Many market participants have already invested heavily into their trade reporting processes and systems, however, firms face ongoing challenges with data quality and complexity. Sapient’s Paul Gibson explores the concerns and challenges.The post-reform landscape has wide-ranging implications for both sell-side and end users of derivative transactions, with trade reporting becoming an increasingly complex process. The majority of firms see the costs associated with this function rising substantially over the coming years as they struggle to manage complexity, maintain data quality and adapt to new requirements due to the inflexibility of their current reporting infrastructure.
Market participants have already made significant investments in their trade reporting processes and systems to achieve compliance for the G20 OTC Derivative reporting milestones—investment banks have spent almost $25 million on average—yet few feel their investment will provide the adaptability, scalability and flexibility needed to meet the upcoming commitments. Additionally, few have started to capitalise on the commercial benefits that can be leveraged once a sustainable central reporting hub is fully functioning.
These sentiments were revealed in a recent survey Sapient Global Markets conducted during this year’s International Swaps and Derivatives Association (ISDA) Annual General Meeting (AGM) in Montreal. The following describes the survey results in greater detail and outlines some of the key factors behind the numbers.
In-house systems are fuelling a significant and sustained rise in trade reporting costs
Our survey found that 72 percent of firms are using in-house systems. Although a high figure, it is not hugely surprising given firms have had to focus on meeting tight deadlines for new market regulations. Given the perceived time and effort involved in a strategic decision and build, many participants gave themselves little alternative to modifying in-house systems that in the long term will not be fit for purpose. The common perception was that the challenges in attempting a single, enterprise-wide solution were too great and the risks too high given the tight timelines for compliance.
Many market participants patched together a solution that wed disparate and often disjointed systems with manual processes. This has fuelled duplicative and inconsistent activities and documentation that, in turn, further increases complexity and the ongoing operational cost of trade reporting. This picture of the current state is supported by our survey findings, where on closer inspection it revealed that firms using in-house systems expect a far greater increase in costs. Over a quarter of in-house system users expect their trade reporting costs to increase by 50 percent or more over the next two years, while all vendor solution users anticipate their increase to not exceed 25 percent over the next two years.
When examining the ‘cost’ of trade reporting , firms must also take in to account the time, money and effort required by their internal teams to deliver more efficient tracking, reconciliation and remediation of trade data. Institutions often do not factor in these additional operating costs beyond the initial capital expenditure and, unfortunately, there is still a persistent belief that once compliance dates are achieved, additional funds will be unnecessary. In fact the opposite has proved to be the case. Many banks will spend almost as much to meet forthcoming regulations as they did to get to where they are now and in all likelihood they will realize little to no savings due to the lack of extensibility and flexibility in their current reporting solutions.
Taking a base number average for setting up these in house reporting solutions, such a large and persistent rise in operational costs for a function that offers no competitive advantage is unsustainable. The tight timelines for initial compliance have resulted in shortcuts and reduced features, particularly related to data categorisation and inconsistent mapping, data ingestion as well as incomplete or inaccurate operational management information reports.
These issues were reinforced by respondents when asked to identify the contributing factors to the rise in cost. Maintaining internal reporting systems and adapting systems to meet evolving requirements were both factors indicated by over half (52 percent) of firms we surveyed, followed by improving ongoing compliance (44 percent). It is clear that unless firms invest in more sustainable data management and control practices these costs will continue to hit margins over the long term – the challenge is convincing senior management to invest in order to see the long term benefits of a fully functional centralised reporting hub.
Rising costs and concerns over maintaining and adapting systems are not related to one particular region. In fact, when reviewing survey responses by geography, answers were similar, demonstrating that firms everywhere are being challenged by how to respond to trade reporting mandates.
Compliance, data and system flexibility issues present significant challenges
The concerns raised regarding cost are not surprising given the multi-layered, sometimes contradictory, nature of the current regulatory environment. Participants’ unease traces back to individual rules, as well as to the cumulative effect these new regimes have on the markets:
- Despite the sizable investments to date, the survey revealed that many banks continue to grapple with data, change management and governance and control issues around trade reporting: 35 percent of respondents indicated that remaining complaint in the midst of regulatory change was their biggest concern. Depending on entity classification, reporting requirements for the same trade can differ across jurisdictions. Institutions delegating their trade reporting or offering reporting services need to be ready for potential conflicts if they are operating within the EU or within countries where local law differs from Dodd-Frank or EMIR.
In order to keep track of all their compliance responsibilities, institutions need sophisticated rules engines, harmonised and well documented business and system architecture as well as strong data management practices included data governance—features which most current in- house systems lack.
- Twenty seven percent believed managing data and data quality is the biggest challenge: Siloed infrastructures persist throughout the financial services industry, presenting tremendous challenges for cross-border trade reporting. Trades with counterparties in different jurisdictions often involve two or more incompatible data stores and trade processing systems. Such structural issues create poor data quality and significantly hinder a reporting party’s ability to achieve high match rates. Compounding the ongoing data quality issues in the short term is the introduction of several new fields that trade capture systems need to accommodate—including LEI (Legal Entity Identifier), Product Taxonomy (UPI) and UTI / USI (Universal Trade / Swap Identifier). While these fields form the basis of a standardised approach to trade representation in the OTC market these practices will take time to embed themselves in financial market infrastructure and will create challenges in the short term.
In order to ensure the best chance of reporting accurately, and in a timely manner, participants must look to establish a common representation of a product across their system architecture. This starts with engaging in industry working groups to ensure they understand the impact of changes to their business and ensure don’t fall behind.
- Twenty five percent identified maintaining and updating existing systems and infrastructure as their primary concern: Many organizations are managing their governance, risk and compliance initiatives through dozens of disparate, often disjointed systems. With such complexity, it becomes easy for suppression logic to become stale. Add the expense of maintaining multiple point solutions, and the cost of compliance can quickly spiral out of control.
In order to establish a framework by which an organisation can manage their risk and compliance initiatives across their enterprise, firms should establish a central point in which they collect and store their data and work towards a standardised set of principles for each asset class and product.
Regulators have already begun to scrutinize the data which is being reported to the different trade repositories around the globe. The industry consensus so far is that the data is not yet at a level of quality to allow meaningful surveillance at the macro level (systemic risk) but there is enough transparency and auditability to allow them to start scrutinising individual participants. As a result a focus on data quality will be a critical aspect. Recent enforcement actions show that regulators are taking an increasing interest in how firms are managing these processes, and the fines being levied are likely to increase further as they audit and analyse what has been reported.
MiFID II and the re-evaluation of reporting infrastructure
The industry’s propensity towards building in house solutions to meet the initial reporting deadlines has further medium-term consequences. Many firms are uncertain if what they have built will meet stringent reporting requirements due to come into force over the next two to three years.
For example, when asked how prepared their firm is to meet MiFID II reporting requirements, less than a quarter (20 percent) of respondents to our survey indicated they are prepared (beginning due diligence and assessing impact), while over one third (35 percent) said they didn’t know their firm’s level of preparedness. Some may be waiting for final technical standards, however much of the reporting infrastructure requirements under MiFID II are already known. Given the scope of the requirements and how these rules will spur significant changes—increased volumes, transactions and data fields, as well as data archiving— MiFID II preparations should already be underway.
Similarly, when asked how prepared their firm is to meet Securities and Exchange Commission (SEC) reporting requirements, 19 percent report they are prepared and have started their build, while 31 percent indicate they are behind or slightly behind schedule and 29 percent admit they don’t know where their firm stands.
Invest now to avoid fines, cut costs and improve data usability for broader trade lifecycle opportunities
With regulators beginning to examine trade data and already starting to issue steep penalties for non-compliance when they recognise an outlier, the time is right for firms to re-evaluate trade reporting and compliance systems with a specific focus on data quality and scalability.
With streamlined workflows, consolidated infrastructure, data quality improvements and standardization central to achieving a sustainable, model for trade reporting, firms must ask themselves if from a budgetary, compliance and governance perspective, they can afford to continue with their current solution?
For many participants the answer to that question will be a resounding ‘no’. The challenge is ensuring that justification for that ‘no’ and changing how firms approach trade reporting is communicated clearly to decision makers. With firms working within tighter and tighter budgets and trade reporting costs expected to increase significantly over the next two years, investment in a more strategic approach to drastically reduce the long term costs is vital in order to ensure firms stay competitive and remain compliant.
The growing availability of managed services and cloud computing has driven many industries to shift away from developing software and maintaining hardware—functions deemed too expensive and complex to keep in house. For example, long ago most major airlines have done away with their proprietary ticketing systems in favour of outsourcing through systems such as Sabre or Amadeus.
Today, robust, third-party managed services exist for trade reporting that offer firms opportunities to reduce total cost of ownership, mitigate many of the challenges firms are facing today and improve overall data usability for broader trade lifecycle processes.
For some firms, cost savings will be a key driver. Others will be seeking ways to mitigate risk and ensure more robust governance processes as regulatory scrutiny intensifies. Either way, outsourcing offers what in-house systems cannot: a more adaptable, cost-effective approach to meeting today’s trade reporting requirements—and those that are bound to emerge in the future.