Thomson Reuters’ Tim Lind explains the challenges both regulators and financial institutions face in the coming year as they address regulatory fragmentation of data standards. He warns that the practical enforcement of such data standards will be very complicated if communication between regulators and firms is not open and transparent.
Regulation might be a catalyst for the adoption of standards for the classification of holdings by sector, asset classes and jurisdiction to name some, however, regulators are not taking consistent approaches to the data classifications and this fragmentation of data standards poses challenges to financial institutions.
We have already seen this in the swaps market where systemically important financial institutions must report trades to swap data repositories (SDRs) but face confusion due to different interpretations of templates and data required for reporting. This confusion has resulted in inconsistent labeling of an asset or data within the product and incomplete data fields included in reporting within that product. And this inconsistency in interpretations of requirements for swaps reporting is in part due to the lack of proactive engagement between the regulator and the regulated entity and also the lack of a common framework for a definition of these data standards via templates.
Another example of this miscommunication among regulators, or rather lack of harmonization, is Legal Entity Identifiers (LEIs) and the Foreign Account Tax Compliance Act (FATCA). LEIs, which are being promoted through the department of Treasury’s Office of Financial Research (OFR) in the US, Financial Stability Board (FSB) are designed to uniquely identify an entity, an issuer or a wholesale participant or swap participant. FATCA, by contrast, relies on a different symbology, the Global Intermediary Identification Number (GIN) when it needs to identify an entity, such as a bank or a foreign financial institution, as needed to support FATCA compliance and reporting to the Inland Revenue Services (IRS) directly or through an Inter-government agreement (IGA). In short, when two regulatory initiatives had to identify a legal entity and the status of that legal entity, they chose to go with different identifier standards.
Moving ahead, I would expect that there would be some harmonization amongst regulators in that they will find new ways to collaborate. Before the crisis, even within the US the ability of the Commodity Futures Trading Commission (CFTC), Federal Deposit Insurance Corporation (FDIC), Securities and Exchange Commission (SEC) – all regulators who have some jurisdiction over banks, equities trading and swaps trading, didn’t have a framework for them to communicate, but now regulators are finding new ways for the various agencies to share information and collaborate.
My optimistic view is that our regulators start to create the infrastructure to communicate and harmonize their demands of the various constituents because clearly risk doesn’t understand borders. And the fact that a Greek sovereign debt crisis can throw the entire world into uncertainty is a perfect example of that. Regulators, I believe, recognize this and will start to harmonize, but from a practical perspective, I don’t see a harmonization of data standards taking place in the next three to five years. This means firms will have to resort to cross-referencing between different schemas, various symbologies and taxonomies for the coming decade. Data managers specifically will have to deal with more and more attributes, semantic alignment between different data standards and of course cross-referencing across all to support the various regulatory and reporting requirements now and in the coming five years.
As stated before, there is a clear need for the regulators to engage their constituents to identify the standards that are most useful for the disclosure requirement to meet regulatory needs but also are in line with a financial institution’s ability to provide that information. Without clear understanding of the practical side of these standards via clear communication between regulatory and financial institutions, practical enforcement of these standards will be difficult.
Taking the Financial Transaction Tax in Europe as an example. If a UK entity is required to collect and withhold taxes from a London branch of an Italian-based bank, how does this UK bank do this? How does it withhold the tax, pay the Italian government the taxes due and calculate this for a particular transaction with a particular entity? And with FATCA, how does the IRS track the compliance of foreign financial institutions in other countries for withholding the proper amount of taxes on a US person? Putting the template together is one thing, but understanding the implementation of the template or tax withholding is a far bigger challenge. And this gap between regulatory requirements and understanding the real implementation process needs to be filled otherwise enforcement will be a serious challenge in 2014 and beyond.
We are only just now starting to understand some of the practical implications of some of these new data classification standards and the regulatory rules they aim to support. It’s hard for regulators to fulfill their role in a public mandate unless there is a common implementation of these standards; only clear communication and an understanding of the challenges firms face will support the purposeful use of standards in a harmonized way. I think establishing a path towards regulatory harmonization of standards and the clear communication between industry and regulators is going to be the main challenges for 2014. It isn’t an easy task but it is essential.
