With implementation deadlines for EMIR classification notifications and timely confirmations having passed in March – and with remaining deadlines for portfolio reconciliation, trade compression and reporting fast approaching – firms are still faced with unclear requirements and little certainty from regulators on what will be acceptable. Unfortunately for firms, regulators have recently been heard saying that while they are open to listening to industry issues, they are not often in a position to respond or offer definitive answers to pressing questions. It is now becoming clear to many industry participants that the most effective way of ensuring unintended consequences are dealt with smartly, is to work on industry efforts collaboratively.
In this way, a many-to-many solution will clearly be the most effective. Attempting to define an approach in isolation won’t get you the answers. This is because the solution is in large part relative; ‘what good looks like’ depends on what others do and (potentially) get fined for; it’s a case of being ‘in the herd’. JWG research has shown that, historically, there is an 18-24 month delay between when a regulation is implemented and when fines start being issued. This means that it is likely to remain unclear for a while yet what the real consequences will be.
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- When does complacency regarding counterparty classification turn into non-compliance?
- How will the market apportion responsibility for dual-sided transaction reporting?
- When will regulators make clear statements about what is acceptable and what isn’t?
From money-laundering regulation to MiFID II there are many regulations in the pipeline that are facing fractured requirements and uncertainty from regulators, and they are likely to eventually require collaborative industry solutions. At this moment in time, the most pressing example of this problem is with EMIR counterparty classification.
EMIR requires counterparties to be classified as either financial counterparties (FC), non-financial counterparties (NFC) or non-financials over the threshold (NFC+). At present, firms do not distinguish between their clients on the basis of whether they are financial or non-financial in nature. Without mechanisms in place to validate customer classifications, firms risk being seen by regulators as, at best, complacent, at worst, non-compliant. While there is an EMIR requirement for NFCs to notify authorities when they, or any others in their group, have breached the threshold, there is no such obligation to inform the marketplace of their status. And regulators have indicated that they are unlikely to provide public access to the data provided to them.
Fortunately, there is currently an industry and trade association-supported effort underway to solve this challenge. Over 20 major banks have come together to define a strategic solution to categorise and maintain accurate classification of non-financial counterparties to comply with EMIR. The intended result will be a fit for purpose, scalable and flexible utility that will meet the industry’s need for an efficient means of capturing key counterparty classification and monitoring information.
One of the reasons this counterparty classification and identification project has been successful so far is that it has had engagement from not only the sell-side, but from non-financials as represented by the Association of Corporate Treasurers. This has provided valuable insight into the needs of non-financial firms, who are being faced with regulatory oversight with which they are likely unfamiliar.
EMIR counterparty classification is only one example of many. The problem of buy-side vs. sell-side and who will start solving the problem first is still a question that remains. A clear example of where this problem is being seen is in reporting to trade repositories. EMIR requires derivatives contracts to be reported to trade repositories. However, unlike Dodd-Frank which requires single-sided reporting, EMIR requires dual-sided reporting. Who will take the lead in fulfilling the requirements to report is unclear. Many buy-side firms lack the infrastructure and expertise to fulfil the obligation in the given timeframe. While sell-side could offer reporting for their clients as part of a service, in investigating how realistic this option is, many internal legal departments have identified numerous obstacles that make this something the sell-side is eager to avoid. Indeed given that reporting is required on intra-group transactions, to which the sell-side will have no visibility, reporting on behalf of clients may not always be wholly possible.
Ultimately, institutions are spending a lot of time and resource in dealing with regulatory change that otherwise would be spent on opportunity development. However it has increasingly become clear that, in many regulatory challenges, there is little benefit to be gained by attempting to differentiate yourself and solving problems independently. Many firms are now recognising that the fastest, cheapest, most efficient, and (most importantly) safest option is for sell-side, buy-side and vendors to work toward a collaborative solution. Is your firm one of the enlightened?
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- Counterparty classification is difficult but the stakes are high
- Classifying NFC vs. NFC+ with legal certainty is almost impossible with existing solutions
- A new industry-led solution with diverse support from the market is currently in its final stages
- ‘It’s difficult’: Regulatory consistency across jurisdictions high on G20 OTC agenda but ‘complete harmonisation’ too hard
- Counterparty classification now centre stage: Issues of EMIR implementation acknowledged by top industry sources
- Only 60 days left to find a solution to Europe’s EMIR classification challenge. What will the industry do?