Market participants face more uncertainty and operational challenges ahead of the next EMIR trade reporting hurdle – collateral and valuations reporting. Lynn Strongin Dodds reports.
Market participants have barely caught their collective breath from meeting the first trade reporting deadline in February under the European Market Infrastructure Regulation (EMIR). The process did not go smoothly and no one expects the next hurdle – collateral and valuation – on 12 August to be any easier. Regulators are still hammering out the final details while questions remain as to whether sell-side firms will offer a helping hand to their buy-side counterparts.
The hope is that brokers and banks will extend the delegated services offered for trade reporting to the next phase which involves submitting daily reports to trade repositories with mark to market valuations of outstanding exposures to their counterparties as well as reporting on the collateral that has been exchanged, either for individual contracts or on a portfolio basis.
The jury is still out as to whether they will step up to the plate. “The main issue is that many on the buy side expect the dealers to do it for them,” says Allan Yip, partner, derivatives practice at law firm Simmons & Simmons. “This is what happened with trade reporting. There was no consensus in the dealer community to accept delegated reporting and therefore no standard delegation until very late in the day and we see the same thing happening with reporting collateral and valuations.”
Currently many brokers provide a delegated trade reporting service for their largest clients but collateral and valuation poses different logistical and operational challenges, not to mention costs. This is partly because collateral held for exchange-traded derivatives is different than those for over the counter and FX flow. Another challenge, according to Stewart Macbeth, president and CEO, DTCC Derivatives Repository Ltd is the unique trade identifiers (UTI) and whether firms have the ability to supply an agreed UTI and valuations. At the moment, it can be a challenge for buy-side firms to piece together details of their dealers’ side of the trade and their own before sending it to the trade repository.
While financial service firms were forced to restructure their collateral operations in the wake of the Lehman collapse, many still rely on legacy systems which would need to be completely overhauled in order to meet the new requirements. Mapping to the correct counterparty credit support agreements would not be that onerous but dealing with multiple credit support annexes (CSAs) per asset class or the more bespoke and complex structured trades which are subject to their own specific collateral arrangements in documentation, could prove difficult.
The other obstacle is that the model used would have to be approved by the fund management group’s board of directors and as one broker put it, “dealers do not want to give out their proprietary models.”
Last but certainly not least is crunching the numbers is not that straightforward and models vary. “Dealers doing valuation and reporting for themselves do not always calculate valuations on a mark to market basis, but rather on a mark to model basis,” says Yipp. “The concern is that if the buy side wants to take it and use that mark to model valuation from the bank, it would be required under EMIR to get board approval of the model used by the bank to calculate the value, which is clearly a sensitive issue.
Emily Cates, London-based operational processing specialist at consultancy Rule Financial, adds, “Broker/dealers are providing the service as part of their customer service relationship but there are quite a few flavours. They have different systems and if brokers use delegated reporting, they need to question how they grade the collateral, the haircuts applied and pricing. This is because they can outsource the reporting but not the liability.”
In other words, the proverbial buck stops with them. Under EMIR, the buy side has the ultimate responsibility for the trade to be correctly reported and dealers have not been willing to indemnify clients against any regulatory sanctions or reputational damage should trades not be accurately conveyed.
Not surprisingly, the bigger fund management houses which tend to have internal valuation and collateral systems are opting to go it alone and do their own reporting as well as number crunching. “We are seeing a growing proportion of buy-side firms who want to have greater control and visibility,” says Cates. “The larger the size, the more complex the products, asset classes and decision making processes. They use multiple brokers and would like to have all the information in one place. Their view is they have to collate and collect all the information so why not build the infrastructure to do the reporting. The smaller firms who do not have the resources are likely to use delegated facilities.”
Creating a blueprint for the future is not that easy when the rules continue to be in such a state of flux. “One of the problems is that it is difficult to have an IT budget when we are still waiting for the final rules,” says Sarah-Jane Dennis, consultant at Investit. “At the moment, we are in the infancy because the requirements are not yet clarified. If it is like the last time, then we will not know until late in the day. Not all asset managers though are big users of OTC derivatives and in their case they like to use Excel to shape the extracted data themselves. However, it is not scaleable and quite high in operational risk, especially when it has to be done on a daily basis. They would like to outsource it.”
While brokers may still be contemplating their service offering, trade repositories are ramping up their efforts to smooth the way between the trade reports and the valuation and collateral reports. Some are working with the industry to help connect the dots between the semantic linkages and associated collateral as well as offering collateral reporting in other currencies versus the base currency of the CSA. This is particularly useful for global firms working across different national platforms.
According to Mark Husler, CEO of UnaVista, the trade repository, is primed to receive valuation and collateral information plus it is also creating new valuation and collateral-specific file formats. “There are different models but we are also providing software solutions that brokers can leverage to provide full or partial delegated services to their buy-side clients.”
Custodians are also looking into industry solutions although in many ways regulation is tying their hands. At the moment we are providing trade reporting for our back and middle office clients but not for our custody ones,” says Judson Baker, product manager at Northern Trust. “This is because we would not be able to get the trade data in a timely manner and are currently not receiving various data elements that are mandated to be reported. We are aiming to provide the valuations and collateral reporting for our back and middle office clients as well as custody clients and are currently participating in industry working groups to see how we could do this as a component that the buy side can leverage as part of the overall trade reporting requirements. However, there are still many questions and we are waiting for ESMA to come back for clarification.”
