Regulatory Reporting: Is a Holistic Approach Possible?

by Matt Rodgers
Feb 14, 2017 Share this! LinkedIn logo Facebook logo Twitter logo Reddit logo Google+ logo

As financial services firms face a continued onslaught of new regulations, broker-dealers are reassessing their operating models. DerivSource spoke with Matt Rodgers, senior manager at Sapient Global Markets, about whether a holistic approach to regulatory reporting is possible, and how firms can leverage such an approach to prepare for future regulatory change.

Q: Various existing and upcoming regulations, including the European Market Infrastructure Regulation (EMIR), the Markets in Financial Instruments Directive (MiFID) II, and the Securities Financing Transaction Regulation (SFTR), have a trade-reporting requirement. Are firms taking a holistic view in preparing for the reporting requirements, or are they approaching it on a regulation-by-regulation basis? 

A:  We’ve seen a variety of road maps from our clients. Some clients, large and small, are taking a holistic view, looking at all the regulations that will impact them, while others are more tactical. 

Broker-dealers taking a holistic approach are assessing whether it is beneficial from a P&L perspective to continue to operate in each jurisdiction, before new rules go into effect. Some firms may eventually decide to exit certain jurisdictions as the cost of compliance becomes prohibitive. Either way, there will be a significant impact. Firms need to execute transactions and make money, and there will be a cost to doing this. Faced with tight spreads, thin markets and a high cost per trade, brokers must find creative ways to offset their compliance costs by either providing new services to clients, or charging clients for services that were previously free. Some are looking at their clearing model or are charging for research. Others are providing new reconciliation or reporting services, as a way of validating the compliance cost for staying in a jurisdiction or providing certain services.

Those that are taking a regulation-by-regulation approach need to have a more hardened road map. Once they have decided which jurisdictions, business types and clients they want to be involved with, they cannot really deviate from that plan. Pulling out of a jurisdiction, or entering a new one for clients, could be costlier than pre-planning for this type of event.

Q: What are the obstacles in data, trade matching or reconciliation that stand in the way of firms either tackling regulatory reporting holistically or strategically? 

A: Data, trade matching and reconciliation are all completely bespoke to every client or institution. From a data perspective, every system is different, with data being captured, stored, archived and reported in very different ways. Right out of the gate, we're dealing with integrity issues, where one firm may capture something as a whole number, and their client may capture it as a whole number with a decimal, for example. Firms have to understand the data requirements at the outset in order to push forward some sort of harmonization.

Trade repositories are already trying to provide some data harmonization. Institutions are also trying to harmonize, normalize and store their data internally, so that it is more readily accessible and easier to understand, and reporting is more fluid, front to back, from a technology and reporting standpoint. This is a massive undertaking. So far, data management or storage in the financial services industry is not regulated, so there is no streamlined approach. 

There are also various obstacles to do with technology, oversight, management, personnel and knowledge. The list of challenges will keep growing until the industry finds a way to standardize how and when we store, report and ultimately manage the data associated with the execution of financial instruments.

Trade matching is only as good as the data firms have captured. Trade repositories and third-party vendors are working to improve matching, but normalizing and understanding the underlying data is key. Firms can only throw so much money, time and people at a spreadsheet. Each client and each regulator is looking for a different type of matching, so harmonization is needed.

Reconciliation is a broad term that means different things to different parties. Everyone from custodians to supply sides, sell sides, clearing brokers, execution agents and prime brokers has a different business purpose, and therefore a different type of reconciliation. The challenge again is to do with data harmonization, as data management and matching criteria are going to be different across the board. Until the industry figures out at more harmonized approach, reaching a common goal of reconciliation between the different parties to an execution will be a challenge. 

Q: Are the challenges managerial/structural, operational or both? 

A: Each institution, be it buy side, sell side, clearing or prime broker, has different business practices, processes, technology constraints and budget availability. From a managerial perspective, it is possible to standardize governance around these same themes, but ultimately, once we move into the structural challenges, everybody is different.  

Every client is asking for different things from their broker. Hybrid solutions are cropping up across the board. The larger institutions that are going to be providing services such as these, are the vendors. They need to streamline their approach by providing limited options. This forces brokers to figure out how to best fit into the vendor’s business plan and practice and whether the offering is right for the client. Society is based on choice. When people are given options and only those options, they have to choose what is best for their business. 

Maybe the clearing brokers, the prime brokers, the execution agents or the buy and sell-side firms can work together toward finding some sort of commonality around data, trade matching and reconciliations. Everybody is focused on the same goal. Organizations need to find a way to get there that suits their business needs, within their structural budget, management, hierarchy, and ultimately, what's best for their client. 

Until the industry figures out at more harmonized approach, reaching a common goal of reconciliation between the different parties to an execution will be a challenge.

Q: What are the benefits for a firm to being more proactive in industry conversations to find that common ground?

 A: Firms need to look at regulation strategically because change is a constant. The Dodd-Frank Act, the Volcker Rule and the Fiduciary Rule could all yet be removed or overhauled. Regulation should be a line item in firms’ balance sheets. Whether or not firms are willing to provide millions of dollars for this budget is within their discretion, but ultimately there is only so much outsourcing and negotiating firms can do. They will still have to comply with jurisdictional rules.  

When Dodd-Frank came out, many firms built their own hybrid solutions. They are now realizing the high cost, from an operating, head count, resource, hardware and data perspective, of managing these ever-changing regulations and the new regulations still coming forth. 

Firms need to look at this strategically to understand their regulatory road map for the next five years. What is coming up? How do they manage it? Who do they have to manage it? What are they using to manage it?  

Ultimately firms may not see a fiduciary benefit right now to taking a more strategic approach. But with a high-level road map in place, firms can plan for regulatory compliance initiatives as part of their normal operating budget. So when a new regulation comes online, or a change is made to an existing one, they will have a system and support team in place, and will have defined resource allocations.  

However, if firms continue using a more tactical, band-aid type of approach, they could put themselves at risk from sanctions. Some firms have already been fined for lack of controls, poor transparency or insufficient reporting. By taking a strategic approach to compliance, firms can avoid negative press and costly fines. The key will be to find other revenue generators to offset their compliance costs and turn a profit. Firms that approach regulations strategically—or holistically—can focus on providing a better service to their clients through any means necessary, even when their regulatory obligation costs are high.

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Matthew Rodgers is a Business Consultant based in New York. He has an extensive background in sell-side banking, where his experience has been pivotal around OTC derivative trading and regulations. His expertise has carried over to various other regulations within the OTC regulatory space for Dodd Frank, Canadian regulations, ESMA, ASIC, MAS, JFSA and HKMA. His current engagement entails utilizing Sapient’s strategic global regulatory reporting and reconciliation solution CMRS. He is responsible for advising clients globally on upcoming regulations within the derivatives and cash space for various financial institutions; a tier 1 investment bank, custodians, and asset managers. His broad understanding of the “front to back” business flow is beneficial in advising clients on strategic decisions needed for compliance within the OTC space.