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Frank/Dodd compliant Derivative Trading Birds Eye View - 2nd June 2013 raman@assetcorporation.

net Introduction 2013 is a make or break year for any organization participating in the global derivative markets. Title VII of the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank) [D/F][1] requires all trades on qualifying derivative instruments to be exchange traded, cleared and reported to public utilities known as data repositories. Exchange traded implies fungible assets with standard contracts, terms and procedures. Clearing and Reporting a trade requires standardization at every level of a trade. We will run into mayhem if trading parties and traded securities are not denoted by standard references. Staus Quo

Abbreviations Swap Dealers (SDs); Major Swap Participants (MSPs); Future Commission Merchant (FCM); Derivative Clearing Organizations (DCO); Swap Execution Facilities (SEF); Designated Contract Market (DCM); Central Clearing Party (CCP); Swap Data Repositories (SDR); Eligible Contract Participant (ECP) Unique Swap Identifier (USI) (aka UTI) Unique Trade Identifier (UTI) (aka USI) Unique Counterparty Identifier (UCI) (aka LEI) Legal Entity Identifier (aka UCI) Unique Product Identifier (UPI) Prior to D/F, derivative trades were not cleared and firms assumed all the responsibility, from trading through settlement, including book keeping, valuation, risk management and execution, over the life of the derivative trade, resulting in significant moral hazard, lacking --transparency, price discovery and fungibility--. Each firm had their own set of counterparty mnemonics, security identifiers and custom valuations making reconciliation amongst firms impossible.

Many basic questions come to mind, such as: What trades are qualifying? Who can trade? What assets are qualifying? Who must report? Are there exceptions to the rule? What are the time limits to report a qualifying trade? Where does one report the trade? What happens to reported trades? Who can access those trade records ? Without basic definitions and clarifications to these, trading over exchanges, clearing and reporting are just not possible!

Roles defined The D/F act defines specific roles. Derivative Market The D/F Act defines the following roles: Participants have to be registered as either Dealers Trading entities (MSP, ECP); (SD), Participants (MSP) and transact through venues intermediaries (SD, FCM,MSP); such as SEF and DCMs and the D/F act assigns Trading Venues (SEF/DCM); particular responsibilities and obligations associated Clearing (CCP,DCO,FCM); and with each role. Registration procedures are Repositories (SDR). described in [4]. Firms may register with either NFA or CFTC.

Processes Defined Under D/F, qualifying derivatives may be traded only over execution facilities (SEF/DCM) and have to be cleared through designated clearing entities known as Derivative Clearing Organizations (DCO). Derivative transactions are to be submitted to 3rd party repositories, SDR [2], so that all trades are centrally available for comprehensive oversight. Thus, in addition to imposing clearing and execution requirements, the D/F Act creates robust recordkeeping and real-time reporting regimes. Defines Product Eligibility Securities that are subject to D/F act; and Participant criteria including the so called End User Exemption as to who is subject to these regulations [3]. Standard Reference To ensure uniform and universal counterparty identifiers, industry has adopted LEI framework. Trading parties must report trades using Legal Entity Identifiers not proprietary mnemonics companies had used. There are vendors providing LEI services. Adopting LEI and using those standard identifiers to denote trading partners industry wide and through the entire trade life cycle will eliminate the usual problems faced when firms failed, such as LTCM in 1998, Lehman in 2008, AIG-2008 and MFG in 2012. Under D/F, all counterparties in the OTC derivatives market must be self-registered as only trades between registered parties will be cleared by the DCO. DTCC launched the first LEI Solution on CICI Utility, accessible here Reflection While D/F Act requires derivative trading firms to undertake major technology initiatives to be compliant, in the event of another failure in the derivative markets the world can anticipate an orderly cleanup and recovery due to these sweeping regulatory requirements. The world will not be faced with such questions as: Who is this trade with? Or what is this instrument?. At the least, that is the stated objective of the regulators behind these reforms. As a matter of fact, Title II of the Act, provides for orderly liquidation of firms when necessary. At an abstract level, as a result of the D/F Act, derivative trading becomes operationally and structurally similar to the proven equity markets. Notwithstanding the growing pains, that is a good thing! References [1] [2]

[3] [4] Acknowledgements This brief is part 1 of our series on technology strategy and realization plan for trading derivative securities worldwide. The research and writing is subsidized in part by ClearTrack LLC, a leader in helping major MNC implement Dodd/Frank compliant trading systems. Author acknowledges valuable insight and editorial input from Dhiren Rawal and William j Sweeney (risk, data, and analytics LLC) . However, author is solely responsible for the content.