Idemnification raises concerns in Europe

I recently had the pleasure to speak at a conference hosted by the Financial Markets Law Committee in London on the state of derivatives regulation in the U.S. and Europe. Among the hot topics of discussion were concerns over the unintended consequences of the new Dodd-Frank rules and the extraterritorial reach of the law. I focused my remarks on how the indemnification provision in Dodd-Frank is Exhibit A for both of these concerns.

New rules in the U.S. and European will require cleared and uncleared swaps transactions to be reported to repositories, which are essentially giant databases that hold the underlying data on these trades. This information is essential for market transparency because when the data is consolidated in a central repository, such as DTCC’s Trade Information Warehouse for credit default swaps (CDS), regulators worldwide can see market positions and monitor concentrations of risk.

If, for instance, a U.S. regulator wants to know the exposure of a particular U.S. bank to the sovereign debt of Greece in the CDS market, it can obtain that information in a matter of seconds through the Trade Information Warehouse’s regulators portal. The portal gives global supervisors unfettered, direct electronic access to detailed transaction data on virtually all CDS trades executed worldwide, in which they have a material interest. In fact, a regulator can access this data faster than it can obtain details about the actual debt holdings of that bank.

The indemnification provision in Dodd-Frank, however, may create unintended consequences that will undo this progress in bringing transparency to the market. The requirement states that U.S.- based repositories must obtain indemnification from foreign regulators before sharing this critical market data with them.

The fact is that the overseas regulators I’ve met with have told me that they are unlikely to enter into these agreements for two different reasons. First, the extraterritorial mandate is inconsistent with traditions and legal structures in Europe. Second, global regulators are already following policies and procedures to safeguard and share data based on guidelines established by the OTC Derivatives Regulators Forum (ODRF).

Without an indemnity agreement, U.S.-based repositories may be legally precluded from providing data to global regulators – most likely spurring these same regulators to create their own local repositories to avoid indemnification. A proliferation of local repositories would inevitably lead to data fragmentation, which would make it extremely difficult for regulators to quickly obtain a full picture of any particular asset class to evaluate risk concentrations.

Fortunately, some members of the U.S. Congress have reached out to their European counterparts to seek a resolution. However, since it’s unlikely that Congress will make technical corrections to Dodd-Frank until after the 2012 elections, we believe Europe should provide international leadership on this issue and establish a policy that the U.S. and other nations can harmonize to in time. But with negotiations between the European Parliament, Council and Commission underway to finalize its financial reform regulation, it’s uncertain how the EU will respond.

There’s a lot at stake in resolving this issue because the ability to establish a consistent global framework for governing financial markets will impact economic competitiveness, capital formation and job creation for many years to come.


Larry Thompson is managing director and general counsel of The Depository Trust & Clearing Corporation (DTCC), a non-commercial cooperative that serves as the primary post-trade infrastructure organization for the U.S. capital markets.

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