By Haydn Lightfoot, works for financial markets consultancy Crossbridge
February’s European Market Infrastructure Regulation (EMIR) trade reporting go-live highlighted the challenge of updating the derivatives market infrastructure to improve stability. Complex issues continue to arise, from client engagement to managing the web of inferred obligations behind the regulation. Attention is also turning to what comes next and whether it is time to re-evaluate traditional approaches to implementing regulatory change.
In this article, we explore five issues with EMIR that we believe require careful management by banks as implementation continues.
Exiting clients? Beware of back reporting
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EMIR requires ‘back reporting’ of historical trades since August 2012, for both current and ‘exited’ clients, each with a Unique Trade Identifier (UTI) agreed with the trade counterparty. February’s reporting go-live demonstrated the challenge of implementing UTIs with current clients. Banks reviewing client relationships may want to consider the additional difficulty, and potential costs, of agreeing UTIs with exited clients.
Are segregated accounts worth the cost?
The EMIR requirement for banks acting as clearing members to offer individual client account segregation may too have cost implications. Currently a premium service for high value Prime Brokerage clients, opening it up is likely to attract increased costs, as banks consider major overhauls to settlement systems, and additional client specific accounts and Standard Settlement Instructions with custodians and depositories.
Firms are likely to seek to pass the costs of such a fundamental shift in market infrastructure and operations to clients, but will they be in a position to calculate the associated costs and fees at the right level?
Navigating the matrix of inferred obligations
Behind these issues lies the recurring theme of complexity. Today’s regulatory environment implies complex, ‘matrix’ style conclusions and a web of inferred obligations across market participants and jurisdictions. For EMIR, this interdependency creates challenges, from effective client engagement to achieving cross industry consistency.
Differing client interpretation of obligations
Client engagement is essential for banks to comply with EMIR, however the fragmented approach to client education has led to confusion and differing interpretations of requirements. In some cases, clients are unwilling to come on-board, particularly those outside Financial Conduct Authority supervision.
A lack of client understanding and engagement with the UTI and Legal Entity Identifier (LEI) reporting requirements is in part the cause of the high volumes of unmatched trades since February’s reporting go-live. Clearer guidance from supervisors has been called for, to avoid similar issues as other requirements come into force later this year.
Cross industry co-ordination challenge
As banks grapple with these complex implementation issues, cross industry working groups have proliferated. This in itself creates a challenge for banks to capture and share information from the various forums.
Timely resolution of the common issues identified by these groups is hampered by the backlog of questions sitting with the European Securities and Markets Authority (ESMA). ESMA issued its latest question and answers on trade reporting a few days before the go-live. Whilst the guidance was welcomed, earlier guidance may have avoided confusion in time to improve go-live outcomes.
Non-compliance timeline unclear
Further uncertainty is added by the lack of clarity around when regulators will start to penalise firms for non-compliance. The FCA appears to be giving firms some time to address issues with trade reporting before penalising them, however the hardening of regulatory guidance on timeliness of confirmations would counsel caution. Regulators moved from an initial position of timely sending of confirmations evidencing compliance, to client affirmations being required, as confirmation-match percentages were not considered sufficiently high.
Judging your course
Unpicking EMIR’s web of interdependencies and short timeframes may result in firms making unilateral judgements on where ‘good enough’ lies, particularly where they deem the impact of delays to implementation, or risk of penalties, too high. Clearly documenting the assumptions and rationale behind such unilateral decisions should help justify them, should they later come under scrutiny.
A challenge for regulators?
Such inconsistencies between firms could pose a challenge to achieving the market transparency and standardisation desired by regulators, without time-consuming and costly retrospective action. This is demonstrated by the volume of remediation work underway following February’s trade reporting go-live.
Greater central guidance and co-ordination would undoubtedly help, particularly given the short timescales for implementation. Whilst issues with trade reporting have added to clamours for guidance, given regulators themselves are facing resource and time pressures, it seems unlikely much more direction will be forthcoming.
MiFIR and beyond
Nor does the challenge end with EMIR. Other regulation on the horizon will significantly impact market infrastructure: the Markets in Financial Investments Regulation (MiFIR) introduces new reporting obligations that aim to ‘marry’ EMIR obligations with existing Markets in Financial Instruments Directive (MiFID) obligations; the ESMA common European transaction reporting requirements may lead to further changes in the way firms report to competent authorities, including interfacing to new reference data standards.
Impacting change prioritisation
The mandatory nature of these, and other, regulatory changes will continue to exert significant influence on project prioritisation. Change resources are diverted from other strategic projects that either promote efficiency or facilitate revenue generation.
Furthermore, the tight, and parallel, deadlines of many regulatory changes may force some organisations to implement tactical technology solutions to achieve timely compliance. These solutions, in turn, increase architectural complexity, requiring greater resource and leadership commitment to implement longer term strategic solutions.
MiFIR, and EMIR are only two of the many complex and shifting regulatory changes impacting banks today. The age of being able to take a draft regulation and quickly construct ‘business requirements’ in the traditional waterfall framework no longer fits the demands of wholesale regulatory change. Banks now have to be ‘agile and risk-based’. Moving forward from Basel II, MiFID, Dodd Frank and now EMIR, the regulatory environment will only become more complex and tightly controlled. Is the time right to learn from our experiences and change our approaches for MiFIR and beyond?