Is Simon Johnson Embracing the FDR Framework?

A couple of months ago, your humble blogger met Professor Johnson at the Boston University hosted State of Financial Reform conference.  At the time, Professor Johnson express reservations about the FDR Framework.  In particular, he was uncomfortable with the idea that governments must ensure that market participants have access to all the useful, relevant information in an appropriate, timely manner.

In a Bloomberg column, Professor Johnson appears to have begun embracing the FDR Framework and its emphasis on bringing sunshine to all areas of the financial markets.

On the face of it, Glencore International AG doesn’t look too scary. With about $80 billion in assets, the Swiss-based commodities trader is a lightweight in comparison to global megabanks like Goldman Sachs Group Inc. (GS), one of its trading rivals. Goldman has assets more than 10 times Glencore’s, is more leveraged and has less capital. 

So why do executives at Goldman, Citigroup and JPMorgan Chase argue that lightly regulated or unregulated companies operating “in the shadows” -- private equity firms, hedge funds and commodities traders like Glencore -- risk another financial calamity? 

What Glencore’s rivals are really worried about is competitive advantage. It’s about to sell $11 billion in shares through an initial public offering in London and Hong Kong. That fresh capital will allow Glencore to expand at a time when its Wall Street competitors’ hands are tied. Glencore doesn’t face the same limits that banks do in proprietary trading, capital reserves, leverage and compensation. This may be unfair, but it’s not the right reason to subject Glencore to the same tough regulatory regime as banks, nor the right lesson to draw from our recent experiences. 

The real question regulators should ask is this: How much of a risk would Glencore pose to the world’s financial system? To use the terminology proposed by Mervyn King, governor of the Bank of England, is Glencore “too important to fail” -- meaning that its bankruptcy would bring down other significant parts of the financial system or real economy? 

... Today Glencore trades and produces minerals and metals like zinc, aluminum, cobalt and coal, as well as grains, cotton and sugar. It owns refineries and drilling rigs and holds large stakes in other mining companies. 

Glencore also has a large amount of capital and little leverage, judging by its shareholder equity, which is worth 25 percent of assets....

There is little sign that a government would feel the need to save Glencore and protect its creditors if it were on the brink of collapse. A restructuring of its debts should not be disruptive to the world economy. Based on the limited information in Glencore’s 2010 annual report, even its derivatives book seems unlikely to create system-wide risk. 

Still, this could change quickly. Derivatives are the wild card. Glencore almost certainly will qualify for the so-called end-user exemption under the Dodd-Frank financial reform legislation, meaning that it may not have to follow new clearing and margin requirements (although these rules are still under discussion). It would be relatively easy for a firm with Glencore’s balance sheet and insight into the physical side of commodity markets to ramp up its involvement in the financial side of commodities. 

We do not want commodity traders like Glencore, Cargill Inc., Paris-based Louis Dreyfus & Cie., an oil major or any other nonfinancial company to be tempted to take financial risks that are big relative to the size of the system. 

Even supposedly expert financial firms can destroy themselves with the mismanagement of risk -- a process made potentially even more devastating to everyone involved through derivatives. 

Remember that Lehman Brothers Holdings Inc. (LEHMQ) was not a megabank -- its balance sheet was about one-fifth the size of Citigroup’s and the largest European banks’. But Lehman’s web of connections through derivative transactions turned out to pose a system-wide threat -- about which the Treasury Department and the Federal Reserve were completely unaware until the day after Lehman went bankrupt. 

The end-user exemption should be interpreted narrowly and applied evenly. If Glencore or a similar company wants to engage in financial speculation or market-making, those activities should be walled off from their physical operations and legitimate hedging needs, as my MIT colleague John Parsons has been arguing. 

Regulators need as much visibility as possible into derivatives transactions around the world. The major players in these markets -- including firms like Goldman -- do not want transparency, primarily because they don’t want their pricing structure to be widely known.

It was transactions between the big Wall Street firms and largely unregulated mortgage originators that brought us the subprime crisis. The open secret of Wall Street is that the “shadows” are often made possible and profitable by the big banks. [emphasis added] 

One example: structured investment vehicles, the undercapitalized, off-balance-sheet entities that large banks created in 2007 and 2008 to house subprime mortgage investments. 

The Treasury Department has been pressing hard to lighten the transparency requirements on derivatives markets, including most recently with its baffling decision to exempt foreign exchange swaps from clearing requirements. 

The best way to deal with potential shadows is to shine a bright light on all markets.  [emphasis added] 

Restricting who can avail themselves of the end-user exemption is one very good way to ensure that the shadows do not get too dark and that stand-alone commodity traders do not become too important to fail.

US Mortgage Market and the Mother of All Databases

The American Banker ran an interesting article on the need for a database containing all the mortgages in the US.

Your humble blogger has been advocating for this since before the credit crisis in conjunction with a loan-level database for structured finance securities.  Just as the loan-level database is needed if market participants are going to be able to analyze and value structure finance securities with all the useful, relevant information, a national mortgage database is needed by mortgage market participants.

Like the structured finance loan-level database, data in the national mortgage database should be standardized.

Like the structured finance loan-level database, data in the national mortgage database should be made available for free to all market participants.

Europe and in particular the ECB and BoE are leading the way in showing how both the structured finance loan-level database and the national mortgage database can be rapidly built.  Specifically, the central banks are making providing data to the loan-level database an eligibility requirement if a structured finance/covered bond security is to be pledged as collateral at the central bank.

There is no reason that the Federal Reserve could not also do this.  There is no reason why the SEC could not make this a requirement of its revision of Regulation AB.  There is no reason that this requirement could not also be added to the Covered Bond legislation moving through Congress.

Why do some mortgage servicers appear to be modifying a great many more loans than others? How many loans are getting principal reduced, rather than interest rate reductions? How many loans in a given neighborhood are more than 30 days late? 

Answering such questions may be critical to craft effective policy responses to the housing crisis. But it's hard to get definitive answers, because data on mortgage performance is incomplete and often expensive. 

Most of the detailed information on mortgage performance is gathered by the two companies, CoreLogic Inc. and Lender Processing Services Inc., and sold in various forms to regulators for sums that can reach hundreds of thousands of dollars for a particular data set. 

Members of Congress, state banking regulators and academics say they have been regularly stymied in attempts to access the data. In many cases they cannot afford it. Sometimes regulators who have the data cannot share it because of proprietary arrangements with data providers. 

... Proponents of the idea say such a database is long overdue. 

"There are no complete data sources and there is over-reliance on third-party vendors," said Richard Neiman, former New York State banking commissioner and former member of the Congressional Oversight Panel for the Troubled Asset Relief Program, who submitted a proposal for such a database in 2009. "We as regulators and stakeholders should not be relying on third party vendors whose data is incomplete and subject to inaccuracies." 

Neiman, who is expected to join PricewaterhouseCoopers as vice chairman of global regulatory practice, said the forthcoming database could be as valuable as the information
collected under the Home Mortgage Disclosure Act, which is used to evaluate possible discrimination in loan approvals. 

"Having a mortgage performance database would provide a similar window on mortgage servicing," he said. "Just like HMDA was used to identify violations in the origination process, a national mortgage database could provide a similar window on servicing
and modifications." 

CoreLogic and LPS depend on voluntary reporting by servicers. And their data has blind spots: CoreLogic covers about 41 million first-lien loans and 7 million second liens,
out of a total of about 60 million mortgages in the country, while LPS has detailed information on about 40 million first liens. 

LPS says building a system like the one called for by Neiman and Dodd-Frank would be unnecessary because currently the mortgage industry, which uses the data to establish benchmarks, is helping to defray the cost of gathering it. 

"Today anybody can license from LPS or from CoreLogic," said Kyle Lundstedt, a managing director at LPS. "We charge the mortgage industry, which benefits, and it is not like the American public is not getting the benefit too, because the regulators who manage the industry on our behalf are also accessing the data. So it leaves me befuddled when someone says, 'Wait a minute, we need to make that data free.' " 

... Having more comprehensive and reliable data could be helpful in assisting distressed homeowners, said Rep. Brad Miller, D-N.C. "There seems to be guesswork on what works and what doesn't work in regard to modifying mortgages," he said. "In the time I have been in Congress, we really have had to rely upon the industry to tell us what is going on and what they have told us has not been reliable. It has not always been accurate and not complete — sometimes plain not truthful — so having an independent source of information would be an enormous benefit." 

The Office of the Comptroller of the Currency, which, together with the soon-to-be-phased-out Office of Thrift Supervision, gathers data on the servicing operations of nine banks accounting for 34 million loans, has made strides in tracking loan performance. Among other advances, the agency's quarterly Mortgage Metrics Report has helped establish common definitions for such categories as subprime and prime. Before the establishment of Mortgage Metrics, these definitions differed from bank to bank. 

However, the report only covers 63% of the mortgages in the country and it does not cover the substantial holdings of second lien loans on bank balance sheets. 

Alan White, a law professor at Valparaiso University in Indiana who has studied various data on mortgage servicing, said the OCC data that is available publicly does not allow
researchers to get a comprehensive picture. 

"The OCC data is a biased sample," he said. "What you get are summaries. The loan-level data is not available anywhere to the public or to researchers. You can get summary statistics from the Mortgage Bankers [Association] once a quarter and then the OCC and OTS metrics comes out, but they give you the numbers they want to give you." 

Another issue is the need to protect borrowers' privacy. 

"We don't share that data because it is supervisory data and the data at loan level includes privacy information," said an OCC official, who did not want to be identified. 

However, White said it should be possible to have a system that releases detailed loan information without compromising borrowers' personal information. "You wouldn't want public releases that included the names and addresses of borrowers," he said. "But I think that there is also certainly with the bank regulators a lot of concern about protecting bank proprietary information. If you were able to look at what kinds of loss severities resulted from foreclosures and modifications, you might get an idea of which servicers are doing a better or worse job for investors and the timing and severity of losses." 

Your humble blogger developed and patented the information system that Professor White would like to see.  The system protects borrower privacy with the standards that Congress approved for protecting patient privacy under HIPAA.

Researchers can gain access to some databases at the Treasury Department, but that comes with restrictions, according to White. 

"Treasury has been very secretive about their data," he said. Although the agency releases periodic report cards on the Home Affordable Modification Program, "and it is possible to
gain access to some of the proprietary databases, but they have licensing agreements and most of the time the licensing agreements prevent researchers from disclosing information that would hurt the reputations of the subscribers to these services" — the subscribers being the banks. 

Andrea Risotto, a Treasury spokeswoman, said she had no knowledge of special access agreements with academics. "I can only answer for Hamp," she said. "We have a database online that literally has every data element for every homeowner who has ever participated or even submitted one piece of paper to apply for the program." 

Lundstedt at LPS argued that a national database would be expensive.... However, government officials say that licensing agreements with LPS and CoreLogic actually end up costing government agencies unnecessary amounts of money and that the new mortgage database could help resolve what has been an enduring issue. 

"We are buying both LPS and CoreLogic mortgage performance data, and other agencies are doing this as well, so those companies are collecting a lot of money," said a senior HUD
official, who also requested anonymity....  

Some agencies cannot even afford all of the data they say they need to do their job. "A lot of this data is very expensive," Neiman said. When he was New York's banking commissioner, he said, "we had some budget restrictions, so our first thought was can we reach out to some of our federal  counterparts, and they are under contractual restrictions for sharing it." 

And when the department could afford to buy private data, Neiman said, it found inaccuracies. "On a quarterly basis we were having to go back and correct data with regard to foreclosure filings," he said. "It is for that very reason that we established a mandatory requirement within the state that institutions have to file pre-foreclosure information with us as well as the filing of lis pendens" — pending foreclosure actions — "because we were continuously finding inaccuracies and lack of completeness from the private sources of that information." 

There are formidable challenges to establishing the national mortgage performance database.
HUD officials say that it could take several years to build it and that no money has been appropriated for the project. (Dodd-Frank does not set a deadline.) Another question is how
the agency would build the database. Would HUD (which already publishes loan-level performance data for Federal Housing Administration loans on its Neighborhood Watch website) gather the data itself or could it buy the information from vendors like CoreLogic and LPS? 

"A potential barrier is will they agree to sell it to us given what we are supposed to do with the data," the senior HUD official said. "Would we render their products obsolete by
giving away the information at the census tract level Congress asked for?"

Conflicts of Interest and Wall Street's Chinese Walls

The Wall Street Journal ran an interesting article on BlackRock Solutions.  The article provides an example of the types of conflicts of interest that exist on Wall Street.

To deal with these conflicts of interest, Wall Street's favorite solution has been to erect a so-called Chinese Wall between the lines of business that have the conflicts of interest.  Left unanswered is the question "Does Wall Street's version of the Chinese Wall function better than the original Chinese Wall which failed to keep out the Mongol invaders?"

BlackRock Solutions is the risk management division of the money management firm, BlackRock.  If all it did was focus on helping to manage the risk of BlackRock's investment portfolios, there would be no conflicts of interest.

However, that is not all that it does.  It also acts as an advisor to third parties, like the Federal Reserve.  For example, BlackRock Solutions is advising the Federal Reserve on the sale of the assets the Federal Reserve acquired in the Bear, Stearns bankruptcy while at the same time the BlackRock money management arm is also a potential direct or indirect bidder for the assets.

To anyone not working on Wall Street, this looks like a situation with conflicts of interest.

Would the conflicts of interest go away if the money management arm agrees not to bid?  No.  So long as BlackRock manages a portfolio containing similar assets there are conflicts of interest as BlackRock is uniquely position to profit from the pricing information contained in the auction of the Federal Reserve's assets.

In another case, BlackRock Solutions has attempted to help an issuer of asset-backed securities provide loan-level information to the market.  To anyone not working on Wall Street, this too looks like a situation with conflicts of interest given the fact that BlackRock manages a sizable portfolio of similar assets.

Now, the fact that BlackRock and other Wall Street firms have conflicts of interest does not mean that anyone has acted for its benefit on these conflicts of interest.

However, the fact that these conflicts of interest exist raises the question of "why work with a firm that has a conflict of interest if the alternative to work with a firm that does not have a conflict of interest exists?"

This can be easily done.  First, have firms disclose publicly their potential conflicts of interest.  Then, select from the firms that are free of conflicts of interest.

Clearly your humble blogger is not the only one concerned about eliminating unnecessary conflicts of interest.  The European Commission expressed its concern about conflicts of interest with regards to financial information vendors when it announced its investigation of Markit, its shareholders who are also the source of its information and the credit default swap market.

Highlights from the WSJ article:

BlackRock Solutions has emerged as a key adviser in helping the government unwind the troubled assets it accumulated during the financial crisis. ...

Yet with the recent success has come some unwelcome attention over how it handles that business—as well as more competition in risk management. 

With more than $3.6 trillion under management, BlackRock is best known for its bond portfolios, including some that hold the same kinds of securities that BlackRock Solutions is helping the government value and sell. 

BlackRock has gone to considerable lengths over the years to keep its Solutions business separate from its core money-management operation. Solutions' employees are housed on separate floors of the firm's headquarters and are accessible by different elevators than other parts of the firm that could profit from its knowledge. All of their data and computer systems are separate from those of the main company. 

Still, some analysts are raising concerns that the firm's government dealings give BlackRock too much access to market-sensitive information—and too many temptations to use that information to boost its main business. 

"They've combined asset-management and advisory businesses, and it raises some issues of conflicts," says Christopher Whalen, co-founder of risk-management consultant Institutional Risk Analytics. He said he isn't suggesting that there have been problems. 

Mr. Goldstein says BlackRock Solutions has been sensitive to such perceptions since its inception. 

...The Solutions group has found a new market since the financial crisis. Not only are many mortgage-related bonds difficult to value these days, but some investors have lost faith in the big bond-rating firms' credit-scoring capabilities, say analysts. Last year, BlackRock Solutions took on 62 new assignments, up from 48 in 2009. 

During an April 21 conference call with investors, BlackRock Chief ExecutiveLaurence Fink singled out Solutions as a high performer, saying it did "an exceptional job" in helping the Central Bank of Ireland understand the market dynamics affecting its banking system. The central bank rescued many of the country's banks after the country's real-estate bubble burst, leaving lenders saddled with souring loans. 

As was pointed out previously on this blog, the work performed by BlackRock Solutions, while very expensive, has failed to restore confidence in the Irish banking system.

... The firm's secretive valuation process also has raised questions. Since the government owns so many subprime assets, critics contend, taxpayers have a right to know how those assets are being valued. BlackRock doesn't discuss its methods publicly, and the Fed offers only broad disclosures about how values are reached. 

"It should all be open," says Allan H. Meltzer, a professor at the Tepper School of Business at Carnegie Mellon. "They may be doing things honestly and above board, but we won't see that unless we see how they got the numbers.…How they calculate the portfolio of those assets is how we know how much the taxpayers are going to pay."  

... "We spend a very significant amount of time teaching clients what the limitations of the risk models are," BlackRock Solutions' Mr. Goldstein says. 

ECB Needs ABS Data Warehouse to Succeed

The ECB needs the ABS Data Warehouse initiative to succeed and end the buyers' strike in the structured finance market.

According to an article in the IFR,

ABS is now the most common collateral group posted at the ECB’s repo window for the first time, according to the central bank’s 2010 annual report. ABS represented 24% of total collateral, up from 23% in 2009, followed by covered bonds at 21%.

Without an end to the buyers' strike, the ECB will have to continue to fund the banks that put up the structured finance collateral until the collateral matures.  Without an active secondary market for the structured finance collateral, how does the ECB know that it is protected in the event that the bank which put up the structured finance collateral becomes insolvent?

Also, it is interesting to note that the ECB handles providing transparency for structured finance securities separately from providing transparency for covered bonds.

Why?

Covered bonds are a simple form of a structured finance security.  The source for the information on the performance of the assets underlying a covered bond is the same as the source for the information on the performance of the assets underlying a structured finance security.

From a technical perspective, there is no reason that the same asset-level performance information provided for structured finance securities could not also be provided for covered bonds.

ECB ABS Data Warehouse: Will It End the Buyers' Strike?

It is fascinating to watch the battle between the buy-side and the sell-side unfold in the development of the ECB's ABS Data Warehouse.  To date, every known aspect of the ABS Data Warehouse has been decided in the favor of the sell-side.

This observation would not be surprising if the ECB was an impartial observer.  As was recognized in the 1930s, the buy-side has an alternative to fighting with the sell-side over disclosure of all the useful, relevant information in an appropriate, timely manner.  The buy-side can effectively go on strike by taking its money and investing in another part of the capital markets that does offer disclosure of all the useful, relevant information in an appropriate, timely manner.

This observation is surprising because the ECB is not an impartial observer.  Under the FDR Framework, the ECB has the responsibility for ensuring that market participants have access to all the useful, relevant information in an appropriate, timely manner.  The ECB also has an incentive to want this type of disclosure as the ECB accepts structured finance securities as collateral.

Ultimately, the question the ECB's ABS Data Warehouse is answering is "will an ABS data warehouse built to sell-side specifications end the buyers' strike?"  Will it provide the buy-side with enough disclosure that the buy-side will return to the ABS market, particularly when the standard for investing in ABS deals has become 'know what you own'?

To make these question more concrete, an examination of the ABS data templates is required.  Why are data templates necessary in the first place?

• If there are going to be many data warehouses, data templates reduce the cost of disclosure to the issuer by providing the issuer with one disclosure standard.  

• However, if there is only going to be one ABS data warehouse and with the ECB's endorsement there will only be one, there is no need for the ECB to develop a data template as the data warehouse will tell the issuer how it wants the data disclosed.

How is this a sell-side versus buy-side issue?  The sell-side favors data templates because it offers the sell-side the opportunity to restrict disclosure of all useful, relevant information by debating what data fields should be disclosed.  Clearly the sell-side does this as the ECB has 20+ fewer data fields in its RMBS template than does the BoE.

The buy-side favors disclosure of all the data fields, while preserving borrower privacy, that the issuer tracks.  This makes sense because the issuer is an expert in the data needed to value the assets backing the ABS security and monitoring these assets performance.  In short, the issuer only tracks data fields that their experience shows them to be relevant.

Having every issuer report all the data fields it tracks to multiple ABS data warehouses would pose significant technical difficulties and costs.  However, when there is only one ABS data warehouse, these technical difficulties and costs go away.  An ABS data warehouse built to buy-side specifications would include all the data fields the issuer tracks (remember, there is useful information in knowing what data fields an issuer does not track).

The questions of more immediate concern are

• Why is the ECB building an ABS data warehouse to sell-side specifications and not to buy-side specifications in the first place?  What happens if an ABS data warehouse built to sell-side specifications does not end the buyers' strike?

• Why is the BoE trying to find some middle ground between the data fields in the ECB's data template and full disclosure of all the data fields the issuers' track?  Do regulators win some prize for finding the fewest data fields required to end the buyers' strike?

• Why should the buyers come back knowing that useful, relevant information is being withheld even under the BoE data template?  Knowing that useful, relevant information is missing, how do European financial institutions prove that they know what they own?

Guide to the ABS Data Warehouse

This guide consolidates the various posts on this blog concerning the ECB's ABS Data Warehouse.  As disclosed previously, your humble blogger has an interest in this data warehouse having originally proposed the idea prior to the credit crisis.

In addition, your humble blogger designed and patented a data warehouse and related information infrastructure that has the flexibility to provide market participants with current asset-level performance information for all types of structured finance securities and covered bonds.

My Idea
The ECB's ABS Data Warehouse was My Idea
Implications for ECB's ABS Data Warehouse of US Government Suing Wall Street Over RMBS Deals
40+ Firms Would Like to Build ABS Data Warehouse, Only My Firm Has

Will It End the Buyers' Strike?
The Choice for Restoring Investor Confidence is Between Current, Free Performance Data or Stale, Costly Performance Data
Why the Sell-Side's Proposed Data Warehouse Will Not Restore Investor Confidence
Will Buyers Return Knowing That Data is Being Withheld?
Buy-side Responsible for Losses under the ECB's ABS Data Warehouse

Data is Worthless if not Trusted!
European Commission Wants Clarity on Lack of Conflicts of Interest in ABS Data Warehouse
European Commission Wants Conflict of Interest Free ABS Data Warehouse
The Data Warehouse is not Valuable if the Data is not Trusted

Three Stikes and Market Group's Version of ECB's ABS data warehouse is out
Why the Market Group's Version of the ABS data warehouse should fail
European Commission Raises Stop Sign for Firms with Conflicts of Interest in Data Warehouse
US SEC confirms once-per-month data is too out of date to be useful
Strike Three or why the issuer always pays for disclosure

As the Only Buyer, ECB Looks for Exit
Given Its Exposure to Structured Finance, ECB Needs Data Warehouse
ECB Wants Transparent, Market-Driven Selection Process for Firm to Build and Manage Data Warehouse

Value of my firm's patent for an ABS Data Warehouse
Sapient Global Markets selected to build ABS Data Warehouse

As Predicted, Without Asset Level Data Investors Not Interested in Investing in Spain's Cajas

The Wall Street Journal published an article that confirms this blog's prediction that in the absence of asset level data, investors would not be interested in recapitalizing Spain's Cajas [savings banks].

The article focused on Spanish regulators' fondness for the good bank/bad bank model for attracting capital.  Under the good bank/bad bank model, all the dud assets are put into the bad bank.  The good bank then turns around and tries to sell equity to investors.

Please note that the good bank/bad bank model tries to send a very explicit message about the quality of the assets.   That message is that an investment in the good bank is safe as the problem credits are in the bad bank.

The fact that the regulators embrace this model and its message is confirmation that the investors had no interest in investing capital into the cajas without asset level data.

There is just one tiny problem with the good bank/bad bank model.  It only works for investors if all troubled assets are truly moved into the bad bank.

Unfortunately, as Ireland showed repeatedly, what bankers and their regulators claim is a good bank may still have a significant amount of bad assets on its balance sheet.  An amount of bad assets that renders an investment worth zero.  Investors are not going to forget this lesson just because the banks are in Spain and not in Ireland.

How are investors to know if all the bad assets have been moved to the bad bank particularly after regulators have been allowing the banks to practice extend and pretend with a number of loans for years?

Ultimately, the only way the banks are going to attract capital is by disclosing asset level data so the investors can analyze this data and decide for themselves the attractiveness of an investment in the good bank.

Why the ABS Data Warehouse Must be Free of Conflicts of Interest

It is common sense that there are no benefits to be gained from tilting an otherwise level playing field by letting firms with conflicts of interest participate in selecting, designing, constructing or operating the ABS Data Warehouse.

All firms involved with the ABS data warehouse should be verifiably free of conflicts of interest with existing structured finance market participants.  These firms should make and keep updated a full public disclosure of all competitive and financial interests in the design of the database, the presentation of the data, the analysis of the data, and the use of the data, including:

• Is the firm engaged in a related business that could gain a competitive advantage from its role? Examples of such related businesses include data distribution, pricing services, trustee services, monitoring, analytic solutions, loan servicing, collection services, consulting, ratings services, investment as a principal or agent or portfolio manager, and underwriting.

• Does the firm have investments that could benefit from its role, such as long or short positions in ABS transactions?

If the ABS Data Warehouse is to be valuable in restoring trust in the structured finance market, the data must be trusted.  Unfortunately, there are many ways that conflicts of interest might raise doubts about the trustworthiness of the data.

Recently, the European Commission announced an investigation of Markit which shows how conflicts of interest jeopardize the trustworthiness of the information and can lead to potential problems.

Markit is the leading vendor of information on credit default swaps.  It also happens to have a majority of its shares owned by 16 major dealers of credit default swaps.  Because of their ownership interest, these dealers have an incentive to only supply Markit with information.  In addition, since they control Markit, they are in a position to control what data is disclosed and when it is disclosed.  Taken together, all of the conflicts of interest that exist within Markit have drawn the European Commission's attention and call into question the trustworthiness of the data Markit provides.

40 firms would like to build ABS Data Warehouse, only my firm has

An IFR article provided an in-depth look at the ABS Data Warehouse.

More than 40 organisations have expressed an interest in building the European Central Bank-endorsed, market-led ABS loan level data warehouse, according to officials at the Market Group overseeing the project.

Of the 40 organizations, only your humble blogger's firm has actually built and patented an ABS loan-level data warehouse and the information infrastructure to support it.

While the general consensus among market participants is that the creation of a centralised ABS data warehouse will restore confidence in the European structured finance markets by ensuring investor access to comprehensive, standardised and timely information, there are growing concerns that the endorsement from the ECB will create an uneven playing field.

As discussed in an earlier post, unless the ABS data warehouse offers current loan-level performance information it will not restore confidence.  Offering loan-level performance data on a once per month basis would just be a continuation of the status quo that failed disastrously leading up the credit crisis.

Other sources, meanwhile, have said that the process is 'hopelessly complicated' and that the Market Group could have made the plan more straightforward.

Actually, as discussed in an earlier post, the process for selecting BlackRock is very straightforward.

What makes the selection process appear complicated is the lengthy request for information that is irrelevant to answering the questions "do you have proven domain expertise in designing an ABS data warehouse and its related information infrastructure" and "what conflicts of interest do you have in the design, construction and ongoing operation of the ABS data warehouse?"

The information requested is highly relevant to answering the question "are you BlackRock?"

A formal Request for Information was sent out last Friday to the interested parties - including specialist data providers, exchanges and IT firms from Europe and the US - and is open for 10 days, after which the Market Group will shortlist suitable candidates for the Request for Proposal stage.

Following the construction of the data warehouse, a private placement of shares in the warehouse is expected to take place, anticipated to be similar to the formation of Euroclear, with the constructor of the warehouse limited to 15 pct of the shares.

It is understandable why BlackRock, with its overwhelmingly large number of conflicts of interest, should be restricted to 15 percent ownership of the data warehouse.

But why should there be any limit on the ownership of the data warehouse by a constructor with no conflicts of interest?  In fact, why should that constructor not own 100% of the data warehouse?

Royal Bank of Scotland analyst Ganesh Rajendra expressed concern that a central bank-endorsed initiative, under which the cost of available collateral data would be passed through to end-users, was creating a market monopoly through a 'utility-like' pricing service. 

This approach is in contrast to the US Securities & Exchange Commission and the Bank of England's data reporting requirements, where issuers absorb the cost of compliance and make their collateral data publicly and freely available to the market. 

'How that data is aggregated and distributed is then usually left to the market,' said Rajendra. 

'The ECB's spearheading role in this regard still confounds us, considering the many private sector data vendors that exist and compete in the European securitisation credit market today.' 

Rajendra, stop confusing the issue with the facts.  You are missing the large number of firms which are investors in Markit and have been able to make a substantial return on their investment.  Everyone sitting on the ECB's technical working group would like to repeat this with the ABS data warehouse.

It is a minor inconvenience that last week the European Commission announced its investigation of Markit and expressed its strong concern over potential conflicts of interest when it comes to financial data providers with a monopoly.

However, supporters of the initiative argue that third-party data providers will still be able to analyse and model the raw data available in the warehouse for the investors that require it. 

This response does not mean that the ABS data warehouse is not a monopolist.  With the ECB endorsement, it will be.

At best, this response suggests that the ABS data warehouse's business model will stop with providing a snapshot of the performance of the structured finance security at one point in time and it will leave value added analysis to others.

In addition, originators will maintain the ability to circulate their data to anyone that requests it. 

'The data warehouse is not an exclusive or closed user group but is an open platform that seeks to promote data consistency and transparency in the ABS market,' said Paul Burdell, CEO at Link Financial, a receivables management company and one of the members of the RMBS technical working group for the initiative.

Hello!  What European originator is going to provide their data somewhere else given that the ECB looks to the ABS data warehouse for information on securities that are eligible to be pledged to the ECB?

The price of access to the warehouse's information will be key to the initiative's success, according to Gareth Davies, head of ABS research at JP Morgan, also one of the members of the RMBS technical working group for the initiative. 

He acknowledged the concerns related to the cost of information, noting that a pricing committee will be established, made up of a representative sub-group of the investing community in the warehouse initiative. Clearly, the more participants involved in the private placement, the more successful the pricing process will be.

'On the assumption that these investors will have an eye to making this initiative successful to ensure a return on their initial investment, we would expect pricing power to be relatively constrained by market forces,' he said. 'If not priced correctly, the initiative will fail.' 

Actually, any committee of investors who are not also shareholders of the ABS data warehouse will set the price for accessing the data at zero.

If there is any doubt about this price level, the Association of Mortgage Investors eliminated it in March 2010 when it expressed its opinion about being made to pay for loan-level data [emphasis added]

The fact that investors have to pay to subscribe to services such as Loan Performance to get data on collateral underlying asset-backed securities they are offered and may already hold is outrageous in light of the no-cost extensive public disclosure required for corporate securities.

The initiative does not have to fail if investors and other market participants are unwilling to pay for the data.  Instead, as pointed out by Rajendra, the issuers could pay.

I realize that issuers paying by building the cost of the ABS data warehouse into each deal would prevent the issuers from having their cake (all costs pushed onto investors) and eating it too (make a substantial capital gain from the investors having to spend money to access data they should get for free).

... The ECB has released its loan-by-loan information requirements for CMBS and SME transactions, which will be introduced for transactions accepted in the Eurosystem collateral framework within the next 18 months. 

This follows the release of requirements for RMBS at the end of last year. All three templates have mandatory and non-mandatory fields and will operate under a 'comply or explain' principle: thus if a counterparty is unable to complete a mandatory field, the transaction may still be eligible, provided that a satisfactory rationale is given. 

'While there is a risk certain smaller non-securitisation dependent lenders will simply opt not to use securitisation as a funding tool, generally the regulations should lead to further commoditisation of data provision and ultimately result in overall improved transparency,' said Conor O'Toole, analyst at Deutsche Bank. 

ABS is now the most common collateral group posted at the ECB's repo window for the first time, according to the central bank's 2010 annual report. ABS represented 24 pct of total collateral, up from 23 pct in 2009, followed by covered bonds at 21 pct. 

This is significant, particularly given that the ECB has made eligibility criteria for repo transactions far more stringent over the past year, such as tougher rating haircuts.

This is the explanation for why the ECB is pushing so hard to get the ABS data warehouse built.

Free, Current Data or Costly, Stale Data from ABS Data Warehouse

Under the FDR Framework, regulators, like the ECB and BoE, are responsible for ensuring that all market participants have access to all the useful, relevant information in an appropriate, timely manner.

But what is meant by the term "all market participants have access"?  This term can be broken into two parts.

• "All market participants" means everyone.  This includes, but is not limited to, investors ranging from mom or pop to PIMCO or BlackRock, rating services, pricing services, data vendors and regulators.

• "Have access" means there are no barriers, like the need to pay for the data, between the market participants and the disclosed information.

Historically, for structured finance securities there have been access barriers.   Market participants can access reports for free at the issuer's or trustee's web site or pay a fee to access the loan-level performance data through a data vendor.

In March 2010, the Association of Mortgage Investors expressed its opinion about being made to pay for loan-level data [emphasis added]

The fact that investors have to pay to subscribe to services such as Loan Performance to get data on collateral underlying asset-backed securities they are offered and may already hold is outrageous in light of the no-cost extensive public disclosure required for corporate securities.

Apparently, investors prefer to access loan-level performance data for free.

But not so the ECB.  In its letter supporting the creation of the ABS Data Warehouse,

Once constructed (... reflected in the fees levied on the users of the Data Warehouse...) the Eurosystem intends to make use of the Data Warehouse in connection with the Eurosystem collateral information requirements approved by the Governing Council in December 2010.

Apparently, the ECB does not mind having to pay to access loan-level performance data.

Unfortunately, the ECB's willingness to pay for data outweighed the investors' preferences for not paying for data when it came to selecting the business model of the ABS Data Warehouse.  As the quote from the letter supporting the creation of the ABS Data Warehouse shows, the ECB supports a business model based on charging market participants for accessing the data.

There is an alternative model that was described in your humble blogger's response to the ECB's Public Consultation.  The alternative model is to build the cost of the data warehouse into the cash flow for each deal.  Under this model, which is preferred by investors, all market participants can access the loan-level performance data for free.

In a previous post, we discussed how the ECB and BoE preferred the status quo of market participants receiving old, stale data on a once per month basis.  This preference can be combined with the ECB's preference for charging for accessing this data.  Taken together, the implied preference of the ECB [and also the BoE given its support of the ECB's activities] is to have market participants pay for old, stale data.

By comparison, your humble blogger prefers, since Wall Street through its servicing subsidiaries has access to current loan-level performance data, to have all market participants have access to current loan-level performance data.  This preference can also be combined with the investors' preference for offering access to this data for free.  Taken together, the preference of investors and your humble blogger is to have market participants have access to current loan-level performance information for free.

Which seems more likely to help the ABS Data Warehouse achieve its mission of

Facilita[ting] investment and support[ing] transparency, integrity and restor[ing] confidence in the structured finance markets

free, current loan-level performance information or costly, stale once per month loan-level performance information?  Common sense suggests that the answer is free, current loan-level performance information.

Your humble blogger is looking forward to helping the ECB and BoE construct and operate the ABS Data Warehouse using my patented solution and provide free, current loan-level performance information on structured finance and covered bond securities to all market participants.