At the beginning of the year, Misys released a whitepaper addressing the influx of regulation in the over-the-counter (OTC) derivatives industry and, more specifically, the risks that have shifted toward buy-side firms as a result.
At the beginning of the year, Misys released a whitepaper addressing the influx of regulation in the over-the-counter (OTC) derivatives industry and, more specifically, the risks that have shifted toward buy-side firms as a result.
The paper’s authors, Will Dombrowski and Bradley Ziff, suggested that the myriad challenges already facing buy-side firms were just amplified by the reporting regulations enforced by the European Market Infrastructure Regulation (EMIR).
They referred to the ‘global goliath’ of regulation, saying that more than 80 percent of bank-based participants felt overwhelmed by the pressure of regulations and compliance. Institutions have felt the need to reassess their whole business platforms, while some even felt that regulations were taking on a life of their own, becoming ingrained with ‘normal’ everyday business life.
Clément Phelipeau, product manager for derivatives and collateral management services at Societe Generale Securities Services (SGSS), expands on this, detailing the issues that have faced buy-side firms, specifically.
“The first challenge for buy-side firms was to add to their transaction reporting, valuation and collateral information on a daily basis,” he says.
“The second is the monitoring and management of the proper integration of reported data in the trade repository platform, as well as the reconciliation with data reported by its counterparties, either in the same repository or between several.”
While Dombrowski and Ziff were not addressing EMIR specifically, the timing of the paper was notable, right in the middle of European Securities Markets Association’s (ESMA) consultation period as it reviews the shortcomings of the trade reporting requirements.
Phelipeau adds: “Now, buy-side firms will have to cope with higher data quality requirements in order for the regulators to globally control all of the EMIR obligations. The reported collateral will reflect the proper application of the bilateral collateralisation expected by December 2015.”
The ESMA consultation addresses the practical implications of EMIR reporting, and intends to clarify the interpretation of data fields needed for reporting, as well as the most appropriate way of reporting them.
With the revisions due to be disclosed in February, an industry just coming to terms with one set of regulations is collectively hoping for some simplification, but preparing to be even more confused
Francis Cook, a specialist in regulatory compliance at GFT, formerly Rule Financial, clarifies that, as this is the first consultation on this issue, it’s hard to know what will happen next.
He says: “The initial views on the consultation are that it will move the reporting in a good direction in terms of the clarity. Unfortunately, it does raise new questions to replace old ones.”
“The major changes proposed are around the product underlyers and an identification of the Regulation on Energy Market Integrity and Transparency (REMIT) reports submitted under EMIR. There is also an expansion of the fields around collateral to provide a complete picture of collateral received and posted.”
“The other aspect is the context of this review and how ESMA expects the output to be adopted. On first reading, the commission do not appear to have a mandate to adopt the results of the consultation into law, unless they somehow work around the adoption of the initial text. All in all, we would expect to see this process changed, or updated in future.”
Phelipeau agrees that the main changes will focus on data quality, in a bid to monitor systemic risk as efficiently as possible.
He says: “With high expectations on a better identification of trade parties, greater details on reported transactions and technical restrictions to limit inaccurate or false reports.”
“We believe that reports submitted to trade repositories will very likely become a key tool enabling European regulators to fulfil their mission in this domain.”
There seems to be a sense that buy-side firms are suffering more than their sell-side counterparts, simply because they have not been subject to reporting regulations before. At the same time, when the regulation first came in to force in March 2014, ESMA was criticised for not providing enough guidance, leaving unanswered questions over how exactly to implement the changes.
To make matters worse, there were also concerns about the costs that rack up alongside regulation.
“Compliance has clearly raised a barrier to the market,” says Cook. “However, the cost of regulation has yet to be fully factored into trading. At this moment any costs would be disrupted by on-going regulatory development, and some firms may have managed to fold this in to their transaction reporting infrastructure.”
Misys’s whitepaper addresses the choices that firms face when choosing how to handle the IT aspects of the reporting—the ‘build versus buy’ decision.
Typically, large banks with $500 billion or more on their balance sheets and buy-side institutions with assets under management reaching in to the billions are opting to develop internal systems to handle their own obligations. Smaller firms, on the other hand, are choosing to employ third-party providers to take care of reporting for them.
Both of these options come at a cost, but outsourcing brings about additional risk as firms are still wholly responsible for their own reporting, even though it’s in the hands of a third party.
It may be unclear, as of yet, how much of the cost will be passed on to the client, but Dombrowski and Ziff suggested that profitability is something that banks will have to consider, with 90 percent of regulated banks surveyed agreeing that they will keep a close eye on their costs.
This shift in the dynamic on the buy side could mean that firms will start to take on less risky business, as regulatory requirements keep on coming with no sign of letting up.
The regulatory changes in OTC derivatives trading has been gracing headlines for more than two-and-a-half years now, and with even more new ESMA guidelines in the pipeline to emerge before the end of 2015, it doesn’t look like its anywhere near over yet.
Cook says: “The turbulence in the industry is certainly making people nervous, particularly with the current focus by the regulator to improve data validation, which is going to cause pressure on the booking and reporting practices in an area where there is no real consensus.”
Phelipeau, however, believes that in the current market, all firms’ business must be intrinsically connected to the regulatory environment, and that they should integrate their systems. He stresses that although it may not be ideal, the ESMA consultation, and anything that comes from it, is a necessary step.
“Any communication channel between the financial industry and regulators can only be beneficial.”
“It is an efficient way to make European regulators fully aware of the market standards, practices and constraints borne on market participants, in addition to bilateral discussions the financial industry may have with its respective competence authorities.”
No matter what comes out of the ESMA consultation, the feeling is that it’s not going to suddenly clear the water.
As Cook concludes: “We are in a maze with multiple exits, but some of those exits may lead to more mazes.”
