Problems still persist weeks following the EMIR trade reporting deadline with confusion over UTIs, details of the new ESMA Q&A and debate over FX derivatives definitions clouding already muddy post-trade processes. Lynn Strongin Dodds reports
To say that meeting the European Market Infrastructure Regulation’s (EMIR) new trading reporting regime on 12 February was challenging is certainly an understatement. The irony perhaps is that no one was surprised. The general consensus before the deadline was that many would be slow to the starting gate, particularly those smaller and regional buy-side firms who simply do not have the resources of their larger counterparts to get their derivative ducks in technical order.
It is easy to see why as the task is monumental. The data required to be reported under EMIR has to be set out in 85 fields and segregated into two categories. The first is the ‘Counterparty Data’ which tends to be more confidential in nature as it will relate to the beneficial owner while the second is the ‘Common Data’, which is essentially the agreed trade and lifecycle data. Some market participants believe that the European Commission underestimated the complexity and time it would take to implement the new rules.
The EMIR text stated that reporting must begin 90 days after the first trade repositories (TRs) were given the green light but the first batch were not approved by the European Securities and Markets Authority (Esma) until last November. This included the London Stock Exchange Group’s UnaVista, The Depository Trust and Clearing Corp.’s (DTCC’s), Krajowy Depozyt Papierów Wartosciowych (KDPW) in Poland and Regis-TR, based in Luxembourg and jointly owned by Deutsche Börse’s Clearstream and the Spanish Stock Exchange’s Iberclear. CME Trade Repository and ICE Trade Vault Europe were recent additions and further TRs could be added to the list over time.
Given the tight deadline, it is no wonder that some of the TRs struggled on the starting day and were overwhelmed by the influx of customer data. For example, it was reported that while trades could be reported at one TRI, clients were unable to then access the reports, which is an essential part of reconciliation processes.
“It is interesting because it was known that people would struggle to get their information together,” says Elspeth Goodchild, specialist in buy side and delivery management at Rule Financial. “Although trade reporting had been coming for a long time, there were definitely a lot of people who waited for the TR announcement (which confirmed the 90 day reporting deadline in February) before starting any work on the project. As this announcement wasn’t until 7 November, by the time projects were mobilised it ran into Christmas and meant that these firms struggled to be ready in such limited time.
Sell-side firms also found the timeline too short. As one large bulge bracket spokesperson put it, “It was too rushed and this proved to be a real challenge for our clients from both a legal and practical perspective. It is fragmented landscape and there are still a huge number of unknowns,” he adds.
Most notably the process of obtaining a legal entity identifier (LEI) which is required in order to trade and is key for the Unique Trade Identifier (UTI) which follows the lifecycle of the trade. Unlike in the US, where trade reporting is one sided and only applicable to OTC transactions, EMIR stipulates that both counterparties use a UTI in order to identify a trade within a TR. It not just covers OTC but also more recently exchange-traded derivatives (ETD) transactions were added to the list. Conventional wisdom was that regulators would wait until 2015 for ETDs but in the industry did not get the breathing space they had requested.
“One of the biggest issues with the UTI is who has responsibility for generating it, and how to get it to the other party to the trade, so that the two trade reports can be paired” says Goodchild. “Also, once you pair the two sides, there may be specific fields that do not match. The format and protocol for the creation and exchange of UTIs is critical to reconciling the two-sided trade reports and many firms are still struggling with this. As a result it will be difficult to reconcile the trades. There needs to be more clarity about the matching process.”
David Broadway, senior technical adviser, Investment Management Association (IMA), agrees, adding, “There are a number of different ways to exchange the UTI and there is still a lot of debate between our members and the sell side as to who will generate and assume responsibility for the UTI. Compounding matters is the Esma Q&A that was issued the day before trade reporting was due to take effect. Some of the answers begged yet more questions and left everyone in a continued state of uncertainty. For example, many firms had been building a platform based on 42 characters which follows ISDA’s recommendation of 32 characters with an additional ten from the LEI. However, the Esma guidance seeks to make more use of the maximum 52, but with no indication as to its expectations re the timing of any transition.”
The Esma Q&A published guidance on trade reporting suggested four methods to determine how to create the UTI as well as a preferred running order for UTI generation. For example, UTIs for centrally executed and cleared trades could be generated by execution venues or at point of clearing by the CCP while those for centrally confirmed but not cleared trades could be created at the point of confirmation. The jury is still out as to whether Esma will endorse a UTI framework in the future.
These last minute changes were not the only alterations that threw market participants into a state. Esma’s request from the European Commission to clarify the definition of a derivative or derivative contracts under EMIR for reporting purposes also added fuel to the fire. Particular attention is being focused on foreign exchange (FX) forwards which are open to different interpretations under the Markets in Financial Instruments Directive (MiFID). For instance in the UK, the Financial Conduct Authority does not require a counterparty – dealer or end-user –located in the country to report its leg of a forex forward to a trade repository if it meets the commercial usage criteria. The US has a similar stance but Europe has its own version which was specifically laid out by the Commission last December in a memo. Simply put, forex derivatives are subject to mandatory reporting.
Looking ahead, industry experts expect that the teething problems and glitches will abate over time. “The expectations are that the trade reporting backlogs will be cleared in the next few months and from there the counterparties and end-users will work through the compliance issues,” says Phong Dinh, senior adviser, Chatham Financial. “One of the issues is harmonisation across Europe and that is harder to do in reality. The FX definition is a concrete example of interpretation and implementation.”
Sandy Broderick, chief executive officer of DTCC Deriv/SERV notes, “The process is nascent and things will shake out over the next few weeks. The number of unmatched trades is an issue but this will be resolved once there is more clarity around UTIs particularly as it relates to FX reporting. I expect there will be a lot of dialogue in the meantime between participants and Esma.”
Broderick also believes there could be challenges with collateral and valuation reporting on 11 August. “They are being bunched together which could prove challenging. For example, it is important to disentangle collateral in order to understand what it means in terms of risk. Also, it will be difficult to understand how it relates to an individual trade as collateral is typically pooled together.”
John Southgate, senior vice president at Northern Trust believes though that the process may be smoother. “The market would have gone through the initial exercise and the connectivity, client set-up and legal documentation would be completed. This should make the exercise easier. Also, there is likely to be less scope for challenges because the next phase is position-based valuations and collateral, rather than transactions.”
