A difficult beginning for trade repositories

FEATURE MI FORUM / 2014 A difficult beginning for trade repositories Trade repositories are a new type of financial market infrastructure. Along with centralised clearing and on-exchange trading, repositories are charged by international regulators with stabilising the OTC derivatives markets, which were identified as a major cause of the financial crisis. Reporting to trade repositories has got off to a shaky start, and is showing signs of regional fragmentation. Regulators have plans to correct both of these shortcomings. Ten years ago, there was not one single trade repository anywhere. The first appeared in late 2006, when the Depository Trust and Clearing Corporation (DTCC) opened a trade information warehouse for credit derivatives. It was built in response to the concerns expressed by the Federal Reserve in 2005 about the backlog of unconfirmed trades in the credit derivatives markets. Eight years on, the DTCC has expanded its remit to all kinds of swaps, and has competed since 2012 for market share with rival swap data repositories (SDRs) controlled by CME Group and ICE. They were joined in January this year by Bloomberg. On the other side of the Atlantic, DTCC confronts not just CME and ICE, but KPDW, REGIS-TR and UnaVista. In Asia, the DTCC Global Trade Repository is the sole provider in Japan, Singapore, Australia and Hong Kong though reports can be sent directly to the Hong Kong Monetary Authority (HKMA) - but only for now. Several Asian countries have built or are building their own, and the ten-member Association of South East Asian Nations (ASEAN) is planning to launch an Asian trade repository (ATR) next year. New needs summon new infrastructures, it seems, or at least new regulations do. The 1

proliferation of trade repositories around by contrast, reporting did not start until 12 Operating Units (pre-lous). Responsibility for the world is a direct consequence of the February this year - and it did not start well. assigning the all-important unique product demand by the G20, meeting at Pittsburgh in That the six European trade repositories (UPIs) and transaction (UTIs) identifiers was September 2009, that OTC derivative contracts should by the end of 2012 not only be traded on-exchange and cleared through central have managed to collect any data at all is an achievement. Between them, the European Commission and the European Securities diffuse, and the methodologies for calculating them extremely complicated. Worst of all, as late as October 2013, Europeans Clients that thought they could self-report counterparty clearing houses (CCPs) but be reported to trade repositories as well. European regulators, as eager as ever to build and Markets Authority (ESMA) inadvertently fomented chaos before, during and after 12 February 2014. They licensed six repositories, did not expect to report exchange-traded derivatives until 2015. ESMA was alarmed enough by the palpable lack of preparedness small volumes of trades on their own the benefits of competition into regulation, at one stage expected to license more than six repositories. Prior to the registration and then expected them to pair OTC derivative trades reported to different repositories. This was an ugly compromise between competition on the part of users of exchange-traded derivatives - the repositories argue they were all ready - to ask the European Commission realised they could not, and there was a process, it was estimated that there would be a far greater number of trade repositories than actually transpired, says Irene Mermigidis, and coherence. In addition, clarification of technical standards ran so late that the crucial 78-page questions and answer paper from for a delay. It was turned down. Effectively, that gave repositories and market participants just three months to incorporate exchange- sudden increase in delegation. managing director at REGIS-TR. A number of ESMA was published on 11 February 2014, traded derivatives into their plans, while vastly potential entrants saw the onerous registration requirements and adapted their models to add value elsewhere in the value chain. A the night before reporting became mandatory. Licensing six repositories, and counting on them to pair OTC derivative trades reported to inflating the number of participants subject to the reporting obligation. That decision impacted everyone, says - Andrew Green, head of sales and relationship management smaller number of repositories should make different repositories by each counterparty, was Andrew Green, head of sales and relationship for Europe at DTCC the evolution of a common standard easier to an ugly compromise between competition and management for Europe at DTCC. It was achieve, whilst retaining a sufficiently healthy coherence. Clarification of technical standards not so much the volume of transactions level of competition to foster as much product ran so late that the crucial 78-page questions that created challenges as the volume of and service differentiation as is commercially and answer paper from ESMA was published participants. Even clients who had done the sensible. on 11 February 2014, the night before reporting work for OTC derivatives now had to report The timetable proved optimistic, at least in became mandatory. exchange-traded derivatives, which brought Europe. In the United States, CCPs have Whether an FX forward is a derivative or not in a host of new clients from the sell-side, the reported rates and credit swaps since October remains unspecified even now. To work out buy-side and the corporate sector. Clients that 2012, and swap dealers began to report the whether they had to report existing trades thought they could self-report small volumes of same instruments in December that year. or not (which is known as back-loading ), trades on their own realised they could not, and Reporting of foreign exchange (FX), commodity banks, fund managers, pension funds and there was a sudden increase in delegation. and equity swaps was under way by January corporates had to wrestle with a complex set What Green calls delegation waterfalls 2013. Although non-financial counterparties of dates governed by the legislative timetable. developed, in which larger banks reported on had more generous reporting timetables, by Legal Entity Identifiers (LEIs), the crucial tool behalf of smaller ones, and investment banks 31 October 2013 all types of counterparty for identifying counterparties, were obtainable on behalf of fund managers, precipitating sell- were reporting swaps. In the European Union, from no less than 22 so-called preliminary Local side firms into reporting on behalf of clients as 2 3

well as for themselves. It was an understandable development. Reporting is a familiar duty We have seen an incredible shift to a transparent, regulated swaps marketplace, and this is an appropriate review to ensure the data we are receiving is of the best possible quality so the Commission can effectively oversee the marketplace. - Mark P. Wetjen, acting chairman, Commodity Futures Trading Commission for sell-side firms. However, some buy-side firms had no prior experience of regulatory reporting of their derivatives transactions, and some corporates had no experience at all. Naturally, they needed an additional level of assistance, explains Daniel Jude, director of client development and sales at CME Group. Corporates were not incapable of doing it, but they did need additional guidance. There are still some smaller corporates out there that have yet to put the necessary infrastructure in place. At SWIFT, head of regulatory affairs Richard Young points out that corporates were not the only counterparties to struggle. Some of the smaller financial institutions trading a small number of derivatives, including some of our clients trading nothing but FX forwards, were pretty last minute in their efforts to comply as well, he says. Joe Halberstadt, head of FX and derivatives at SWIFT, adds that he is absolutely convinced that not every institution which is obliged to report was actually reporting in the early months, including some quite large fund managers, though the situation has improved since. Smaller managers and banks were encouraged initially to procrastinate by promises of a benign approach to enforcement by regulators. More than six months on from 12 February 2014, they are exactly the type of institution anxious to delegate responsibility for reporting to their counterparty or a third party service provider. This is increasing the complexity of 4 5

party, like Impendium Solutions, can provide the marketplace. By March, the investigation a valuable service, she says. Participants had given rise to a public consultation on the are able to route the data piecemeal and the quality of the data being reported to SDRs, provider can re-model it into a data package that meets regulatory templates, not just for EMIR but also for other regulations, including which identified 70 unanswered questions on the subject. In Europe, the start in August this year of daily Once markets get back to greater the European Regulation on Energy Market Integrity and Transparency (REMIT). For our participants, inter-connectivity with leading reporting of the type and mark-to-market value of collateral led to a massive augmentation of the volume of data being reported. This posed volatility, we may see people paying providers like this is a crucial factor. Richard Young says the lack of clarity from regulators is to blame. People were confused further data filtering and aggregation tests for firms trading multiple derivative instruments, for back office systems invariably differ by asset the price if they are not hedging properly Joe Halberstadt Head of FX and derivatives at SWIFT about what they had to submit, so they just started putting in everything they had, he says. The European regulators will also want to think class. Collateral has to be reported in a single currency, entailing the selection of an exchange rate, and the adoption of a procedure to avoid anymore. the data chain, while leaving end-clients with full responsibility under the law for the quality of what is reported. Worryingly, data quality is poor. The accuracy of the data we receive is a problem, says Daniel Jude. The ability of the back and middle office of clients to collate the about how they can structure this information better. They know this, because so far no meaningful aggregation or analysis of the data coming in from the six repositories appears to have been done by regulators in Europe. Different formats and ways of expressing the inadvertently inverting it. Though firms must report collateral by Unique Transaction Identifier (UTI), they move it in practice by portfolio, forcing them to link portfolio codes to UTIs as well. In addition for centrally cleared derivatives, valuations have to be obtained from CCPs. - Joe Halberstadt, head of FX and derivatives at SWIFT data in an accurate and timely matter is limited. data across the different repositories only add At DTCC, Andrew Green argues that the Irene Mermigidis agrees that market participants to the problem. sheer discipline of daily reporting of collateral have struggled to deliver clean data, and that The data collected by the SDRs in the United is increasing the appetite to delegate the task. the start of collateral position and valuation States ran into similar issues. In fact, by Daniel Jude has also noticed an increase in reporting on 12 August 2014 was bound to January 2014 the Commodity Futures Trading the number of clients interested in delegating increase the difficulty. Some participants are Commission (CFTC) was sufficiently concerned reporting to CME Group, but also rising interest pulling data from five or six different platforms to establish an internal investigation. The in obtaining collateral reports sent by its CCP to and then still have to augment it manually, she agency must have accurate data and a clear clearing brokers. Clients know CME Clearing is says. Collateral and valuations reporting will picture of activity in the marketplace, said sending a file to their clearing broker on a daily only complicate this further. CFTC acting chairman Mark P. Wetjen at the basis, and they want access to that report so Mermigidis adds that buy-side and corporate time. We have seen an incredible shift to a they can use it to enrich their trades internally difficulties in sourcing and cleaning the data transparent, regulated swaps marketplace, and for reporting purposes, he says. Uncleared was one reason why Deutsche Börse Group this is an appropriate review to ensure the data trades, on the other hand, need clearing acquired London-based Impendium Solutions we are receiving is of the best possible quality brokers to value collateral on behalf of buy- in January this year. It is here that a third so the Commission can effectively oversee side clients, which is sparking disputes over 6 7

collateral valuations after the collateral is posted In the United States, because only one side is only the first stage, and pairing rates are (as it always has). reports, they do not have a reconciliation issue, not good, so it went wrong even before By contrast, participants are telling REGIS-TR says Halberstadt. In Europe, by contrast, matching could begin. If you do not pair, Pairing is only the first stage, and that they are not comfortable reporting sensitive valuation data via a delegated provider. Particularly from investment managers, we counterparties to the same trade are reporting to different repositories, and the inter-repository reconciliation is, by all accounts, not working. you cannot match. Pairing rates are better when one repository receives both sides of a report but, when it comes to pairing reports pairing rates are not good, so it went have seen much interest in our partial model, whereby a third party reporting participant can continue to report mainstream trade details to This is an under-statement. Trade repositories are struggling to pair the two sides of trades, let alone match the reports. Literally, millions of between repositories, things are currently not working anything like as well as they should. If we do get a pair, we then have to match wrong even before matching could begin. If you do not pair, you cannot match. REGIS-TR, whilst the underlying participant can report the collateral and valuation data directly, explains Irene Mermigidis. Joe Halberstadt thinks the growing burden of reporting will eventually persuade some market participants to stop trading OTC derivatives trades fail to pair. It is undeniable that pairing reports and then matching them is an issue, explains David Nowell, head of industry relations and regulatory compliance at UnaVista. Pairing the reports, and there are issues there too. The trade repositories have to decide which fields should match, and we are working with ESMA to try and formulate a harmonised set altogether, and switch to futures, if not to that - David Nowell, head of industry relations and regulatory will-o -the-wisp, the futurised swap. They will face less regulation, and it will cost them less in capital, he warns. The danger is they end compliance at UnaVista up with imperfect hedging. At the moment, with interest and exchange rates relatively stable, that does not matter. But once markets get back to greater volatility, we may see people paying the price if they are not hedging properly anymore. If derivatives users are finding it wearisome to report trades, the quality of what they are reporting is creating substantial problems at the trade repositories in Europe. In the United States, the Dodd Frank Act was content for SDRs to receive reports from one side of a trade only, enabling fund managers and investors to rely on their clearing brokers to do the job. In Europe, by contrast, the EMIR insists both sides of a trade report separately and they do not even have to report to the same repository. 8 9

of standards to improve those matching rates. Although 294,362 LEIs were issued in 187 centrally traded or centrally cleared in Europe, Irene Mermigidis of REGIS-TR agrees that countries by 14 pre-lous by mid-august this ESMA by default left it up to counterparties to discussions between trade repositories, and year, many participants in derivatives markets agree UTIs between them in the case of swaps. the early involvement of ESMA, means solutions to the matching problem are developing, albeit not as quickly as the market or the regulator had still to obtain LEIs many months after 12 February. This was unforgivable, since LEIs are readily available from the 22 pre-lous, and Coupled with the duty to report more or less immediately - on trade date plus a day (T+1) - swaps users took to meeting their compliance Inevitably, clients generated a UTI, would like. We are in the process of agreeing a matching protocol, including reasonable tolerances, which should ease the process they are not expensive either. True, a large fund manager with hundreds of funds needed a LEI for each, but pre- obligations however they could. Inevitably, clients generated a UTI, and so did their counterparty, and both took the view they had and so did their counterparty, and whilst not undermining the integrity of the reconciliation, she says. The inter-trade repository committee approach, combined with LOUs accepted bulk applications and trade repositories even manufactured so-called pre-leis to help them (at least until ESMA complied with their obligation when they used it to report, explains Jude. We ended up with two UTIs. Joe Halberstadt agrees that the UTIs both took the view they had complied market consultation and the need to validate with ESMA, means that this is taking time. But as we are working towards a common goal. insisted that LEI manufacture be reserved for pre-lous). The last-minute rush to obtain LEIs did create bottlenecks at pre-lous, but they SWIFT is seeing in its message traffic are not common. We have UTIs, and they are being carried in large volumes in our confirmation with their obligation when they used it to Participants and regulators will have a clear view of the issues that are material to them. Matching is not a communications problem. were long since cleared. If anyone says now that they have a good excuse for not having an LEI, I am afraid they are incorrect, says David messages, he says. The problem is that we do not always have both sides of a trade using the same UTI, which is what is creating the lack report. We ended up with two UTIs. In Europe, the six repositories meet regularly, Nowell. of reconciliation. and have agreed a single technical specification for inter-operating. The real problem is the lack of LEIs, UPIs and especially UTIs. UPIs (which The lack of a common UTI for the two sides of a trade proved an even bigger problem. You cannot report at all without an LEI but David Nowell says he would prefer ESMA to insist CCPs allocate UTIs to cleared trades, and mandate which party to an OTC trade is - Daniel Jude, director of client development and sales at CME identify what was traded) are the least important inter-operability between repositories depends responsible for generating the UTI. But trade Group of the three, and the least troublesome. After on UTIs, says Daniel Jude. If we have not flows in OTC derivatives make this awkward to a difficult start in the immediate aftermath of got those available, it is very difficult to match achieve. Uncleared bi-lateral trades are often 12 February 2014, they are being generated trades reported to different repositories. UTIs confirmed manually, and can take time to fill and successfully. Counterparties are creating UPIs are still a massive problem. then allocate between funds. You can book a out of combinations of ISINs and Aiis with One reason for this is the failure by ESMA block trade in your system, and wait for the market and country codes, using an interim to publish four different methodologies for allocations to come in, but you need to report it, taxonomy published by ESMA, while the generating a UTI it had sanctioned until 11 so what do you do? asks Jude. Do you report International Swaps and Derivatives Association February 2014. A further obstacle was the a block level UTI or an allocation UTI? The trade (ISDA) works out a permanent solution. refusal by ESMA to dictate who is responsible flows cause problems in UTI generation. But it is LEIs and UTIs that are key to successful for generating a UTI. It suggested trading Once trading platforms are in place in Europe for pairing and matching, because they alone venues or trade confirmation platforms or CCPs OTC derivatives, they can assign UTIs, but Joe enable a repository to identify the counterparties generate them for exchange-traded derivatives Halberstadt is not convinced they will solve the and the trade. Both have proved challenging. but, without OTC derivatives yet being either problem. In theory, trading of OTC derivatives 10 11

should make reporting easier, he says. But Its final report has yet to materialise. Are we in the United States, where trading has been going to see a more prescriptive approach to going on since February this year, it has not yet standardising this data? asks Richard Young. In practice the technical guidelines made it easier. It is always the exceptions that create the difficulties, and trading platforms will not eliminate them. Not all OTC derivatives will We do not know. Irene Mermigidis notes that EMIR is providing the broad template for reporting under both for regulation with different purposes end up on platforms anyway. Even if Halberstadt is wrong, the first OTC derivative platforms in Europe are unlikely to REMIT and the Financial Market Infrastructure Act (FinfraG), the Swiss version of EMIR. However, there will of course be variances in and across different regulatory jurisdictions will never be facsimiles of each other. be operational before early 2017, the projected implementation date of the updated Markets in Financial Instruments Directive (MiFID II). The pairing and matching problem needs to be solved long before then. Just one trade in a hundred is currently being matched successfully. After adopting a forgiving approach to compliance at the outset, regulators are now the reportable data sets, she says. REMIT is intended to monitor market manipulation, whereas EMIR is to monitor counterparty risk. FinfraG will necessitate changes to beneficiary information owing to Swiss law. In theory, you can have a guiding principle to re-use existing infrastructure and formats to the greatest extent possible, but in practice the technical Irene Mermigidis Managing director, REGIS-TR participants approach reporting. At present, showing signs of impatience, and fines for non- guidelines for regulation with different purposes even the largest firms can resist calls to invest - Irene Mermigides, managing director, REGIS-TR compliance are anticipated. We are now many months on from 12 February, says Richard Young. Regulatory patience is wearing thin. and across different regulatory jurisdictions will never be facsimiles of each other. In July this year CFTC commissioner Scott in the systems, people and procedures to report consistent, timely and accurate data to multiple repositories in multiple jurisdictions, One reason for the greater sense of regulatory O Malia called on regulators everywhere on grounds the global regulatory environment urgency in Europe is the growing frustration of to work together to harmonise swap data remains fluid. Exemplary fines will alter that regulators at the global level. In a consultation reporting through an outcomes-based psychology. As David Nowell warns, it needs to paper published in February 2014, the approach premised on substituted compliance alter anyway, because regulatory reporting will Financial Stability Board (FSB) expressed and mutual recognition. That implies mutual never be static, and will always evolve. Look at concern that reporting to multiple trade recognition by national regulators of trade MiFID reporting, he says. It has been going for repositories according to different templates, forms and formats was undermining the ability of regulators to use the data to monitor and manage systemic risk. It put forward a number of proposals for aggregating the data, including repositories in other jurisdictions. There is a need for greater equivalence between markets in derivative reporting, not least to overcome the problem of extra-territoriality, says Andrew Green. There is still no equivalence between nearly seven years. It has only 24 fields against 85 under EMIR, but firms are still making errors, and regulators are constantly putting out new advice as new trading scenarios emerge. Regulatory reporting will never stand still. a physically or logically centralised model. 1 the United States and Europe. As regulators try to harmonise reporting, that will affect the way we collect and report data. 1 Financial Stability Board, consultation paper, Feasibility study on It will also affect the way derivatives market approaches to aggregate OTC derivatives data, 4 February 2014. 12 13