Deriv Low Transaction Fees
Derivatives are risk management tools that reduce transaction costs in the market. This is because they're cheaper than spot trading, which requires using exchanges and paying margin fees.
In 2002, the Securities and Exchange Commission (SEC) passed rules requiring FINRA member firms to report over-the-counter (OTC) derivatives transactions on eligible fixed income securities. To facilitate this reporting process, FINRA Trade Reporting and Compliance Engine (TRACE) was created.
Central Clearing and Trading
The G-20 Leaders have called for reform of the OTC derivatives market to achieve central clearing and, where appropriate, exchange or electronic trading; reporting all transactions to trade repositories; as well as higher capital and margin requirements for non-centrally cleared transactions. This paper evaluates policy options available to jurisdictions in responding to this call, outlining their feasibility, risks, benefits in light of financial stability concerns, legal ramifications and tax implications.
The primary rationale behind central clearing is that bilateral OTC contracts are fragile, and should be replaced with a single, transparent, efficient transaction between counterparties under an established regulatory framework providing netting and collateral guarantees. This move is especially crucial for securities firms since it offers them better ways of managing counterparty credit risk efficiently.
To reduce this risk, buyers and sellers typically entered into master agreements that outlined how much money would need to be paid each other in the event of default or bankruptcy by a counterparty. Unfortunately, the financial crisis highlighted how fragile these arrangements were and necessitated their replacement with a central counterparty (CCP) model.
While there are various CCP models that could be implemented, each presents its own set of challenges. These include product characteristics and volumes in a given local market, the legal framework supporting it, as well as any implications on an authority's current or prospective tax regime.
This paper investigates the viability of four possible models to facilitate central clearing and trading for standardized OTC derivatives, with an emphasis on EMDEs. In addition to these considerations, it also highlights the challenges involved in deciding which products should be cleared centrally and where.
When selecting where to clear OTC derivatives, one important consideration is whether the local market structure supports setting up a local CCP. This presents an especially difficult obstacle for emerging market economies (EMDEs), which lack adequate onshore markets and lack direct policy tools with which to influence trading and clearing activities.
Indirect foreign clearing can be a viable alternative for local participants in an EMDE to centrally clearing their OTC derivatives, but it also presents several systemic risks. Notably, it may lead to the concentration of local banks' derivatives risk at foreign CCPs, thus increasing the possibility that countries will experience financial crises as banks must bail out their borrowers.
Trade Reporting and Compliance Engine (TRACE)
TRACE is a database containing OTC trades and market data related to eligible fixed-income securities used by FINRA members for reporting transactions. This initiative plays an integral role in FINRA's mission of making OTC bond markets more liquid, regulated, and transparent.
FINRA members must report trades in TRACE-eligible securities to TRACE when they occur, unless an exception or exemption applies. In certain instances, members may not need to report certain types of transactions such as repurchases of debt securities with less than one year until maturity or transfers among syndicate members that do not alter price or material terms.
To reduce the costs of transaction reporting, FINRA has developed a tool that assists members in filing TRACE-eligible trades more promptly and efficiently. This system is built upon an algorithm that incorporates real-time data from various trading venues, market data vendors, and financial websites.
The tool provides members with TRACE-eligible trade reports through a TRACE Web browser. Furthermore, FINRA members have access to other TRACE data services and feeds, such as end-of-day transaction and activity reports and enhanced historical data.
Firms without access to a TRACE Web browser can utilize the TRACE Interactive Trade Management function of a non-FINRA member service bureau for viewing their TRACE reports. However, in order for this option to be valid, the non-FINRA member service bureau must have current Regulatory Approval from FINRA.
If a service bureau does not currently hold a Regulatory Approval, firms can obtain one by filing Form TRACE 6830 (Transaction Reporting) with FINRA. FINRA will review and approve or disapprove the application within 30 days of filing.
Furthermore, firms using non-FINRA member service bureaus for TRACE reporting must submit copies of the reports generated by those firms to FINRA for review and instructions on how to correct any mistakes.
In the example provided, BD/IA A would report the purchase of 100 million bonds to TRACE and then allocate 25 sales to managed customer accounts that are subject to a markup or commission from BD/IA A according to allocation instructions from a third-party IA.
TRACE Report Cards
FINRA member firms must report transactions in TRACE-eligible securities according to SEC approved rules. This enables FINRA to monitor the market, detect trends and ensure members are adhering to their regulatory responsibilities.
In addition to reporting transactions, FINRA publishes TRACE report cards that can be downloaded and analyzed by firms to assess how well they are doing on trade reporting. Not only is the TRACE report card an efficient way for firms to measure their progress in this area, but it's also an invaluable educational tool that will help members make the most out of their time spent on trade reporting tasks.
TRACE recently added the TRACE quality of markets report card for securitized products to their repertoire. This monthly status report provides members with the perfect way to stay abreast of market developments, identify areas for improvement and guarantee compliance with ever-evolving regulations that impact the industry.
The TRACE report card may be short but it's free! All you have to do to take advantage of it is subscribe to alerts on your TRACE system; once a report is published, an email will be sent automatically. Moreover, you can review all other alerts by logging into your TRACE account at any time. You can view the quality of markets report card in three formats: table, spreadsheet or PDF file.