Is MiFID II the catalyst firms need to tackle trade reporting strategically? Jim Bennett, Managing Director and Arun Karur Vice President, both at Sapient Global Markets, talk to DerivSource about challenges and opportunities firms face as they navigate their way to compliance with this new regulation.
Q. How is MiFID II driving firms to look at trade reporting and data in a wider capacity?
JB: One of the primary reasons that MiFID II has become a catalyst is that it’s probably the most comprehensive regulation to date, both for trade and transaction reporting in terms of the whole trade lifecycle. The result is that firms are basically stepping back and looking at how they can be more strategic in the way they meet the requirements. For instance, one of the main considerations is whether they should continue doing the reporting in-house or opt for a partner or managed service? Historically, 75 percent of firms had built their own regulatory reporting but now the increasing cost curve is forcing them to look at other alternatives.
AK: While there is no doubt an operational directive to meet regulatory requirements, it is also an opportune time for firms to review their long-term strategy around compliance, data and risk management. Whether the reporting deadline is January 3, 2017 or a year later as is now being discussed, firms must begin to determine how they will address the reporting challenge—be it tactical or strategic. Now is the time for firms to to review how they want to proceed. And since trade and transaction reporting is becoming a significant cost burden, firms will be looking for cost-effective solutions or options in the market place in the coming months and evaluating them against existing in-house solutions.
Q. How are firms currently preparing for MiFID II trade reporting requirements and the challenges they face in terms of governance and technology?
JB: I think firms are looking at their existing reporting environments in an EMIR context and realizing that governance needs to be tightened. They are addressing three main issues: reporting, traceability, and confirmation/affirmation within the market of trade repositories to ensure that reporting is tied to the right rules and regulations.
The challenge with this three-pronged approach really comes down to technology. Organizations put in-house systems in place so that they could meet the regulatory reporting deadlines as part of the first phase of the EMIR regulation. Even though the window was pretty tight, financial institutions did a good job in meeting this requirement. However, now the focus is on the quality of the reporting. The output is being analyzed more thoroughly and many firms are finding that their systems were built for reporting and pulling in the necessary data and aren’t scalable and extendable. What’s more, these environments have many manual processes instead of the automation that is needed to meet the rising governance and quality standards.
Q. How does a lack of automation currently impact data quality for firms?
AK: A lack of automation means manual touch points that often lead to errors and omissions. The problem is exasperated by the lack of documentation or record keeping of manual activities, making them difficult to trace, recreate or do a root-cause analysis in the future. The post-trade space in a bank is still very people dependent with only basic record keeping at best. Some of the regulatory requirements under MIFID II around pre-trade and post-trade transparency present a data quality issue for firms and in most cases might also create data capture issues. Some firms are not even currently capturing information that might need to be reported to the regulator. A lack of automation and a dependence on people and manual processes directly translates to high rates of data reconciliation errors, low confidence on what is being reported to the regulators and a higher risk of receiving fines for noncompliance. To avoid these issues, firms will need to keep transparency and assurance as the overarching benchmarks as they address the MIFID II challenge.
Q. Given the backdrop of accountability, how are people looking at trade reporting in the long term?
JB: I think firms are looking at trade reporting now with three considerations. First, financial institutions have now come to the realization that they can no longer do trade reporting in-house; it is not optimal nor does it offer a competitive edge. Secondly, they need to explore alternative options for reporting, such as mutualization. For example, with the Money Markets Securities Reporting that’s coming out in Europe (there are 53 European banks involved), it is easier if there is a common data dictionary in place to use instead of each of the banks having to build their own system. The third consideration is about trade execution. Financial institutions are increasingly looking at collaborating with their peers by forming working groups to jointly interpret the rules and come to a common understanding on the response; agree on common messaging standards for data exchange; and establish industry standards around unique trade identifiers, unique product identifiers, etc. The end objective is to collaborate, standardize and create efficiencies and, in the process, reduce the cost of compliance.
Q. You mentioned common data, what about data standards? How have firms attempted to address data management processes to support reporting thus far?
JB: Standards are always imperative, but there are so many different committees, such as the European Central Bank (ECB), Financial Conduct Authority (FCA) or the British Banking Association (BBA). They are trying to create standards that everybody agrees on. While there has been progress, the reality is that MiFID II is only a year away. There needs to be an environment that is flexible and can automate the convergence of the various standards of these different entities in order to create a common standard. However, it’s going to take years for this to happen.
Having a good understanding of data is essential for reporting. So many firms have attempted to establish internal data warehouses, which I call ‘skinny transaction data warehouses’ to normalize the data from various sources and support trade reporting. The problem with these internal warehouses is that they are very difficult to institutionalize and are very expensive to build and maintain as regulatory change continues. In fact, it is the combination of those challenges—needing to normalize data, managing the complexities of regulation and conducting ongoing maintenance to keep up-to-speed with changes in the industry—that are driving some firms to think strategically when they view MIFID II reporting.
AK: The lack of data standardization is a key challenge for firms developing a trade reporting solution. By leveraging an approach that normalizes all data into a cross-asset class, cross-product common data model, firms can more efficiently and effectively source data from various source systems to improve transparency and provide end-to-end compliance assurance for users.
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