The Dodd-Frank Wall Street Reform and Consumer Protection Act, passed in July, created the Office of Financial Research (OFR) with an explicit goal of helping the U.S. Treasury assess banks' risk by collecting, harmonizing and analyzing banks' financial information. To accomplish this, one of the OFR's mandates is to develop standards for reference data and positional reporting as well as to develop a catalog of financial entities.
These are very laudable goals. But can they be achieved?
One of my first assignments (in 1981) was managing a firm's mid-office money market operations. This was a fancy way of saying I managed a data entry group responsible for typing trade tickets back when this wasn't in a trader's job description.
On most days, upon arrival I would get "a talking to" (read: reamed out) by at least one trader whose positions were off because tickets were entered incorrectly. The handwriting was illegible, the ticket was written wrong or the reference data was miscoded - meaning, we entered the wrong customer, security or ledger number on the ticket. Fun, eh?
While order management systems, electronic trading and trader-entered tickets have eliminated many keypunch errors, unfortunately we still have not been able to rectify the reference data-related challenges. There are thousands of customers and millions of products, and a large number of these entities and even products are not uniquely identified.
In the world of money markets, discount notes would always mess us up, as they had some secret (or at least, secret to us) algorithm for generating a CUSIP; today, it's OTC derivatives, foreign products or products that the trading floor bought before the mid-office could set up the security - not to mention counterparty data and delivery instructions that can be very difficult to get right, as one money manager can have thousands of named accounts, many seemingly similar, but only one is right.
Now comes Dodd-Frank and, voila, all of this information and very detail-dependent reference data is to be normalized, centralized and accurately valued. This is fantastic! All of our nightmare challenges of determining which product was traded, its underlying characteristics, the counterparty, and its reference price and figuration formulas all will be centralized, clean and pristine.
All I can say is: "From Dodd's and Frank's lips to You-Know-Who's ears." Good luck.
This will be an incredible challenge that will cost the taxpayer/industry/investor dearly, and in the end, I am not sure that it will (or even can) be successful. Color me skeptical.
First, what is the incentive for getting this right? While I am sure that the OFR will be thoughtful and diligent and will want to do "right," the incentive for getting the proper valuation characteristics will not sit in Washington; it will sit with the dealers and investors - after all, they're committed (it's their money), while the government's involvement is only statutory.
Second, even members of the same firm can't agree on a product's underlying characteristics, valuation or even valuation methodology. If bankers in the same institution can't agree, how are we going to drive industry consensus?
Now, certain constituents have incentives to shade prices. But regardless, how do you price a product that hasn't traded in days or months or that was sold only once or twice? Unfortunately, there is no easy answer.
Third, how do we register new products or counterparties? Will there be a listing process? Will this be immediate, like a shelf registration, where all securities of a certain type are preregistered and the details just need to be filed upon issuance? Or will this become a bureaucratic nightmare in which issuance grounds to a halt?
While it is nice to sit on my perch and throw stones, the challenge is that, if we really want to understand risk, we need to get this right. The hard part will be doing it in a way that doesn't bankrupt the industry or burden the taxpayer and that provides something meaningful to the regulators - in other words, finding a way to limit the downside risk while developing a cost-effective platform framework that the industry can leverage. Again, good luck. This is no easy mandate.Larry Tabb is the founder and CEO of TABB Group, the financial markets' research and strategic advisory firm focused exclusively on capital markets. Founded in 2003 and based on the interview-based research methodology of "first-person knowledge" he developed, TABB Group ... View Full Bio