When G20 leaders met in Pittsburgh back in September 2009, there was clear consensus on the direction that the financial industry needed to take in the aftermath of the global financial crisis. Transparency was a key theme. The view was that, by mandating industry-wide reporting obligations for OTC derivatives, regulators would be armed with the information needed to mitigate future systemic risks and protect against market abuse.
Roughly four and a half years on, much progress has been made in responding to the broad requirement that OTC derivative contracts be reported. Dodd-Frank’s reporting obligations have been in force for roughly 18 months, EMIR’s came into force today, while equivalent regulations across Asiapac jurisdictions are closely in tow.
However, while the obligation to report trade data is underway to being satisfied, question marks still remain as to how easily regulators will be able to use all of that data to meet the G20’s stated end-goals – namely to mitigate systemic risk and protect against market abuse.
For those goals to be met, regulators need to make sense of the data. And to do that, they face a monumental challenge in normalising data from trade reports given the lack of standards currently in place.
For regulators to meet the political objective of identifying the ‘bad apples’, they must articulate the characteristics of a high-quality data management system. If they don’t then we run the risk of all this effort resulting in lots of bananas, apples and pears being blended into a smoothie that can’t be picked apart for meaningful analytical purposes.
In the US, where reporting has been ongoing for 18 months, standards are still being worked on with the intention of addressing grey areas and helping simplify processes that, in many cases, now involve painstaking manual reconciliation. A meeting of the CFTC’s Technology Advisory Committee earlier this week noted that regulators are still prioritising feedback from market participants to determine at a high level which areas will have the most impact.
So if a regulatory jurisdiction that operates only three SDRs (compared to the six TRs in Europe), and has provided more clarity around technical standards from the onset, is still looking to prioritise areas that need improvement (six months down the line), it is natural to presume that Europe will face a much tougher challenge ahead in getting its data in order.
For now, European industry participants have been too busy scrambling to meet their trade reporting deadline, in a bid to tick off one more item from their compliance to-do lists. But in all the rush to generate and submit trade reports, regulators may find it nigh on impossible to draw any accurate or meaningful conclusions from the data generated.
Problems that will need to be fixed apply to both data standards and processes – not only specifying exactly ‘what’ firms need to report but also ‘how’ they need to do so. For example, simply specifying that firms need to tag trades with a Unique Transaction Identifier (UTI) sounds simple enough. But determining who generates that UTI when both counterparties to a trade are obligated to report, and third parties are involved, becomes problematic when those rules aren’t defined. Equally, a lack of standards governing the use of Unique Product Identifiers, and the adoption of Legal Entity Identifiers, will pose similar challenges.
In addition to ‘what’ and ‘how’ to report, confusion still reigns in some cases over ‘who’ should report. Jurisdictional questions were highlighted as recently as last month, following a communication by a leading Dutch clearing bank notifying its clients that (under certain caveats) they would be exempt from their reporting obligations because of a Dutch legal concept known as ‘lastgeving’, which was an interpretation upheld by their national regulators, De Nederlandsche Bank and Autoriteit Financiële Markten.
And finally, question marks even remain over ‘when’ firms should be filing their trade reports. While the regulatory requirement is for T+1, this will invariably cause issues for some. By forcing firms to report before they have had time to run their own reconciliation processes, there will inevitably be trades that get reported incorrectly, and will have to be amended later. Why, then, would regulators not give participants an extra couple of days to identify breaks and ensure they are reporting accurate data?
Ultimately, the old adage ‘garbage in, gospel out’ applies. And there are plenty of reasons to think that data being submitted, while not exactly garbage, will contain enough errors and inconsistencies to make it of questionable value. Let’s hope the FSB consultation process moves quickly …