There is a famous quotation, often ascribed to Winston Churchill, that goes: "The Americans will always do the right thing… after they've exhausted all the alternatives." Much the same could be said about the US Commodity Futures Trading Commission (CFTC) and its approach to swap data reporting.
On December 22 of last year, the CFTC issued draft technical specifications for 120 data elements that firms are reporting to swap data repositories (SDRs) as part of their obligations under the US Dodd-Frank Act. It was perhaps the most arcane, impenetrable document the regulator has put out in recent months. But it raised hopes that the CFTC will finally clean up a gigantic mess that emerged out of its own Dodd-Frank rules and, in the end, bring greater harmony to commodity derivatives markets.
Let me rewind to explain how we got here. The 2008 financial crisis was so bad, in part, because nobody had any idea what sorts of systemic risks had emerged out of the vast web of bilateral, over-the-counter derivatives trades that firms had executed with one another. So regulators decided that all those trades needed to be reported to giant databases. By monitoring those databases, regulators would gain visibility into the previously opaque OTC markets.
In the US, those databases were called SDRs, and the CFTC granted the SDRs significant leeway in how market participants would report the details of each trade. That meant the handful of SDRs that emerged each adopted mutually unintelligible templates for swap data reporting.
This made it impossible for the CFTC to make apples-to-apples comparisons of trade data across the different SDRs. Making matters worse, some of the SDRs also took a distinctly relaxed route to validating the data submitted by market participants. If you want to report a swap with an absurdly high notional amount of $1 quadrillion or an underlying commodity called "ASDFGH", you can do it.
As a result, SDR data is riddled with errors and inconsistencies. The CFTC admitted as much in a study published in November, for which CFTC staffers reviewed all trades reported to SDRs over a 12-month period. Among other things, they found that more than a quarter of a million interest rate swap (IRS) and credit default swap (CDS) transactions, representing some $30 trillion in notional volume, had been reported without valid legal entity identifiers, the tags assigned to individual counterparties. And the IRS and CDS data is relatively tidy compared to the data on nonfinancial commodity swaps, which by all accounts is tremendously messy.
Which brings us back to those draft technical specifications that the CFTC released just before Christmas. By putting out that document, the regulator has taken an initial baby step towards imposing order on the chaos of SDR reporting.
Of course, the road ahead will be long and painful – particularly for firms that have grown accustomed to reporting in one format, only to discover the standards have changed. But unless the CFTC does something along these lines, SDR data will continue to be garbled, and swap trade reporting will continue to be a pointless box-ticking exercise for all parties involved.
So the CFTC should be commended for doing the right thing. It's just a pity this couldn't have happened sooner.