The industry welcomes input from The European Securities and Markets Authority (ESMA) but there are areas of the recently published ESMA Q&A that still need implementation and clarification. David Broadway, policy adviser at the Investment Management Association (IMA) shares his views on the top five elements of the Q&A that are complicating necessary progress on the EMIR trade reporting front.
Despite ESMA’s best efforts, there are still grey areas within the Q&A (most recently updated on 10 July as at the time of writing) due to the fact that either market participants interpret the guidance differently or elements of the guidance are not drafted in a way that is consistent with the industry’s understanding of how the market works. The issues are many, but below are five areas of the Q&A pertaining to EMIR trade reporting that seem to come up most frequently in my discussions with IMA members.
1. What does posted collateral mean exactly?
There is still some confusion as to what ‘posted collateral’ actually means. Specifically, there are a number of firms still confused as to whether if you hold collateral today and you return it tomorrow, does that return constitute a posting of collateral, or is it just what the other counterparty holds of your assets? Also, there is still some argument around the scenario where initial margin flows in one direction and variation margin flows in the other, as to whether the margin should be netted or if each party should report what they deliver to the other, although I believe the Q&A clearly indicates the latter.
There are actually two main issues here. The first surrounds a reference in the Q&A to reporting the ‘absolute value’, which I hear at least some trade repositories generally understand as referring to the technical sense of absolute number, (i.e. no positive of negative sign). This is causing confusion because it is counter intuitive to the way many firms would see the valuation of a particular contract depending on whether they are in or out of the money.
The second is on the exchange-traded side, where there is considerable debate as to whether it should be the open trade equity valuation or the present valuation of the notional, which some people seem to think is what ESMA is looking for. Again this would be counter intuitive to the way the market operates.
3. FX buyer and sellers
There is a particular area of the Q&A that talks about a methodology for determining the buyer and seller in a foreign exchange (FX) transaction, which is counter to the normal market convention. Many market participants, as I understand it, are essentially continuing to follow the market convention and not building systems to follow the quite rigid approach that ESMA suggests, using the alphabetical order of the currencies concerned.
4. How to deal with multi-leg contracts?
Another problem area is complex and multi-leg contracts. There is still much work to do to get consensus on how all the different types of contracts should be reported. A good example, which I discuss frequently with IMA members, is an FX swap with spot and forward components – some firms are reporting these as a single contract; others are reporting the spot leg and the forward leg as two separate contracts; and others are reporting just the forward on the grounds that the spot leg is out of scope.
Different market players are doing things in different ways and ultimately we need to get consensus and agreement as to how these should be done in a consistent manner across the entire industry if the two sides of these trades are ever going to be paired and matched.
5. What transaction code for ETDs?
The exchange-traded derivatives (ETD) side of EMIR trade reporting is proving challenging because firms still lack clarification they need on various areas in order to adhere to the requirements. ESMA’s suggested source and use of the transaction reference number (TRN) is an example of this.
ESMA has stated in the Q&A that it wants the TRN (as distinct from the Unique Trade Identifier (UTI)) to be taken from the trading venue or CCP and used as a common identifier to link together all the trade reports that result from the same trade order. This appears to be at odds with the Regulatory Technical Standards, which essentially define the TRN as the reporting entity’s own unique reference for the transaction and, as far as I am aware, simply isn’t happening in practice.
In summary, these challenges aren’t all necessarily elements of confusion surrounding the ESMA Q&A but rather areas that market participants simply are not or cannot implement yet.
Overall, I think the challenge for the market is that there is much work to be done before trade reporting can be considered a “business as usual” process.
* For more insight from David Broadway on trade reporting, please listen to our recent EMIR trade reporting podcast