Dodd–Frank Turns Three—What's Next?

The sweeping legislation has not fully taken effect, and the New England legislators it is named after aren’t in office anymore. But their monikers are sure to live on for years to come. Added to the august list that includes Glass and Steagall; Gramm, Leach and Bliley; and Sarbanes and Oxley, are Dodd and Frank. And this latest pairing may prove more significant than its predecessors.

On July 21, 2010, President Obama signed the Dodd–Frank Wall Street Reform and Consumer Protection Act into law, named after Sen. Chris Dodd of Connecticut, then chair of the Senate Banking Committee, who introduced the bill in the upper chamber, and Rep. Barney Frank of Massachusetts, former chair of the House Financial Services Committee, who did the same in the House. Obama described the legislation at the time as “a sweeping overhaul of the financial regulatory system, a transformation on a scale not seen since the reforms that followed the Great Depression.”

The aim of this initiative was to improve the financial markets, to create transparency into opaque trading environments, and to provide for a safer, more stable overall market structure.

Dodd–Frank also provided the skeleton for what every financial institution in the US and throughout the world, would grapple with over the next three years, and beyond. According to law firm David Polk & Wardwell, which produces a monthly report on Dodd–Frank deadlines met and missed, as of June 3, 2013, 279 rulemaking deadlines had passed, which accounts for 70 percent of the 398 total rulemaking requirements.

On the capital markets side of the equation, the Commodity Futures Trading Commission (CFTC) has finalized 41 of its 60 rules, and has missed 17 deadlines. The Securities and Exchange Commission (SEC), meanwhile, has finalized 34 of its 95 deadlines, while missing 49 (see Figure 1). When it comes to Title VII, the Wall Street Transparency and Accountability section, which covers the over-the-counter (OTC) market, the CFTC has finalized 35 rules and missed eight deadlines, while the SEC has finalized 10 requirements and missed 19 deadlines. Of the tasks required of swap dealers and major swap participants, according to Davis Polk, there are 747 technology-related tasks and 1,195 operations tasks that must be met (see Figure 2). Needless to say, while many requirements have been ironed out over the last three years, there is still much more on the horizon.

“The hardest part of the new regulatory environment is dealing with the uncertainties of how parts of Dodd–Frank could or will be implemented.” —Steve Ellis, Wells Fargo

The Road Taken on the Sell Side
“The hardest part of the new regulatory environment is dealing with the uncertainties of how parts of Dodd–Frank could or will be implemented, particularly when there are tight compliance timelines within which to implement and be in compliance. It’s difficult to build business and systems requirements, to figure out new processes and procedures, and to figure out the economics of products and services, when the regulatory landscape continues to change,” says Steve Ellis, head of wholesale services at Wells Fargo.

As for whether there were any overhauls that turned out to be easier than expected, Ellis says, “Nothing was easy.”

It is clear that the sell side has had more to handle when it comes to Dodd–Frank-related IT projects. OTC derivatives regulation is only just now beginning to take effect after the CFTC finalized much of its swap execution facility (SEF) rules on May 16. (To read more about SEF-related technology challenges, see SEFs at the Starting Gate on page 34.)

Margin requirements on central counterparties (CCPs) will be stricter, and initial margin posted by trading firms for most derivatives will become mandatory. This means that collateral optimization systems have taken on greater importance.

Ted Leveroni, executive director of derivatives strategies at Omgeo, says business conduct rules—both internal and external—pertaining to Dodd–Frank have created the greatest challenge for trading firms. He says sell-side firms do not traditionally have their infrastructures set up to create mark-to-market reports for their clients on all of their positions. They have a variety of positions that are being traded through various desks and that are supported by a range of technologies, he says, so to create a consolidated reporting structure that shows all of those positions has proven to be a major pain point.

“Overall, these requirements that have been placed on the sell side were not intended for—and did not really align with—the way a lot of the banks were structured,” he says. “As a result, banks had to figure out the best place and method to source from for this information.”

According to Suresh Kumar, CIO at BNY Mellon, the short timelines and moving delivery dates, along with staffing transitions to meet stiff compliance deadlines, provided difficulties along the way. Most significantly, he says, “ensuring that solutions met the requirements of all clients in a world where industry practices are evolving and are continuously being defined” proved the greatest challenge.

The main areas of focus for Kumar and his team were trade capture, portfolio reconciliation, mandates around central clearing and compliance surveillance. But this also helped to improve the institution because of the industry-wide push toward standardization.

“Ultimately, standardizing security and trade identifiers aids in the reconciliation process and in identifying counterparty risk. By ultimately moving to an industry standard, it relieves many of the complexities involved with dealing with external parties,” he says. “The Dodd–Frank effort offered us an opportunity to examine our existing processing of derivatives—both operational and systematic—and helped us think more broadly and creatively about how best to use our technologies and teams across over-the-counter and exchange-traded derivatives to create an holistic solution for managing derivative risk.”

Ian Grieves, managing director of Americas at Object Trading, a London-headquartered provider of direct market access (DMA) services and technology, says pre-trade risk management—and managing those limits across many vendors and being able to visualize those limits and exposures—has proven difficult. David Zinberg, director of compliance product strategy at Nice Actimize, a provider of financial crime, risk and compliance technology, says post-trade record-keeping of swaps transactions is a new phenomenon in the derivatives market. “The type of record-keeping that we know exists in the equities and futures markets has never existed in the swaps market and that has to change,” he says.

Depending on a firm’s expertise, the challenge of staying compliant will be vast and varied.

The Road Taken on the Buy Side
For the buy side, while the components of Dodd–Frank have stressed business strategies—such as whether or not a firm wants to continue trading swaps—when it comes to addressing their technology, efforts have been focused on data warehousing, collection, and distribution concerns. This need can be directly connected to the Form PF requirement, spawned on the back of Dodd–Frank, which is designed to allow the SEC to monitor for systemic risk among hedge funds and private equity firms.

Warren Master, CTO at The Rohatyn Group, which has less than $5 billion under management, says that in addition to the collection and reporting of data, the firm’s main concern has been “providing a flexible data infrastructure for multiple user-defined perspectives,” or mappings. As the firm grows, Dodd–Frank will require it to add more granular data attribution mapping and further automate its filing processes.

Form PF requires concise data management—a master data source—while adding governance around that data warehousing, adds Richard Alexander, CIO at Cerberus Capital Management, which collectively manages about $35 billion.

“We’ve done a ton of work around our data-warehousing capabilities and how we’ve transformed big data into little data, by bringing in all this data and having a master data management system—that’s really where we’ve put most of our time and effort, specifically around all the new filing requirements and the Dodd–Frank mandates,” he says. “It’s really around data management.”

While the pressure on buy-side technology teams hasn’t been quite as intense as that placed on the sell side, buy-side firms are still going to have to learn to adapt and follow changes that sell-side firms are making to their processes and procedures, according to Alexei Miller, executive vice president at DataArt.

“To date, the impact on the buy side, if you isolate Dodd–Frank, has been limited, but there are still unknowns,” he says. “Today, the impact is limited, but the bigger impact is probably coming up.”

Meawhile, from a reputational risk perspective, investors have become savvier when it comes to compliance-related issues. Prior to 2008, investor meetings used to be cordial, 20- to 30-minute affairs. Now they’ve become more akin to an interrogation, notes the CTO of a $20 billion hedge fund.

In this new environment, investors want to know what systems and processes are in place and then they want to see real-world demos of the systems in action. “This has led hedge funds to both improve and rely on their back-office processes,” the CTO says. “It’s basically made the back-office people the rock stars. It’s a situation where the tail is wagging the dog.”

The Next Three
Post-2008, IT teams were forced to deal with constrained budgets and a paring down of headcount amid the mass layoffs that have ravaged the capital markets. But despite those setbacks, the regulatory agenda pressed forward.

This forced firms to redirect their efforts away from innovation and toward Dodd–Frank-related projects, says Jeffrey Wallis, president of SunGard’s consulting services business. He adds, though, that this is starting to change as firms are trying to figure out how best to incorporate into the investment process the data they’re being forced to collect and retain.

“Most organizations have addressed compliance in a tactical way, in the sense that they’ve done what they needed to do to comply and get by, as opposed to looking at it in more of a strategic sense,” he says. “Dodd–Frank has killed the innovation agenda and the ability to be thoughtful and articulate about how to use the data differently and how to be creative with it. The whole focus has been on ticking the box rather than thinking about how to look at the business differently. But a sea change is coming.”

Wells Fargo’s Ellis says the next stage of Dodd–Frank compliance will be finding ways to use these IT upgrades to the bank’s advantage.

“Reporting requirements continue to get more detailed and complex for various agencies, both domestic and international,” says Ellis. “The second challenge will be transforming compliance to a proactive, competitive advantage.”

And there’s still a high-level of uncertainty that exists, even if a good deal of clarity has been provided since 2010. Matt Grinnell, buy-side compliance officer at Fidessa, says firms will have to continue to plan for the unexpected. For the buy side, this will continue to mean a push toward hosted solutions so that they can reduce costs and/or free up staff. That means leaning on vendor and fund administrator relationships.

“The buy side is now asking if it’s worth maintaining this stuff on an enterprise-wide basis,” he says. “They need flexibility to manage their resources.”

Mission Accomplished?
Three years on, the question remains: Has the Dodd–Frank Act delivered its intended transparency and stability to the markets?

After polling dozens of industry veterans for this story, the answer is that it’s too early to tell. While there are concerns over the way this regulatory overhaul was handled—whether or not it was wise to have legislators deciding how best to remedy extraordinarily complex financial instruments and processes—the consensus is that it’s good that things like transparency and unraveling complexity are being addressed in the open. Whether form follows function has yet to be seen.

The major worry is that the industry has been moved from a model where risk was spread out among various institutions—and thus, was hard to monitor—to one where risk has become significantly more concentrated and centralized. According to one source, Lehman Brothers’ failure naturally had repercussions for the market. They were significant and painful, but ultimately the fallout wasn’t a fatal blow. If there was a central counterparty failure—say, the Chicago Mercantile Exchange or LCH.Clearnet—the result would be catastrophic.

Risk has been bundled and consolidated—and thus, more centrally managed—but the capital markets have also moved to an environment where another Lehamn-type catastrophe could touch off a chain of events that make 2008 look like a walk in the park.

Salient Points

• Dodd–Frank compliance has been tougher on the sell side than the buy side. New over-the-counter (OTC) rules and data storage requirements, as well as mandates around pre- and post-trade risk, have proven to be extremely difficult to tackle.
• On the buy side, Dodd–Frank has been more about improving data warehousing capabilities, collecting data and distributing it, and automating filing processes for regulations like Form PF.
• While there is still some uncertainty as to various deadlines for Dodd–Frank, the next three years will force firms to figure how best to use Dodd–Frank-related projects to help in the investment process and for risk and customer analysis.
• While the regulators have made risk more centralized—and in the process made it easier to monitor—it also opens the door for catastrophe should a major CCP fail.