Daniel Parker, vice president, SunGard’s capital markets business, explores the embargo rule and explains the competitive advantage this new public reporting of swap transactions rule may present to market participants.
A discrete and often-overlooked rule has recently become a major influence concerning the systems design of real-time public reporting of swap transactions.
Although data automation has always been the lifeblood and inherent advantage in any tradable financial marketplace, the embargo rule explicitly allows for preferential sharing of swap transaction and pricing data with certain market participants – ahead of others. As a result, there is an unprecedented and urgent systems development push to identify, connect, and process swap transaction and pricing data as a distinct competitive advantage – even beyond traditional time-and-sale data – to leverage related asset classes.
Codified in Section 727 of the Dodd-Frank Act (DFA), the Commodities Futures Trading Commission (CFTC) is authorized to promulgate rules relating to the public reporting of swap transaction data. Similarly, Sections 763 and 766 authorize the Securities and Exchange Commission (SEC) to create rules for the reporting and dissemination of security-based swaps modifying the Securities Exchange Act.
The joint final provisions of the embargo rule by the CFTC and SEC permit swap dealers (SDs) and major swap participants (MSPs) to share data with their customer base concurrently with dissemination of such data to a swap data repository (SDR). This simply means that market data – such as traditional time-and-sale transaction data, as well as other after-the-fact or beyond original execution techniques, i.e., compression, novation, etc., which may likely have a substantial impact on price discovery in related asset classes – falls within this provision, and creates a potential timing advantage for, in this instance, the customer base of those SDs and MSPs with the requisite capabilities to share the data.
The agencies’ final rules also permit a swap execution facility (SEF) to disseminate swaps data to their customer base “upon transmission of such data to an SDR,” which is generally defined as a repository that collects and maintains records with respect to transactions in swaps, mixed swaps and security-based swaps for the purpose of providing a centralized recordkeeping facility.
Taken together, this means that those market participants duly connected to SEFs, and aggregation facility, and/or a customer of a SD or MSP with the requisite data dissemination capabilities are clearly privileged.
Privileged Market Participants
Although the rule, enumerated in Title 17, Section 43.3, does not expressly use the term “privileged,” the rule does articulate the conditional existence of a special relationship such as “customer base,” or trading privilege holders, in order to receive concurrent, and likely pre-publicly available swap transaction data.
A qualified “customer base” under the embargo generally applies to those entities with trading privileges or that subscribe to data streams. As a result, systems development including swap data aggregation, cross-venue reconciliation, margin netting, and collateral deployment optimization techniques are becoming default enablement. In fact, market participants, whether privileged or not, will reasonably need to upgrade data ingestion models just to remain relevant, if not competitive.
In other words, not all market participants need concurrent SDR reportable data, (which is the basis of embargo rule data) and are not necessarily disadvantaged by a time delay. However, real-time risk systems should optimally operate with real-time data.
For instance, the CFTC has recently adopted a more prescriptive view of the risk mitigation techniques, including pre- and post-trade processes that were originally proposed under the European Markets Infrastructure Regulation (EMIR). Therefore, as a standard risk control, beneficial owners, or parties that retain the risk of a transaction, as a best practice, should employ a real-time data-to-risk infrastructure.
Valuable Swap Data Extends Beyond the Original Trade
The newly created regulatory structure that requires all “available-to-trade” swaps to be transacted on a SEF, or subject to its rules will cause substantial shifts in price correlations for ancillary asset classes.
This is true because although there is data value in capturing details of an initial swap transaction, the same transaction may be subject to post-trade requirements, such as portfolio compression, risk mitigation exercises, and block trade allocation, as secondary transactions that will likely have pricing effects on related asset classes, including listed derivatives.
For example, entities that provide risk mitigation services such as portfolio compression where the execution results in a netting of trade count and/or notional value of swaps, as opposed to a transactional discovery mechanism, that assist market participants in managing exposures and other sources of risk, may be deemed to be a SEF.
Although, in this instance, the entity merely redistributes or processes a mitigation service for market participants’ risks, where the service produces executable terms or prices and new trades are executed, the service is considered to be a SEF – and data capture of this secondary transaction is necessary.
Importantly, this example describes how the real-time public reporting (embargo) rule significantly extends beyond time and sales data for an initial swap to a requirement for netting-based transactional information thus, creating a new layer of potentially significant opportunistic data advantages for those market participants with access to secondary data.
The next generation of transparency appears to be opportunistic, with data aggregation and automation taking center stage.
