The lengthy list of financial regulatory rules coming onto the market have a familiar ring. Lynn Strongin Dodds highlights the most important ones and what preparations are required as we move into 2024.
A new year may be dawning, but the regulations that will be coming through the pipeline have been making their way for some time. The EMIR Refit first saw the light of day in 2019 while the US Commodity Futures Trading Commission (CFTC) Rewrite was first mooted the year after followed by the Securities and Exchange Commission’s (SEC’s) security-based swaps (SBS) or Rule 10B-1 in 2021.
CFTC Rewrite
There are of course long lead times and the inevitable delays. Take the CFTC Rewrite, which was a wholesale overview of the swap data reporting rules. The first phase was pencilled in for 25 May 2022, but the deadline was extended until 7 December 2022 to provide market participants with more time to comply to the raft of changes.
The amendments were geared facilitate the submission of more standardised trade data. It included the reporting of collateral valuations and a Unique Transaction Identifier (UTI) developed by the Committee on Payments and Market Infrastructures (CPMI) and the International Organisation of Securities Commissions (IOSCO). In addition, they obliged firms to verify the completeness and accuracy of the data held at the swap data repositories (SDR).
If any errors were discovered, they had to notify the regulator within seven days. If they could not, then inform the CFTC’s Division of Market Oversight with a remediation plan.
Phase 2 is set to go live in January 2024 with the implementation of the much-anticipated unique product Identifier (UPI) which will replace an array of product classification and identification approaches with a single identifier to expedite analysis and aggregation.
The ANNA Derivatives Service Bureau will be leading the charge and firms trading credit, interest rates, foreign exchange and equities swaps are in the catchment group. The commodities asset class has been deferred to a later phase due to its implementation complexity.
In the summer of 2024, the CFTC’s revised post-initial appropriate minimum block as well as post-initial cap sizes for publicly reportable swap transactions will make their debut. The initial target date was 4 December 2024, but this was extended to July following a no action relief letter which encompasses the Commission’s 43.3 and 45.4 regulations.
Part 43 sets forth real-time public reporting requirements – governing the public dissemination of swap pricing and transaction information, whilst Part 45 comprises both record-keeping obligations and the regulatory reporting of swap data.
Specifically, the letter states that no action will be taken against entities which “fail to timely report the change in the floating rate pursuant to the ISDA Fallbacks for an uncleared swap referencing any Impacted Rate” under regulation 45.4. This is only in cases where entities have made best efforts to report the change by applicable deadlines.
In addition, no enforcements are to be taken in the event that an entity fails to report “the change in the floating rate pursuant to the ISDA Fallbacks for an uncleared swap referencing any Impacted Rate” under regulation 43.3.
SBS back on the agenda
The summer of 2023 also saw the Securities and Exchange Commission (SEC) reopen the comment period for its proposed rule requiring public disclosure of security-based swap (SBS) positions that exceed certain thresholds.
The SEC initially published Rule 10B-1 on February 4, 2022, to enhance the transparency in the SBS market and prevent market participants, including net short activists, from influencing the markets without other participants’ awareness of their true economic position. All market participants would need to report large positions of SBS and related products within one day of that position crossing a certain threshold, and that this is made public simultaneously with being reported to the SEC. More: Proposed SBS Position Reporting: 3 Risks to Firms and the Markets
Trade associations including Securities Industry and Financial Markets Association (SIFMA) are concerned that the proposals pose risks. This is because the rule requires exceedingly detailed information about SBS and related positions, including identifying the market participants that hold the positions. Some compare capturing a huge amount of data to finding a needle in a haystack and believe that only a tiny sliver is actually useful. For example, SIFMA identifies large directional positions, while other things may be mistaken for important information.
There are also concerns over the operational burdens the regulation would impose as well as traders reverse engineering trades and replicate the patterns of their competitors. Although no timelines have been given, it is likely the debate and discussion will continue into the new year.
EMIR chapter 3
Market participants on the other side of the Atlantic will also be kept busy with the impending EMIR Refit set to go live in Europe on 29 April 2024 and 30 September 2024 in the UK. The goal is to further enhance the harmonisation and standardisation of reporting under EMIR.
There are several key changes such as the increase in the number of fields to 203 from 129 and introduction of completely new categories such as nature, corporate sector, and clearing threshold of the other counterparty to the trade. Equally as significant is the event type field which will increase the transparency around the lifecycle of a trade. There will also be modifications to existing fields including new details relating to counterparty information that organisations may need to acquire.
Other important revisions include the introduction of ISO20022, a global standard for financial data communication, which requires all messaging of EMIR reports to be done according to a standardised XML structure. Data quality is also high on the list. The Regulatory Technical Standards (RTS) introduced by ESMA emphasise the verification of the correctness and completeness of submitted data, and the validation of lifecycle events reported for a trade. The updated version welcomed UPI as well as changes in the generation process of UTI. The UPI complements the information captured by the ISIN and CFI code.
Given the numerous modifications, the challenges should not be underestimated. Firms will need to track a wider array of transactions for both exchange-traded derivatives and over-the-counter derivatives to provide much more granular details in reports. Brokers will also face difficulties integrating data from various systems, challenging data consistency and accuracy. Implementing automated systems for data validation is helpful but requires investment and human oversight for complex cases. More: EMIR Refit is Coming: Don’t Underestimate the Scope of the Changes
DORA
Although the Digital Operational Resilience Act (DORA) does not hit the markets until early 2025, financial service firms including those trading derivatives will need to start building their foundations next year.
First presented in 2022, DORA is part of the European Commission’s strategy to bolster digital resilience across the European Union’s financial sector. (https://www.digital-operational-resilience-act.com) The legislation has five major pillars – ICT risk management, incident reporting on ICT-related topics, administration and oversight of critical third-party providers. It also includes digital operational resilience testing, and information and intelligence exchange.
Banks, insurance companies, and investment firms are not the only ones having to comply. It stretches to any enterprise such as cloud platforms, data analytics and audit services inside or outside the EU offering information and communications technology (ICT) services. More: Cybersecurity in Derivatives: Emerging Regulation
According to a recent report by Acuiti, the biggest challenge facing firms is the operational resources required to meet the requirements. This ranges from resource allocation to understanding threat analysis criteria and obtaining information from vendors. “The industry will need to work together with vendors to streamline processes such as information requests in order to reduce the operational burden,” it added.
The report noted this will require mapping third-party relationships and conducting extensive due diligence on digital supply chains. In addition, firms will need to be equipped with preventive, detective, and responsive measures to ICT incidents as well as strategies for restoring ICT systems post-disruption.
