RegTech Intelligence 
2013 has been a real wake-up call for the buy-side. New requirements from regulations like EMIR, AIFMD and Dodd-Frank have meant that funds, asset managers and even corporates are suddenly in regulators’ sights, some for the first time. In the past, the reaction to such changes has frequently been to delegate new compliance responsibilities to sell-side counterparties or third parties. However, changes to the way regulators draft and enforce rules may mean that this is soon no longer an option. Here are three areas in which the buy-side will have to take on more responsibility (and hence greater risk) in 2014.
Firstly, with the Commission’s refusal to delay ETD reporting and ESMA’s approval of four TRs (covering all asset classes), we can now say with almost certainty that trade reporting (both OTC and ETD) will commence in February 2014. As a result, regulators are telling the buy-side that they must now, as a priority, make some key decisions over how they will meet the reporting requirements, such as whether to delegate reporting or to build reporting systems in-house. However, the text of EMIR makes clear, and regulators have confirmed numerous times, that no matter which approach firms opt for, the responsibility for the report remains with the parties to the trade. Ultimately, this means more risk to deal with for buy-side firms.
For instance, many firms are considering having default fields filled out with TRs to reduce the workload required for each new report. And although ESMA indicated that this was acceptable, they also made clear that firms would still be the ones fined if the reports were not accurate or timely (within T+1). With TRs generally not offering validation of reports, this means that firms are faced with having to build efficient validation systems into their reporting workflow or else expose themselves to significant operational risk, either from data inaccuracies or from missed reporting deadlines.
Issues like this, which require additional technological and operational resources, are made doubly worse for buy-side firms by European regulators cracking down on outsourcing practices. For UK asset managers, this trend materialised in the FSA’s December 2012 ‘Dear CEO’ letter, which required firms’ boards to have approved outsourcing relationships and to have robust contingency plans in place for their failure. Building on this, at the European level the AIFMD requires fund managers to notify competent authorities where they intend to delegate functions. Furthermore, in the context of reporting, MiFID II (due to be finalised in December 2013) will mean that firms will only be able to delegate reporting to registered ‘ARMs’ (approved reporting mechanisms). In all these examples, regulators are increasing firms’ responsibilities by encouraging them to keep more functions in-house.
And even where firms are able to outsource functions, regulators are forcing them to retain the legal and regulatory liability, and thus the risk: Within the AIFMD, where managers are able to delegate functions, the Directive makes it clear that they are still liable to investors for the performance of those functions. Furthermore, regulators have made it clear under numerous circumstances that they will be looking to buy-side firms to take responsibility for their own compliance, such as for dual reporting under EMIR.
One instance where this shift in responsibility, towards the buy-side, becomes interesting is in the unique trade identifier (UTI) debate. Professionals are largely in agreement that the main way that UTIs – which must be reported for each trade under EMIR – will be produced is to have one party generate them and then communicate it to the other. Generating is much easier than receiving, because you can design the process around your existing systems, rather than adapting your systems to accommodate external data. It also allows much greater control over the trade reporting process, because it means not having to wait for the UTI, which may often be sent over with the trade confirmation. Therefore, bigger institutions are often taking the role of generator; and where they don’t, they are unlikely to wait for smaller counterparties to confirm the UTI before reporting. In both instances, this means increased risk for buy-side firms dealing with larger broker-dealers, but no decrease in their responsibility for the eventual accuracy of the trade report.
This evidences a wider trend in regulation, in that buy-side firms are being faced with greater risks of operational failures and fines from regulators, but are less-and-less able to unload that risk onto service providers and the sell-side. This has certainly come as a shock to the industry, and many seem unwilling to acknowledge it, but it is a change that will continue for the foreseeable future, and to which firms will have to adapt.