Fordham Law

EC Official: Don't enforce trade repository indemnity rules

Corporate Law Center in IFLR, June 16, 2011

Media Source

Lukas Becker | Juen 16, 2011

A senior EC official has suggested that rules requiring indemnity agreements for swap data repositories before they share information with foreign regulators might not need to be enforced practically if Europe and the US both have similar provisions.

“If you have similar rules on both sides of the Atlantic, is it possible that because you have common and consistent rules that you can actually agree on, that they don’t need to be applied in practice?” said Patrick Pearson, head of Financial Markets Infrastructure in the EC’s Internal Market Directorate General, speaking at a Fordham Law School event in London on June 10.

Pearson added: “That is a third option that cannot be discounted.”

One market participant said it was the first time they’d heard this suggested approach. They said it might solve the US-EU issue, although it wouldn’t apply to other foreign regulators.

“Asian regulators will still need to sign these kind of agreements, both in the US and in the EU,” said the participant.

Information gap

The Dodd-Frank Act’s requirement that swap data repositories receive indemnities from US and foreign regulators has concerned some market participants.

Dodd-Frank requires US swap data repositories to receive an indemnity agreement from any party requesting information. The agreement says the requesting party will indemnify those trade repositories for any expenses resulting from any litigation that started as a result of that information. 

General counsel of the Depositary Trust & Clearing Corporation (DTCC), Larry Thompson, said in a podcast on its website that foreign regulators are highly unlikely to give any indemnity to US-based swap data repositories.

"Without those agreements the following would happen. Swap data repositories could be legally precluded from providing information to overseas regulators. Then foreign jurisdictions will be incentivised to create their own local repositories to avoid indemnification," said Thompson.

"There will be a proliferation of local repositories in different jurisdictions worldwide, leading to less transparency in the marketplace," he added.

While most swap data repositories are based in London, the repository for credit default swaps (CDS), the DTCC, is based in the US. it does however maintain a mirror image of the CDS data in a London-based repository, which also serves as the global equity derivatives repository.<BR></P><p>Given the impact of CDS contracts on the financial crisis of 2008, one source said a regionalisation of information gathering may leave a gap for systemically important information to fall into.

Retaliation or mutual recognition?

Speaking at the Fordham Law School event in a personal capacity, Kathleen Kelly, senior counsel in the SEC’s Office of International Affairs, said that while the Commission hasn’t had a chance to officially take a view on the issue yet, it is aware of international concern about the provision.

“It’s an issue that we are very much aware of, and we are having discussions with foreign counterparts as to how we can remain faithful to the statute yet still give the access which is very important,” said Kelly.

Pearson said there is no similar provision in European legislation.

“We did have one consultation with our industry and our regulators, but the general feeling was that this was not something that we thought to be propitious,” he said.

However in a March 30 draft report entitled “Proposal for a regulation of the European Parliament and of the Council on OTC derivatives, central counterparties and trade repositories” by the European Parliament’s Committee on Economic and Monetary Affairs, France’s Jean-Paul Gauzès proposed the following amendment to Article 63, paragraph 2, point d a:

“the relevant authorities of a third country that has entered into a [sic] international agreement with the Union as referred to in Article 62 provided that they agree to indemnify the trade repository and the EU authorities for any expenses arising from litigation relating to the information provided by the trade repository.”

This is the exact same text as in Dodd-Frank – including the syntax error.

Pearson said he hadn’t had a chance to speak with Gauzès about why the European Parliament included the indemnification clause. “Either they thought this was a spectacularly good idea, or they read something into that provision that I haven’t yet been able to uncover,” he said.

The market participant said they understood the amendment as either a retaliation against the US provision to save face, or the basis of mutual recognition between the US and EU.

Sharing is caring

While the potential consequences of the indemnity clause are now clear, what is unclear is how the clause got into the Dodd-Frank Act in the first place.

“You know the old saying about success having many fathers and failure having none? This is a case where no-one seems to claim responsibility for having inserted this provision into the Act,” said Don Lamson, a counsel at Shearman & Sterling in Washington DC.

“Having helped write Dodd-Frank, when this issue arose I asked a lot of people whether they recalled where it came from, and no-one can remember.”

Lamson nonetheless believes that the idea behind the indemnity clause is understandable, as swap data repositories need to be able to honour the confidentiality of information provided by the parties that are transacting in the trades.

According to Lamson, the problem is that Dodd-Frank ignores the idea of an ever-shrinking globe, making its extraterritoriality is unclear. Therefore US regulators take the position that where a single US counterparty is involved, Dodd-Frank protections are coextensive.

But foreign regulators are under the impression that they’re all on the same team, and that information sharing should be second nature.

Alternative approaches

So what is the best approach to the indemnification issue? Lamson said that the market must recognise that all regulators have an interest in this information, and they need a quick method of obtaining that information.

There needs to be more trust between regulators, particularly in times of crisis. In the absence of trust, you see corresponding requests for indemnification, he said.

“Everyone says the DTCC seems to have created an approach that works,” he said. “I can’t say one way or another whether it’s the best way to do it, but enough people have said that it seems to work that I think regulators should look at the model.”

Writing for The Congress Blog on on May 25, DTCC general counsel Larry Thompson suggested that one option is for the US Congress to modify the indemnity provision in a technical corrections bill.

"Congress could 'deem' regulatory compliance with the indemnification provision in situations where foreign regulators are carrying out their responsibilities in a manner consistent with international policy forums, such as the ODRF [OTC Derivatives Regulators Forum]," said Thompson.

Another suggestion floated by market participants is to have all the global data aggregated in one place outside the US and EU, and then mirrored to local or regional trade repositories to avoid any specific national provisions. In that case EU regulators won’t have access to the US swap data repositories, but it won’t matter as they’ll have the same information.

“But it’s only conceivable if US regulators accept that you do not report directly to the US, but you report somewhere locally,” said a market participant. “If you do that you avoid any kind of specific national provision. That could be a way to bypass that kind of provisions.”

Yet another approach could be to open international negotiations on coordinated rules and data confidentiality. Dodd-Frank has a section on international cooperation, so the US could sign a multilateral agreement with the International Organisation of Securities Commissions (Iosco) for example, said the market participant.

Alternatively the US could sign bilateral memoranda of understanding between individual regulators that agree on reciprocity involving confidentiality of information.

“The only problem is that for the time being US agencies have never said that those international agreements will actually avoid having indemnification procedures in place,” said the market participant. “So they have not committed on anything like that for the time being.”

Going by EU internal market commissioner Michel Barnier’s letter to US treasury secretary Tim Geithner last month describing regulation as a two-way street, and Geithner’s subsequent speech calling for more coordination on derivatives regulation, Lamson said it is clear that there is dialogue going on.

Where that dialogue will lead is unclear. What is clear is that all participants need to find a solution to this tricky and potentially dangerous issue if effective oversight of the sector is to be achieved.