Bart Chilton Argues in Favor of Reform as FTF Panel Warns Against DIY IT Architectures
Shortly after CFTC Commissioner Bart Chilton declared at the 7th Annual OTC Derivatives Operations & Processing Conference last week that the Dodd-Frank reforms will deliver transparency, it became clear during a subsequent discussion that if firms haven’t done so, they need to get their IT architectures in place now to stay on top of the forthcoming OTC reforms.“When we get Dodd-Frank in place, there will be transparency,” said Chilton at the conference sponsored by Financial Technologies Forum (FTF). “I know we are a pain,” he added in reference to regulators.
The regulatory process may benefit from “the observer effect,” Chilton said. He was referring to the new views that regulators will have into the new facilities for over-the-counter (OTC) execution and clearing such as swap execution facilities (SEFs) and swap data repositories (SDRs).
The new transparency will work both ways as observed participants can let the regulators know what they’re thinking.
Clear Everything
To bolster his argument in favor of Dodd-Frank, Chilton recounted milestones that led to the Great Recession—the collapse of the “overleveraged by 30 to 1” Lehman Brothers; the creation and wide acceptance of overly complex OTC instruments; and the repeal of the Glass-Steagall act.
Chilton was quick to emphasize that he is not against firms taking risks in commodities and financial markets. But the risk should not have “the gravitational pull to bring down the rest of the economy,” he said. “So, anything that can be cleared, should be cleared.”
The commissioner also repeated his assertion that the CFTC will appeal a recent ruling against its position limits initiative for commodities markets; ISDA and SIFMA have been challenging in court the CFTC’s efforts to implement a position limits rule.
In a Q&A with FTF News earlier this month, Chilton said that position limits will impact OTC trading.
“It’s one thing to say this is what they’re doing on a regulated exchange and potentially have concerns about that. But there could be more concerns based upon what the OTC position is,” Chilton said. “If you ameliorate a large concentration in on-exchange trades by offsetting them with OTC positions, you could also exacerbate that circumstance to the point where it could be an even greater concern. And we’ve seen that in recent years.”
If the position limits rule goes into effect via Dodd-Frank, there will be a new view into OTC trading and on-exchange trading.
“We will have some fairly balanced parameters for the positions that traders can take,” Chilton said. “Right now, we’re in a little bit of a netherworld because the banks took us to court and they have won at least a temporary reprieve on moving forward with position limits. I expect the agency to appeal that position. I also expect that we will promulgate yet another position limits rule in the not too distant future.”
Plenty of Scandal
In contrast, action has been slow for many of the other Dodd-Frank rules to come, Chilton acknowledged. A little more than one-third, or 133 of the expected 398 rules, has been completed. At the same time, there has been a steady stream of scandals in financial services—MF Global’s meltdown, the global Libor scandal, and banks ripping off credit card customers—making the case for reform.
Chilton also argued for new controls upon high frequency trading (HFT) firms or “cheetahs” as he’s dubbed them although he says he’s aware of their positive impacts upon liquidity. “I think they need some regulation—they’re just too fast.” His main concern is that there is no kill switch to prevent extreme market events such as the “Flash Crash” of May 6, 2010.
The standard fine is $140,000 per violation, which is generally perceived to take place during one day. But HFT firms could be committing violations in seconds. “They should be fined by the second.
At the FTF conference, Chilton also said that the CFTC is likely to finally clarify its definition of a SEF. “I expect by the end of the year that we can have the SEF specification out and done,” he said.
Despite the recession and new regulations, the financial services industry has bounced back, Chilton said. “Since 2008, what sector has done better than the others?” he asked. “The financial services sector … Good show for them.”
Yet to keep those positive returns moving in the right direction many firms will have to come to grips with the IT infrastructure demands of OTC reform, according to a conference panel on whether firm should buy or build the technology they need for executed and cleared OTC trading.
While preparing for the new execution and clearing of OTC instruments is “an incredible time for IT,” the panelists agreed that it was too late for most firms to build new systems internally from scratch. “You’d be behind the eight ball now,” said a panelist.
While the Dodd-Frank reforms have taken their time to come to fruition, the “big ticket items” such as enterprise-wide accounting, reconciliation and collateral management systems need a lot of lead time if they are to be created internally, according to the panel.
In addition, the “sticker shock is unbelievable” for the cost of many of these internal development projects, a panelist said. C-level executives.
The panel said some of the key points to keep in mind while building out an IT architecture are:
- The regulators are still formulating some key specifications and using a third-party provider can help in anticipating what the final versions will be;
- The OTC overhaul will impact front, middle and back-office operations so be prepared to let IT straddle the traditional demarcations;
- Use the latest best practices to guide the creation and deployment of an infrastructure;
- The buy side may not be able to rely on sell-side broker-dealers to supply the IT as they have in the past;
- And be rigorous when reviewing the capabilities of third-party suppliers and take control of the service level agreement (SLA) negotiations. Failing to do so could mean missing regulatory requirements and facing harsh penalties.
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