It has also become a four-letter word for fund managers struggling to fulfill reporting requirements.
About five months after the effective date for fund managers and broker dealers to send details of trades executed on exchange-listed and over-the-counter swap transactions to recognized trade repositories, fund managers are bemoaning the number of rejected reports that they now have to clean up or reconcile.
Their stress is about to grow exponentially and time isn’t on their side. In mid-August they begin reporting even more details about their swap deals – including the value of each contract and information on the collateral posted. That means that right now they are handling two concurrent tasks. First, cleaning up rejects in the previous reporting and hopefully learning how to fix whatever they or their third-party agents did wrong in fulfilling the European Commission’s reporting requirements. At the same time, they are designing and testing the systems that will handle the onerous task of sending information on valuations and collateral.
“It’s been a colossal mess,” one operations manager at a UK fund management firm tells FinOps Report. “We are receiving word from trade repositories that reports on the same trade sent by our broker-dealer don’t match up.” Yet another operations manager at another UK fund management firm says, “We received notice from our reporting provider of errors but no clear understanding of where they came from and how they can be fixed.”
The rate of mismatches in previous reporting? No one would disclose hard figures to FinOps, but one London fund management firm estimates the industry-wide number to be somewhere between 10 percent and 30 percent of reports. The percentage reflects the size of the firm, the volume of transactions involved and whether or not they have outsourced the reporting work. As a rule of thumb, those using outsourced reporting providers have had a higher rate of rejects, say fund managers.
“There have been sufficient problems so far to warrant some large fund managers deciding to take the reporting process in-house,” says PJ DiGiammarino, chief executive of regulatory think tank JWG–IT based in London. “Add concerns about whether third parties can handle the valuation and collateral reporting requirements and insourcing is becoming more attractive.”
European regulators are well-intentioned in demanding trade reports on swap contracts In their mission to map and control systemic risk, they want to know just who is trading what types and value of contracts with which counterparties. There is just one catch: when European Union securities watchdogs came up with EMIR, the European version of the US Dodd-Frank Wall Street Reform Act, they required both counterparties to each send their own transaction reports to an accredited trade repository.
Such dual work virtually guarantees mismatches between the reports of the two firms, and thus rejection of both reports. Until the firms research the problem, there is no way to know which of the firms’ data is incorrect, or if the mismatch is simply the result of inconsistent identifiers or calculation models. In the US under Dodd-Frank, this potential for mismatched reporting doesn’t exist, because the reporting onus rests squarely on the banks and broker-dealers executing the transactions.
Of the more than 100,000 financial firms affected by the EMIR reporting requirements, fund managers represent at least 60 percent by some estimates. Many outsource their reporting work — often to their counterparty broker-dealers — but they are still saddled with legal liability in case of errors.
It’s understandable that everyone involved is overwhelmed by all the additional responsibilities,and will be until they iron out the kinks in reporting process, say operations experts. Still, there ways to ease the compliance pain and cost. Here are four pieces of advice gathered by FinOps in speaking to UK operations, compliance and regulatory reporting experts.
1. Check IDs
One of the most common reasons trade reports sent by fund managers and broker-dealers are bounced back by trade repositories for further investigation and correcting is because one or more identification codes aren’t the same or are lacking. Among the 85 data fields to be completed are the three that identify the counterparty, transaction and product. Unless those are accurate and consistent between the two reports, the repository and ultimately the regulators won’t be able to track whether the dual reports are talking about the same deal or the same trading partner.
“Fund managers could be relying on different unique trade identifiers, or instrument codes than their broker-dealers,” says David Nowell, head of industry relations and regulatory compliance for the London Stock Exchange Group’s Unavista trade repository. “In some cases, they may not even have the required legal entity identifiers.” The solution: ensure their identifers agree with the broker-dealer’s assignment of 52-character unique trade identifier (UTI),as well as the type of instrument identifier. Also verify they have received an LEI from a local operating unit, such as a national numbering agency or other registration agency.
2. Monitor Work by Service Providers
Fund managers that rely on a third firm to do the reporting work should not assume the work will always be accurate or or that the oursourcing provider will even inform their clients of potential problems before they take place. “[Fund managers] need to ask for more frequent updates from their service providers, and have daily online access to all their transaction reports and conduct sample testing,” recommends Geoffroy vander Linden, head of post-trade business development for the MarketAxess subsidiary Trax in London. “Fund managers must also review their agreements with third-party reporting providers, as they might not address the additional requirements for valuation and collateral reporting coming into effect in August.”
3. Dedicate Internal Resources
Whether or not a firm outsources its reporting, it still will have to assign data analysts, IT and compliance specialists to bring internal data up to par, and then make sure transaction reporting is done correctly. Trade reports can’t be generated out of thin air. Because of all the data elements required, reporting engines are likely fed by multiple applications, including front-end systems. That’s great if the data is consistent and accurate. Multiple staffers need to review all the reports and someone has to sign off — presumably a compliance specialist. And it’s best if the individuals are dedicated to regulatory reporting.
“When it comes to completing data fields on valuation and collateral used, fund managers need to ensure they can reconcile figures sent by clearinghouses and broker-dealers with their own,” says DiGiammarino. That means they also need to have robust automated systems to do portfolio reconciliation, mark-to-market pricing, and fast number crunching to come up with the correct amount of collateral. Of course, they also need to handle any discrepancies or disputes quickly and keep on top of the backlog of exceptions– aka the mismatched figures.
4. Think Twice About Big Changes
Time is short before the expanded reporting requirements go into effect, and this means it’s probably a bad time for any drastic change. Experts warn that fund managers that are unhappy with an outsourced reporting process should plan carefully before taking it inhouse, unless they already have sufficient internal staff to handle the job. Better to increase monitoring the oursourcing provider, while internal staff is bulked up and trained to eventually take over. For those who are already handling the work on their own, don’t change. There simply isn’t enough time to verify a third party’s credentials, do a test run and hand over the work.
That advice from experts comes with an acknowledgement that the temptation to change may be high right now. “Fund managers may have opted to outsource the reporting process as a tactical fix, but now realize the operational and legal ramifications,” says Nowell. “Likewise, broker-dealers are beginning to question whether they can adequately handle the reporting on valuations and collateral.”
Success at this point looks like a lot of communication and maybe some compromise. If brokers are lucky enough — and that’s a big if — to have the correct infrastructure in place to make the necessary calculations, they will still have to reconcile them with what fund managers have on their books. Presumably, they will rely on the same data inputs, models and methodologies, but if they don’t they will be forced to address discrepancies. Fund management boards of directors might end up having to accept the broker-dealer’s mathematical model for calculations, despite the fact that broker-dealers will not indemnify clients against regulatory sanctions.
Dissatisfaction with current reporting arrangements is likely to create some churning as firms take outsourced reporting inhouse and vice versa,; if not at this risky time, then relatively soon. As a rule of thumb, the larger the asset manager, the more asset classes they handle and the greater the number of clearing brokers, the more likely they are to take the reporting challenge inhouse. Smaller ones, with far less volume might just bite the bullet and deal with the risks of outsourcing.