Interview with Larry Thompson, Vice-Chairman of DTCC and Chairman of the Board of DTCC Deriv/SERV
"It is challenging to obtain a coherent view of systemic risk"
Has the financial system become safer since Lehman? Yes, but only with a caveat, says Larry Thompson, Vice-Chairman of the global settlement and clearing giant DTCC. Although there is more data available than in 2008, it is difficult to obtain a coherent picture of all risks on the basis of this data, explains the Chairman of the Boards of the DTCC derivatives division Derivatives/Serv.
Mr. Thompson, when you look back on the Lehman collapse ten years ago, what is the most important insight from today's perspective?
The key learning from the 2008 global financial crisis was to ensure that banks are well capitalized and to improve transparency in the markets. The financial industry requires a system that is stable, sound and secure. DTCC played a critical role in helping to identify credit exposures during the crisis by providing data to regulators and the public on global derivatives markets. Our Trade Information Warehouse, which processes approximately 98% of all credit derivative transactions in the marketplace, proved to be a vital source of information as it helped to stabilize the market during the crisis.
How did DTCC take part in the aftermath of the Lehman collapse?
In total, we netted $285 billion in credit default swaps in terms of gross nominal value, reducing them to an effective payment of $12 billion, almost $6 billion of which was accounted for by Lehman – significantly less than the amount that was initially referenced. We also offset $500 billion of Lehman's open positions without having to use the clearing fund.
What are the lessons learned?
We learned that there is a significant lack of transparency in global financial markets. Trade repositories have been established worldwide as part of wide risk-mitigating reforms mandated by G20. Unfortunately, a lack of global coordination and a local approach towards implementation of trade reporting rules has resulted in a lack of global standards and multiple repositories in many of the jurisdictions, with divergent data standards and data collection requirements. While there is a lot of additional data available if compared to 2008, unfortunately it is challenging to obtain a coherent view of systemic risk based on all this data. This is a challenge which needs to be urgently addressed now to avoid similar crises in the future.
So there is more data, but there is no collective framework for its collection in interconnected markets?
I can say with certainty that regulators now have a better view of what is happening in their respective markets. Much of what is possible today would have been inconceivable in 2008. Local supervisors have more transparency in the marketplace through data reported to trade repositories, but only in their individual market. The derivatives market however is global in nature. A global approach is therefore required to determine where market stress begins and how it moves from one jurisdiction to another. We haven’t achieved this holistic picture yet. Global data standards are needed now to obtain a view of global systemic risk.
This seems surprising, as the need for a global approach was recognized at the G20 summit in 2009. Or what do you think?
The 2009 Pittsburgh Summit initiated a comprehensive set of reforms aimed at bringing more transparency to financial markets through trade reporting. But each of the G20 jurisdictions has since set up their own trade reporting frameworks - and not all of them have even implemented all of the measures proposed by the 2009 meeting. The US was the first to put the required measures in place in 2012, with the CFTC reporting, followed by the European Union in 2014; Japan and Singapore were ready in 2013. However, the existing trade reporting rules do not yet cover all asset classes and the data that needs to be reported is not standardized.
Isn't that wishful thinking?
I certainly hope not. We see a growing recognition by international standard setting bodies such as CPMI/IOSCO and the Financial Stability Board (FSB) that they are best placed to take the lead in ensuring that local regulators use standards that are globally compatible and that they conclude mutual information exchange agreements. On such a basis one could bring more visibility into the opaque area of derivatives regulation.
Who is currently the pacemaker?
CPMI/IOSCO and the FSB, with the CFTC and the European Commission working closely with these standardization bodies. DTCC is also extremely involved - we are an associate member of IOSCO and work closely with global regulators. We have much to contribute here. We have an 80% market share in derivatives reporting and are the largest derivatives trade repository in Europe. Working better, together, we can significantly improve transparency in global financial markets.
In which asset classes do you see the greatest pressure to act?
Our Trade Information Warehouse for CDS processing continues to be leveraged by global regulators. We started with CDS because they‘re the most standardized type of derivatives. But the biggest class is interest rate swaps. Interest rate swaps should be the next focus area in terms of improving transparency.
However, transactions in interest rate swaps are already reported?
Yes, of course, but it is key to agree uniform reporting standards.
What is the relationship between the USA and Europe in this realm?
It is a very cooperative one. Recent achievements by the FSB and CPMI-IOSCO on governance and technical standards have led to policy decisions being made in each of these jurisdictions, and others, that are expected to result in broad adoption of a common framework for derivatives reporting. Naturally, occasionally there are different views, but always against the background of constant dialogue. I’m very confident that we will see further progress in this regard in the near future.
There were concerns about the new European data protection regulation that it could hinder the exchange of information.
Data protection is to be welcomed first and foremost, and this European legislation pertains to personal data, not transaction data. Transaction data should remain accessible and can be made anonymous. It should not be used to inform on market players’ trading strategies and patterns, but rather to identify systemic risks – its purpose.
At this stage, would you say that a financial crisis like 2008 can no longer happen?
A financial crisis can manifest itself in different ways; however, all financial crises have one thing in common: they are based on a lack of transparency in certain market areas and a lack of understanding of risk and market developments. At a minimum, improved transparency enables investors and the public to be better protected.
Is the level of transparency higher than in 2008?
It is certainly higher.
So a lower risk of a new crisis?
The increased transparency achieved since 2008 should be helpful in the event the industry has to deal with another significant market event.