Transparency and Convergence

For over a year,my firm (CarveOut Partners)and I have been watching the changes in the regulatory world.Our goal is to provide advice on applying the latest technology to capitalize on the opportunities presented due to these changes.

The Uncovering

The Dodd-Frank bill brings significant focus by regulating derivatives via exchange listings,spinning out proprietary trading under the Volcker Rule as well as new focus by the SEC on regulating high frequency trading (HFT)and cracking down on “expert networks.”The areas where recent financial reform will have a significant but quiet impact dates previously to the Dodd-Frank bill or the SEC’s and FBI’s focus on HFT and expert networks,respectively.This is the area of interactive data and the digitization of financial reporting by publicly listed entities that list on a US exchange.

In 2007,the SEC developed rules to formalize XBRL reporting requirements,finalize taxonomy formats for GAAP,and create a technological infrastructure for interactive data formats.In early 2009,the SEC published final rules for operating companies (also known as issuing firms)as well as rules for publicly listed mutual funds.

It’s time to look beyond the regulatory haze and the enabling technologies to discover how Wall Street can lead in creating the value-add necessary for financial transparency.

Most Wall Street firms do not understand the significance of this wave of financial transparency brought on by the XBRL GAAP reporting initiative.Most traditional vendors who focus on the Wall Street space see XBRL as just another reporting format,while publicly listed entities view the XBRL SEC mandate as a Sarbanes-Oxley directive.It’s time to look beyond the regulatory haze and the enabling technologies to discover how Wall Street can lead in creating the value-add necessary for financial transparency.

The FIX XBRL Analogy

By July 2011,all public listed US corporations will be filing 10ks and 10Qs in standardized XBRL formats.There are more than 15enabling vendors now assisting these issuers in formatting and submitting their financial statements,much as there were niche vendors in the FIX (Financial Information eXchange)space assisting firms with trade submission formats and communications.As FIX became ubiquitous,so did the advancement of the electronic trading world.The ability to process data at light speed has led to quicker trade execution and analysis as well as new decision-making tools and processes that have arguably changed the global trading landscape forever.

XBRL is much different from FIX;it is a reporting standard and FIX was a communication protocol.In addition,compared to XBRL’s number of tags in a standard GAAP taxonomy,FIX has a relatively small number of tags associated with each asset class.This may or may not matter.It may mean that there are more opportunities to exploit the standard,driving more innovation.It may mean that the standard will take longer to become universal and advance to the value-add stage –think FIX Engine vs.Algorithms enabled by FIX as a standard.

Looking Forward

Where is the opportunity?Where will we trend?

If you understand the process of XBRL submissions and the interaction of the players (issuers,the SEC,wire houses,and other disseminators and users),you see that the Street can help drive the new push to transparency.

XBRL will trickle down to Portfolio Managers.They can now build their models to instantly take a publicly disseminated 10Q filing via an RSS feed and know immediately that one of the holdings has disclosed a new executive compensation disclosure,one that was previously hidden in unformatted non-standardized footnotes.In the past,it would have taken hours to sift through paper filings and make this discovery.

XBRL will be able to integrate directly with Equity Traders'blotters,matching up holdings in order management or execution management systems to an interactive earning news release with embedded tags showing that EPS has slipped substantially from their own targets and the whisper number.

Quantitative Portfolio Managers will be able to access vast amounts of data directly from the SEC that was submitted by issuer firms’minutes or even seconds earlier.They can then fully rebalance positions in their baskets without any human intervention.

An ADR or Pairs Trader will be able to build a model that compares an international conglomerate's European earnings submitted in IFRS to a US peer filing in GAAP without having to understand the different accounting standards,understanding only how each taxonomy tag says “receivables”.

MBS Broker/Dealers will be able to optimize capital allocation models to minimize reserves as capital requirements increase.Because the underlying loan data will be tagged and standardized,it will be easier to gather a true real-time valuation of the constituents in a pool.This will facilitate more frequent re-pricing of underlying assets and collateral.

Once we begin to exploit XBRL within US capital markets,we may even be able to lead the world in creating more efficient transparent capital markets.

In Closing

In the end,standardized interactive data –whether in XBRL format for GAAP and IFRS reporting or in RIXML for global investment –research will lead to new delivery mechanisms,analysis tools,streamlined processes,and greater transparency.We should be able to discover anomalies faster,and this should help to limit losses and decrease systemic risk.We can only hope that there will soon be a mandated standard for all governmental finances.