Next year will mark a decade since the start of the global financial crisis, writes Larry Thompson, vice chairman of DTCC and chairman of the board of DTCC Deriv/SERV. While there has been significant progress in addressing the shortcomings that led to the near-meltdown of the global financial system the question remains: Have we done enough to protect against a future large-scale crisis?
While the implementation of stricter rules and regulations have, at times, presented challenges for market participants, there’s widespread consensus that they have been effective at combatting market abuse, minimising fraud and aligning incentives and conduct with the long-term interests of clients. There are many signs of this across the industry, but the decision by the US Federal Reserve in June to give banks the green light to issue dividends and stock after all 34 major institutions passed stress tests mandated by the Dodd-Frank Act is a good example that the new rules are generally working.
While this is good news for the stability and integrity of the global marketplace, a cautionary lesson of the 2008 crisis is that it continues to grow more complex and interconnected. In addition, the nature of risks is constantly evolving in response to diverse regulatory, structural and technological changes. Because of this reality, the need to monitor and analyse the relationships between financial market counterparties and across market infrastructures, such as payment systems and central counterparties becomes even more important with each passing year.
Understanding where risks may be building up in the global system was a driving factor behind one of the most important reforms introduced after the crisis: the requirement to report derivatives transactions to regulators with the intention of bringing new levels of transparency and risk mitigation to the global market. While some progress has been made, unfortunately this goal has still not been fully achieved due to domestic legal barriers that prevent or limit information sharing across jurisdictions and the lack of common reporting standards as highlighted in the latest Financial Stability Board (FSB) report (FSB Report on Reforms to OTC Derivatives Markets, June 29 2017). That said, the FSB has been coordinating activities among local regulators to resolve these issues and to establish a harmonised approach that would provide regulators with the market information they need to better understand exposures and the potential for systemic shocks to the system. Despite these best efforts, it is widely anticipated that the G20-mandated task of implementing a global reporting framework may not be finalised before the 10-year anniversary of Lehman Brothers’ demise.
In parallel to its work on data harmonisation, the FSB is also coordinating efforts to standardise the use of unique transaction identifiers (UTIs), which were introduced to identify individual transactions in reports to trade repositories, thus avoiding double-counting and providing a crucial element of the global infrastructure needed to accurately monitor systemic risk. The FSB is now working with the industry and the regulatory community on governance arrangements for a global UTI, and we’ve recommended that global consistency and coordination in the implementation of the UTI be made a criterion of the future governance model.
Regulators and the industry have also been focused on the adoption of legal entity identifiers (LEIs), which are complementary to the reporting of derivatives and applicable to other financial instruments and market segments. LEIs provide consistency to the identification of parties to financial transactions to ensure a transparent and integrated view of exposures. According to FSB data, the LEI is now applicable to regulations in over 40 jurisdictions. By December 20 2017, some 916,981 entities from 200 countries had obtained LEIs – an exponential increase in number since the LEI was first used in 2012.
Since the financial crisis, the industry and regulatory community have made great strides in introducing post-trade initiatives to assist in mitigating systemic risk. But as we look ahead, we have more work to do to achieve the level of transparency and risk reduction first identified by policymakers almost a decade ago. We urge the industry to continue to collaborate across participants, technology providers and the regulatory community to ensure we can overcome these long-standing hurdles in order to create a safer and more resilient financial market for all.