By Stuart McClymont, co-founder and MD, base60 Consulting
We are all familiar with silo-orientated organisations having a right hand that never quite knows what the left hand is up to.While large organisations are addressing this challenge internally in a continuing efficiency drive, the problem is in a different league altogether when poor communication between regulatory bodies results in conflicting requirements. This can lead to an organisation in an effort to comply with one regulatory requirement fall foul of another.This conflict is a significant problem to market participants on both a national and international scale.
Regulators need to talk
The issue is that regulatory bodies act independently of each other, and the market, they have different objectives and often make different interpretations of international guidelines. Regulators are understandably keen on market transparency, protection and confidentiality, but it doesn’t take much imagination to realise that transparency and confidentiality are often mutually exclusive.
MiFID and GDPR conflict
The MiFID II transparency requirements around transaction reporting require personal information about the actual individual person executing a transaction,and this collides with the General Data Protection Regulation (GDPR) around individuals’ personal information.Fraud and identity theft is increasing at a time that transaction reporting requires a large amount of personal information required to be captured across multiple industry infrastructures,and this surely increases the risk of personal data not being protected.It would have made sense for the regulators to have asked market participants how they keep individuals’ personal data confidential, and, in parallel ellicit suggestions from market participants as to how they could increase the transparency of individuals’ transactions.Armed with this knowledge the regulators could have improved the legislative and regulatory requirements around transparency and confidentiality with all players on board form the get go.
How it started
Back in 2004/05 it was apparent that the FED in the US was uncomfortable with the level of outstanding unsigned confirmations for Credit Derivative Swap (CDS) across the global CDS market. The major market participants, who accounted for most of the transaction volume, worked together to address the issue. Known as the G14 Dealers, they agreed among themselves a set of self-regulated targets to reduce this back-log, and to track and report progress against these targets to the FED on a regular basis. These became known as the ‘FED Targets’.Through working collaboratively together, the G14 market participants not only reduced the backlog and average time confirmations remained unsigned, but also developed an industry standard electronic confirmation messaging language, the Financial products Markup Language (FpML).Participants of trades then used technology to electronically match confirmations and eliminate the manual, lengthy and time-consuming process around paper confirmation. This electronic matching not only eliminated the back log of paper confirmations but was also scalable to support increased trading volumes across the global markets. This is a great example of market participants, who understand their products and processes, introducing changes to increase control in a self-regulated environment and providing ongoing transparency to the regulatory community.
Independent interpretation of 2009 commitments
In 2009, the G20 summit in Pittsburgh agreed four commitments around Global over-the-counter (OTC) Derivatives:
- Reporting OTC Derivatives to Trade Repositories
- Increased use of central counterparties for OTC Derivatives
- Execution of OTC Derivatives on electronic trading platforms
- Increased use of collateral and risk mitigation techniques.
Each G20 country then independently interpreted the global Pittsburgh OTC Derivatives commitments and developed them into local legislation. Not only did each country interpret the four high level commitments differently but they also implemented different regulatory requirements – Dodd-Frank (US), ESMA (Europe) and JFSA (Japan) – and had different compliance timeframes. Depending on the location of their primary regulatory supervisor, market participants were then faced with the challenge of having to comply with the different requirements when products were being traded between market participants across national borders.
It is understandable that each country wanted to assume control of implementing the changes given that most countries had to bail out organisations domiciled in their countries using taxpayers’ money.But it is in times of stress that we need global collaboration and harmonisation across regulators and not local protectionism by local regulators.
Fast forward to 2014/15 and many market participants had to implement bespoke tactical solutions to comply with the differing regulatory requirements across the globe.Moreover,it is doubtful that any regulator has a full and accurate transparency over the global OTC Derivative market place.
The solution – a collaborative approach
A small group of the G14 Dealers (albeit a few names have disappeared due to the bankruptcies in 2008) again started to work together to understand how to simplify and automate this complex, costly and fragmented infrastructure. They identified opportunities to optimise collective investment in technology and resources to increase control, capacity and client service, while delivering against regulatory requirements, through collaboration, innovation and market participation.
There is little doubt that a collaborative approach, bringing together market practitioners is logical for matters of regulation and market safety. The FCA is sensibly using the sandbox approach to provide an environment where participants can collectively design, develop and test solutions to meet regulatory objectives. The Monetary Authority of Singapore (MAS) adopts a similar approach.
Ongoing regulatory consultation with market participants is also imperative ahead of introducing regulatory rules and requirements even sometimes at a very basic level. A simple and recent example where this hasn’t happened is with the implementation date of MiFID II. Given the significant ‘go-live’ challenges that MiFID II imposes on all market participants it would have made sense for the implementation date to be on a Monday (so that the preceding weekend could be used to migrate, test and deploy) or in the quiet market period between Christmas and New Year 2017 to minimise and mitigate the risks of go-live for all market participants. However, the regulators decided to choose Wednesday 3rd January 2018 for its implementation which is firstly in the middle of a week and secondly the day after the first full global trading day of 2018.
What regulators should do
On the basis that regulators have access to everything, and don’t like surprises, there are three broad processes that would assist regulators when formulating regulations:
- Consult with market participants who have a deep understanding of the market and its processes and have the expertise to suggest workable solutions to meet multiple regulatory objectives in a sustainable and efficient manner.
- Harmonise interpretations and regulations through cross border regulatory conversations and by working with the global international governance bodies.
- If they’re looking at a market that is subject to other regulations (e.g. GDPR), sit down and consult with the other regulator(s) (e.g. MiFID II) to ensure that there are no conflicting requirements. Regulatory bodies have differing objectives and lens of focus. This is understood, but all large organisations have different objectives across different departments and they work together to ensure that they are all achieved by talking and communicating.
People affect change communicating and collaborating and this leads to the right changes being made for all.