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Tackling the Challenges of Trade Reconstruction

One of the lesser known financial regulations implemented as part of Dodd-Frank is the requirement for swap dealers to be able to produce a full reconstruction of a trade within 72 hours of a request by the Commodity Futures Trading Commission (CFTC). Satisfying the new requirement will require a range of technologies and processes, many of which are still in their infancy.

Bloomberg Vault sponsored a webinar “Tackling the Challenges of Trade Reconstruction,” exploring issues such as:

• Handling unstructured data, including tagging
• Weighing in-house versus outsourced solutions
• Establishing best practices around compliance

“The new rules [regarding trade reconstruction] are onerous and affect lots of different parts of the organization—front, middle and back office of firms,” said Harald Collet, Global Head of Bloomberg Vault. Those rules cover such areas as:

Recordkeeping: Records must be kept of all written and oral communications that lead to execution of swap.
Searchability: Data must be maintained in a form that identifiable and searchable by transaction and counterparty.
Archiving and maintenance of records: Records must be kept for the life of the swap plus five years. Given that some swaps are for 30 years, maintaining records can be very difficult.

Perhaps the greatest challenge lies in capturing complex and unstructured data and then tagging it, notes Stephen Marsh, founder and CEO of Smarsh. “The content can be anything from email to IM to video coming in on cell phones. We want to apply as much metadata to that content as possible, because that will help our search efforts down the line,” says Marsh. The search has to be flexible and fast, he adds, especially since the swap dealer has only 72 hours to complete the trade reconstruction for the CFTC.  “Legacy systems are simply not up to the task of overcoming the multiple obstacles,” says Collet. “You need a robust system that pull the data in the requisite time.”

The ability to search the unstructured data by way of key phrases is a complex undertaking, says Mitch Avnet, Managing Partner, Compliance Risk Concepts. “The key is understanding ‘trader-speak.’ Traders do not speak the way everybody else speaks—at least not while they are trading. They tend to use a lot of slang—and that’s a problem for the compliance people.”

But even if the technology was in place that could speedily tag and organize the information, the quality of the data presents a different set of problems. The data is rife with invalid counterparty names and LEIs; poor data quality; inaccurate legal hierarchy information; lack of cross-referencing between counterparties; hard-to-share data between systems. “The challenge of poor data quality is one that cuts across the entire industry,” says Collet.

Trade reconstruction in many respect resembles a “big data” problem, Collet notes. “It’s the size and scope of data required by CFTC, the parts of the organization. It’s the front, middle and back office across the organization with multiple types of communication systems impacted on the trading workflow,” he says. “A logical way to approach [such a complex big data problem] may be to take a step-by-step approach. And what many firms are doing [as a first step in the effort] is mapping out all the different steps that go into a trade. ”

Outsourcing versus In-house Solutions

Trade reconstruction is not simply a compliance problem but an enterprise-wide issue that cuts across multiple areas in the firm. And the long-term solution is a technological one that addresses all aspects and challenges of trade reconstruction, Collet points out. “Young, less mature firms are going with outsources, managed compliance system. Other firms take a hybrid approach. And still others want to own the technology and system,” says Collet.

Among the benefits of an in-house solution:
• You own the technology
• You are able to allay privacy concerns

Benefits of outsourced solution:
• Budget (off-the-shelf solution can be cheaper)
• Staffing needs are taken care of

Avnet notes that one reason why firms may want to use an outsourced solution is the strain it places on internal IT resources and manpower. “I’m a big believer in an external cloud-based solution: First, there’s power in numbers; second, regulators have a greater opportunity to become familiar with and get more comfortable with the outsourced solution; and finally, as changes take place in the cloud and technology, you are the beneficiary of those changes.”

Clearly we are at the very beginning of what is likely to be a long learning curve for the regulators and the industry, says Avnet. “The bottom line is that regulators are looking for transparency in nontransparent markets. This is a journey [for everyone] and there is no silver bullet.”

To listen to the full webinar, click here.