could be that some hedge funds could begin executing different transactions and trading alternative products.

Further challenges will arise as a result of the regulations, demanding comprehensive derivative- contract reporting with the final details still forthcoming. The requirement for electronic trade transmissions will also mean that there will need to be increased use of electronic blotters for OTC trades, meaning additional costs for firms.

For global organisations, compliance with the regulation is complicated even further by the European Market Infrastructure Regulation (EMIR). Global organisations struggling to navigate the requirements of Dodd-Frank will also be impacted by parts of EMIR. While the regulators have spent time trying to align the two regulations as much as possible, there are both key overlaps and differences between EMIR and Dodd-Frank, and separate effort will be needed to meet EMIR’s additional requirements.

As firms and financial institutions work to comply with the requirements of Dodd-Frank, despite the regulation’s unclear implementation status, a new set of compliance activities have already emerged. Firms should invest in an application-agnostic technology solution to improve trade processing and remove the risks that accompany manual processing of esoteric securities. Financial institutions are currently developing new workflows and trade processes within the limited guidelines available, but many fear that these efforts may need to be adapted at a later date once the details have been finalised in order to ensure compliance.