Summit to think about

Hugh Daly of Message Automation explains how regulatory changes from the Pittsburg G20 summit could lead to multi-purpose strategies and a more organised OTC derivatives market

Many organisations are still in the midst of wide-ranging projects to fulfil regulatory requirements in the arena of derivatives trade reporting, typically driven by either the Dodd-Frank Act in the US or the European Market Infrastructure Regulation (EMIR) in the EU, but now also being complicated by additional requirements from other jurisdictions such as Canada and Australia.

Forthcoming requirements in 2015 from Switzerland and as part of Markets in Financial Instruments Directive (MiFID) II will bring additional demands, particularly on buy-side organisations that may have delegated EMIR reporting. The question now is whether the necessary effort being deployed to address mandatory trade reporting can be used to strategic advantage elsewhere.

Reporting challenges

This is not another article on the implications of the Department of Foreign Affairs (DFA) and EMIR. If you need full details now, you are probably too late. But for those a little bit fuzzy on the subject, some reminder of context is appropriate.

These new regulatory demands stem from the Pittsburgh G20 summit in September 2009. The over-the-counter (OTC) derivatives market was identified as a major contributor to the confusion and fear in the market in 2008. The relevant core principles in this context were to increase transparency and to reduce counterparty risk. These goals have been translated into global initiatives such as mandatory clearing of OTC derivatives, increased use of collateral and intra-day trade reporting.

The concept of near time reporting of all derivatives trades is new, and poses huge challenges to almost all market participants of any size. The T+1 reporting mandated under the European regime poses additional challenges as it applies to all participants, not just major players. For those not immersed in these projects already, it is worthwhile questioning why not. However low your volume, or even if it is relatively common FX trading, you may be ensnared.

From our conversations with market participants facing EMIR, we have found many were fixated on the infamous ‘85 fields’. Those who thought that didn’t sound too bad were missing the catch. Some of these will be populated from a variety of sources, and fields may be populated within different data elements for different products types.

Buy-side organisations that delegated the responsibility to brokers are now realising that they still have to have their own records and that they are accountable for what has been reported. As not all brokers are accepting delegation, they may still have to do some reporting themselves, and this will almost certainly be the case under MiFID II.

The immediate challenge is obvious; sourcing the data from your trading systems and ensuring the accuracy and completeness of the data submitted to the trade repositories, whether that’s via a broker or not. It is highly likely that not all of the data required is freely available from a single source system. Enrichment of the data will be required as a result.

There are other pitfalls to look out for, too:

• The reporting obligations are framed to cover the full range of OTC asset classes, that is, interest rates; credit; equity; commodity; and foreign exchange derivatives. Although exempt from Dodd-Frank obligations, exchange-traded derivatives are included within the scope of EMIR.


• TIn the typical siloed model, different asset classes are booked in different primary systems, or different versions of the same system, and often there are trades that do not conform to the high level model. Examples might be an associated foreign deal exchange booked in a commodities system or a rates application.


• Your internal product taxonomy or hierarchy may not map easily onto the regulatory unique product identifiers. Some products may end up being shoe-horned into your legacy systems, as it is the only way to book them at all.


• There is the issue of operational preparedness. Although EMIR does not require intra-day or near-time reporting, there are still complexities, for example, over unique trade identifiers. With such a lack of clarity even at this late stage, we believe that breaks are inevitable. Actual people will be required to manage these exceptions.


• For reconciliations, fundamentally, the move to central clearing and trade reporting creates at least two new representations of your trade population. Remember that the external copy is the truth. When disagreeing with a clearinghouse, either directly or via a broker, you are simply wrong. Therefore, performing a population reconciliation between your books and records, and each of the central counterparties (CCPs) is essential. Otherwise, you may be powerless when margin calls are made.


• Regulatory reporting on behalf of clients is another opportunity for something to go badly wrong. What are your service level commitments and your liability?

• So, all bad news so far. We’re left with poorly defined requirements, project risks, pressurised deadlines, regulatory imperatives, and plenty of scarce resources required with little or no choice. But there is a silver lining to the G20 cloud. There are various areas to consider:
  It could be possible to create a data warehouse by stealth. Many organisations have spotted that describing all trades in an externally recognised fashion, across asset classes, is something that is difficult, but this has knock-on benefits elsewhere.


• Product taxonomy is important. For perhaps the first time, all trades across siloes will have been classified according to a single product hierarchy. The taxonomy may not be exactly to your liking, but it is consistent and clearly understood by external parties, as well as new joiners. There are clear opportunities to use this for better risk management, management reporting and front- and back-office reconciliation. It also should make future migrations and system replacements easier.


• Trade reporting forces the organisation to have a consistent view of counterparty data, creating a client master database. Work probably needs to be done for domicile classification, and almost certainly for reporting classification, plus, of course, the mandatory legal entity identifiers.


• Organisations must be prepared for the new collateral challenges. The subject of collateral changes is broad, but the same opportunities arise. To achieve the holy grail of cross asset class margining and efficient collateral optimisation, a pre-requisite is the simple ability to provide a single view.


• When viewing these potential benefits as a whole, one can see that together they can become the building blocks of an internal control framework. The trade lifecycle is changing for OTCs, with significant new external events including reporting, clearing, and continuation reporting, and valuations are supplied from clearing houses.