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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[1].
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.
