Swap Data Repositories (SDRs): Most Complex, Challenging Component of Dodd-Frank

I had the honor of participating at the joint CFTC/SEC public round table today on the topic of the Swap Data Repository (SDR).  The session, which can be found at www.cftc.gov covered a wide range of topics ranging from data standardization to confirmation workflow to reporting requirements to governance issues.

One of the first steps will be for the Commissions to define the scope and requirements of the SDR and to then open up a registration process.  It has become pretty apparent at this stage that there will be a need to have more than one SDR, with a big question of how many and what type of SDR might be allowed.  The risk of having just one SDR serve as the utility is fairly obvious, but the practical issues are how difficult it will be and how long it will take for one SDR to meet the fairly broad goals of the reform.   Even with multiple SDRs that have experience in data warehousing and regulatory reporting, it may take years to get every trade in the repository as there is a backlog of over $500 trillion notional of OTC derivatives and the need to connect to hundreds of dealers and major swap participants.

My personal view is that the Commissions should allow the market to compete to ensure that SDRs offer the fairest pricing for mandated services and that innovation is promoted.   Furthermore, even having one SDR per asset class could pose a potential bottleneck as Swap Dealers and Major Swap Participants rush to try to connect to the Fx SDR, CDS SDR etc.

Fortunately, lawmakers wanted to relieve the end-user from having the burden of reporting their derivatives to the SDR and currently the Swap Dealer would be required to post.  However, this makes some of the duties of the SDR more challenging.  For example, the bill requires the SDR to confirm the trade.  The intent, according to my discussions with Capitol Hill, is to confirm that the details of the trade submitted are correct, not to confirm that the trade between the Swap Dealer and its counterparty is confirmed or matched.  It would be very difficult to confirm two sides of a trade without having both sides of the trade submitted to the SDR.

Another requirement is that the SDR is supposed to monitor entities that are claiming clearing exemption and the extent of their claim.  Because end-users who can show that they are not a Financial Entity and are reducing commercial risk can voluntary ask for exemption of clearing, this could be a very crucial but subtle requirement of the SDR.  If the Swap Dealer is on the hook for keeping records to show that the end-user is exempt, are they on the hook if indeed the end-user should not have been exempt from clearing?  If the SDR is on the hook, then again it would need both sides of the trade to know who both counterparties are and be able to confirm that the exemption is allowed.

In either case, the end-user will need to have a policy in place and documentation to support that it qualifies for the end-user exemption.   Given that the overall goal is to have the law implemented  by July 2011, it’s time to start thinking about it now.  We certainly would advise clients currently complying with ASC 815 (FAS 133)/IAS 39 to leverage the documentation already in place.  Otherwise, your risk management policy should be leveraged.

The end-user may be largely exempted from the key regulatory requirements, but that does not mean that you have no work to do and will not be impacted as we are seeing by the SDR language, which is only 10 pages of the 2000+ pages of the reform.