It’s widely recognized that politics – particularly as practiced by Congress --plays a central role in the outcome of financial regulatory reform. But in a January report from Boston-based research firm Aite Group titled “Smart Regulation,” author and senior Aite analyst Paul Zubulake goes a step further.

Leaving politics aside, he writes, “The key component of all the discussion is how regulators can use technology to prevent another crisis.”

Specifically, he says, “Improving and creating standards in data management will allow the regulatory community to have tools at their disposal” as they deal with the next  financial emergency.

The first step, according to Aite, is to increase transparency in the over-the-counter markets by mandating the processing, clearing and eventually electronic trading of most OTC products.

This will, he says, “create an electronic trail of a firm’s activity.” There cannot be any exemptions from this model, he says, including buyers and sellers of OTC derivative contracts who would like to be exempt from clearing due to the increased costs that would entail.

“The answer to providing smart regulation is in the data,” Aite says – how to manage it, consolidate it, understand it and react to it. “Data collection is no longer a technology issue, but a business issue that firms need to address.”

The good news, Aite says, is that there is already an organization dedicated to addressing the need: the Enterprise Data Management Council. This non-profit trade association was created by the financial industry to make good data management a business and operational priority.

Members are 39 financial services firms and technology companies, including SunGard Data Systems, Interactive Data, Broadridge Financial, Bank of America, and JP Morgan Chase.

The Council's agenda is focused on the business and technical challenges of documenting best practices in operational systems; of creating auditable methodologies to determine how mature a company’s management of its data is;  of standardizing the use of business emantics and identification of legal entities; and of  improving the management of data from creation through consumption.

“The common goal is to ensure that business users trust and have confidence that the data they need for precision-intensive applications is fit for purpose, accessible when needed, easy to integrate into downstream systems and comparable across multiple sources without the requirement of additional transformation or the need for manual reconciliation,” the council says on its Web site.

In managing data, Aite says that there are four components that need to be captured by regulators: data that foreshadows risks; data that shows the amount of debt taken on and capital available to firms; data that shows the interconnectedness of investors, firms, and contracts; and data that shows how exposed a market is to particular types of risks.

The idea is to create a centralized depository from which systemic risk can be monitored.

For its part, the EDM Council has proposed a three-step effort: First, creating a National Institute of Finance, comprised of a central national data depository and a research and analytics center. Then, implementing standards, creating precise identifiers of all financial instruments; and finally, managing the information, which includes coordinating and validating data collection

The only way to effectively address systemic risk, Aite concludes, is by providing the regulatory community with direct access to a database that contains all firms’ networks of financial information.

Let’s hope Washington is paying attention.

This blog post can also be found at SecuritiesIndustry.com.

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