What Do Obamacare and Dodd-Frank Have in Common? Technology Dysfunction
By Allan Grody, Financial InterGroup
Originally published on TABB Forum
In their haste to pass Dodd-Frank, lawmakers failed to consider the back-end infrastructure needed to support compliance. But passing framework rules and leaving technology implementation as an afterthought has proven disastrous.
Both the Health Care law and Dodd-Frank legislation were passed during a four-and-a-half-month period when both houses of congress and the White House were controlled by one party. When I roamed the halls of congress with our “Fix the Plumbing” amendment, Dodd-Frank was then known in conference as the Wall Street Reform and Consumer Protection Act. The clarion call of the reformers then was: “Just let’s pass the damn thing – we’ll fix it later!” Well, now is later; and at the detail level, especially where the rubber hits the technology road, things are failing. The politest comments now heard are that we are living in a transformational period of unintended consequences.
While the Obamacare fiasco has reached out to all Americans, the Dodd-Frank derivatives implementations are similarly ‘problematic’ but not understood enough to touch the lives of many Americans and others – yet. After all, it’s just the ‘plumbing,’ the back-end ‘stuff’ left to others – left as an afterthought, in fact, even though it will power, in the first instance, the Heath Care website, and in financial reform, the American economy. Most do not understand that today’s diverse capital markets cannot work without equivalent risk shifting markets.
Fixing the plumbing in the derivatives markets is not a simple issue that is easily and glibly stated in catchy sound bites, as is the case of Obamacare; though there are exceptions. One cannot forget Warren Buffet’s “weapons of mass destruction” statement, not quite on point but nonetheless ‘catchy.’ The other was when Dennis Weatherstone, then Chairman of JP Morgan before it and Chase Manhattan merged, pronounced his “4:15” risk management report to be the indicator of either a restful or restless night. This set a tone right up to the financial crisis, suggesting that his bank’s newly devised Value-at-Risk creation embodied all he and other bankers needed to know about the safety and soundness of the banks they ran – all in just 15 minutes after the US markets closed!
Second only to raising more capital, the most visible part of DFA was regulating the shadow financial markets, particularly OTC derivatives. These derivatives were thought to be one of the main contributors to the financial crisis. They contributed to AIG’s blowup and bailout, and produced securitized and synthetic fixed income products that every bank held on their books. Like a hot potato, they were bounced from hand to hand until the trading stopped and the credit markets froze.
Derivatives regulation was troubled from the start when the DFA’s newly empowered Office of Financial Research punted the technology data standardization of counterparty identification (who is trading with whom) to a global regulator, the Financial Stability Board. The FSB itself was a creation of the G20, reacting to the financial crisis by empowering a new global institution for stabilizing the global economy.
However, in the US the Commodity Futures Trading Commission chose to proceed with its own version of counterparty identifiers even while the FSB was deciding on a global standard, still not finalized. In its haste, the CFTC, wanting to be the first to check off an ‘I implemented Dodd-Frank rules first’ box stumbled badly. Passing framework rules and leaving technology implementation as an afterthought has proven disastrous. Like the website debacle of Obamacare, it has brought to the fore big data issues yet to be resolved.
In March of this year the CFTC asked for data on the newly regulated swaps derivatives markets. The CFTC was unprepared for the data deluge that followed. Their systems were overwhelmed by non-standardized data, brought about by their failing to provide guidance on data standards. If this wasn’t bad enough, rather than waiting until conformity of data occurred across the many industry members sending data, then piloted and approved, they instead went ‘live’ before it was time.
Now the problem has again been punted up to the Financial Stability Board, this time to resolve not only the counterparty identifier issue and nonstandard data in the US, but how data can be aggregated across the many new global derivatives infrastructure entities that have been put in place anticipating regulatory initiatives in their own countries.
The FSB has called for a coordinated approach to how newly mandated facilities like Swaps Execution Facilities (aka swaps exchanges) and Swaps Data Repositories will interoperate. Most important, these new facilities must be capable of providing a systemic view of their data to regulators across multiple sovereign regulatory jurisdictions. Without this capability, a technical issue of major importance, we have simply created another version of a shadow derivatives market, this one an electronic version that neither regulators nor industry members can observe transactions in.
The FSB study group’s derivatives data aggregation rule-making work is scheduled for completion in mid-year 2014. The Bank for International Settlement’s recently concluded ‘
Principles for effective risk data aggregation and risk reporting’ is due for implementation in 2016.
Lest we suffer again the lesson of unintended consequences, it’s best if we stop checking off nonsensical boxes that attest to ‘I completed’ this or that regulation – it only signifies the rule was written. Instead, we need to check off the ‘I implemented the solution and it is working’ box. That is where the rubber hits the technology road.