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(Entity) Data is the new oil
Market sentiment says the pace of new reporting regulations is slowing down as the majority of key financial markets in the US, Europe, Canada, Hong Kong, Australia, Japan and Singapore have instituted some measures of derivatives regulatory reporting over the last seven years, starting with the introduction of Dodd-Frank reporting in the US.
If no new rules, then what to do for the regulators? Data quality and enforcement
As the Commodity and Futures Trading Commission (CFTC) and other global regulators, particularly the European Securities Markets Authority (ESMA), Canadian Securities Administrators (CSA), Australian Securities & Investments Commission (ASIC) and the Monetary Authority of Singapore (MAS) move to towards cross-border data harmonization, enforcement of the quality on data being reported will take center stage. The question of whether an entity has a reporting obligation in the U.S. is now posed with the recent passing of the Final Rule for Cross Border Swap Activity. Trade and economic data capture, entity information and other product related reference data becomes increasingly more important to get right, not just during onboarding of a new counterparty/client, but throughout the trading relationship.
Clean, updated and accurate entity data with appropriate regulatory classification is really the key in getting reporting right. Several of the examples below highlight how critical this is in being able to report the right trade, in the right jurisdiction, at the right time:
- If a non-US bank is entering into an OTC trade with a U.S. client, the bank has to know if that client is a Swap Dealer or if they are classified as a U.S. person to determine the reporting obligation, if any, under Dodd-Frank.
- The new EMIR Refit mandates that Financial Counterparties (FC) have to report on behalf of their counterparty if that counterparty is a Non-Financial Counterparty (NFC) that is below the clearing threshold (NFC-).
- MiFID II transaction reporting requires the reporting of passport numbers of traders as part of the submission requirement to Approved Reporting Mechanisms (ARM).
- MAS has instituted a reporting regime that includes the concept of "nexus" where reportability of a derivative contract is determined by both the "booked-in" location and the "traded-in" location.
- Under SFTR, both sides of a trade must normally report the trade details so accurate data is needed to coordinate who is in scope, delegated reporting options, who will generate the Unique Trade Identifier, etc.
As witnessed by the recent NFA examinations and findings of the Swap Dealer community in the US, regulators are taking entity data seriously. The CFTC has not flexed their enforcement muscles around trade reporting issues resulting from data quality, most of the fines thus far have been around missed reporting and incorrect entity classification. Surely this will change going forward, particularly as the data quality comes into focus with the rewrite of the reporting rules several years in the making. The CFTC has published draft proposals of Parts 43, 45, 46 and 49 in 2019 and is eager to finalize the rules in advance of the U.S. presidential election in November of 2020. The implementation timelines will either be 12 or 18 months, so the end of 2021 or mid-2022.
This rewrite will certainly be the largest overhaul of the rules since they first went live in 2013 and will impact every market participant including Swap Dealers, Swap Data Repositories (SDRs), Swap Execution Facilities (SEFs) Designated Contract Markets (DCMs), Designated Clearing Organizations (DCOs) and everyone that sits in the ecosystem of OTC derivative trading.
Again, the primary objective for the rewrite is to improve the data quality of what is being reported to the Swap Data Repositories (SDRs). This would enable the Commission to fulfill their mandate of monitoring for systemic risk in the financial system.
The proposals include changes to the technical standards (the actual data fields) that must be reported which provide more prescription on the data elements. In the past, the CFTC allowed for SDRs and market participants to decide how to implement the data field technical standards, which made it difficult to create a holistic view of the market due to these silos of non-standard data sets.
Additionally, the proposed rules introduce additional data verification requirements on both submitters and SDRs.
In advance of the changes to the reporting rules themselves, on 23 July 2020 the CFTC approved the Final Rule for Cross Border Swap Activity which significantly softened the rules on offshore affiliates and swap activity conducted in the US by non-US affiliates. The CFTC also introduced a new construct, the "significant risk subsidiary" or SRS, to encompass overseas affiliates of US entities whose swap activities pose significant risks to the US financial system. However, given the thresholds and exclusions, the outcome is that most participants will be excluded from the SRS classification. The Final Rule also eliminates the concept of a "conduit affiliate" from the 2013 Guidance, and clarifies and streamlines a number of key definitions from the 2013 Guidance, such as "U.S. person" and "guarantee," to harmonize with related CFTC and SEC rules.
These changes are the most debated aspects of the Final Rules with dissenting Commissioners challenging these definitions as walking back key aspects of the cross-border rule making. Ultimately, implementation could result in the exclusion of reporting to SDRs in the U.S. if the offshore affiliates are no longer classified as U.S. persons and are not facing a U.S. client on the trade, which fits into the CFTC's view that these entities do not pose a systemic risk in the U.S. derivatives market.
The CFTC is certainly not unique in their hunt for the holy grail of data quality as ESMA and the National Competent Authorities (NCAs) have revised EMIR numerous times over the last 5 years in an attempt to create some standardization of data submission across the trade repositories and market participants.
The focus by the regulators has understandably been around the economic elements (price, notional, quantity, etc.) of the trade itself. However, the cornerstone of the reporting logic utilized by market participants rests on the entity data they have for their own internal entities and, perhaps more importantly, for those of their clients/counterparties.
In sum, regulatory enforcement is increasing, and each firm must ensure that the appropriate trading entity classifications are in place for each of their trading counterparties. The majority of audit failures have centered around incorrect regulatory entity classifications leading to misreporting and costly remediation efforts. Ensuring that a fit-for-purpose regulatory reporting solution is at the heart of a client's holistic compliance solution is becoming increasingly important. At the onset of Dodd-Frank reporting, many firms built custom reporting solutions that solved for the specific obligations in the U.S. at the time. As new global reporting mandates have been implemented over the last seven years, it's a great opportunity to revisit how that data stored, captured as well as how and where it's reported.
By Igor Kaplun
Executive Director, MarkitSERV at IHS Markit
IHS Markit provides industry-leading data, software and technology platforms and managed services to tackle some of the most difficult challenges in financial markets. We help our customers better understand complicated markets, reduce risk, operate more efficiently and comply with financial regulation.
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