The Securities and Exchange Commission told Congress today to grant regulators “direct access to real-time data” on credit default swaps (CDS) and other derivatives.
The request comes, the agency said, because the lack of such information hampered its efforts to investigate potential fraud and market manipulation in the over-the-counter (OTC) derivatives markets during last fall’s financial crisis.
The SEC’s enforcement actions in investigating market manipulation in OTC derivatives “were seriously complicated by the lack of a mechanism for promptly obtaining critical information – who traded, how much, and when – that is complete and accurate,” said Henry Hu, the director of the SEC’s new division of risk, strategy and financial innovation, in written testimony to the House Financial Services Committee.
Hu testified that “data on securities-related OTC derivative transactions were not readily available, and needed to be reconstructed manually.” He asked Congress to expand the SEC’s inspection authority over trade data repositories and clearinghouses for derivatives.
The comments represented a rebuke to industry efforts aimed thus far at making more information on CDS and other OTC derivatives data more readily available.
The main collector of information on CDS contracts has been the Depository Trust and Clearing Corporation (DTCC), which could be required to supply it in real-time to the SEC. DTCC chief spokesman Stuart Goldstein said the clearing corporation has provided the SEC with derivatives data when asked, and “will continue to look for ways to be responsive to their requests as they ask for information.”
The DTCC collects data on swaps contracts and places in its Trade Information Warehouse (TIW). Last Nov. 4, DTCC began publishing weekly aggregate data for some of the contracts placed by dealers in the database.
“One of the basic principles of the warehouse has been to try and make information available to regulators as they require it,” Goldstein said.
"With insider trading investigations in particular, speed is often an essential element for success," said SEC spokesman John Nester. "The exchanges can rapidly provide us with trading information they believe is suspicious. Real-time access to the trading information and to the identity of traders is key. Currently, we simply do not have these tools with regards to the CDS market."
The TIW is a service offering of DerivServ, DTCC’s confirmation and affirmation subsidiary, which is not regulated. DTCC in May announced filing applications for the TIW to become a trust company regulated by the Federal Reserve Bank of New York and the New York state banking authorities.
DTCC says its CDS data proved critical in calming the markets last year when Lehman Brothers declared bankruptcy. While market analysts estimated potential net liabilities on CDS on outstanding Lehman obligations could top $400 billion, DTCC released data from the warehouse showing the amount would be less than $6 billion. Ultimately, $5.2 billion was transferred among affected Lehman counterparties, DTCC said.
“One very important case going on right now involves using credit derivatives for insider trading purposes involving people who learned about certain restructuring events of a company, and used credit default swaps as a way of betting on that transaction,” Hu told the Committee during questioning. “A drastic increase in transparency coming from the clearinghouses and swap repositories would help us ensure a greater ability to detect market manipulation.”
Hu also told legislators to define CDS as “securities” under the Exchange Act; fold inter-dealer CDS brokers into the regulatory framework; and specifically define how regulators could determine when swaps trading risks destabilizing the market or large individual participants.
House Financial Services Committee Chairman Barney Frank released Oct. 2 a revised version of the Over-the-Counter Derivatives Markets Act of 2009, a draft bill for regulating OTC derivatives first introduced in August by the Obama administration. The bill does not define CDS as “securities” under the Exchange Act nor specifically include inter-dealer brokers for CDS regulation.
Frank said he would heed suggestions and make improvements to the bill. For instance, he said corporate users, which buy OTC derivatives to hedge risks to their businesses, may be excluded from certain clearing and collateral provisions. Most CDS are traded between financial institutions, the majority of which are dealers, but Wall Street has rallied support of non-financial institutions to convince Congress to avoid proposing rules that could make it more difficult to sell derivatives.
This article can also be found at SecuritiesIndustry.com.
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