This week marked the one year anniversary of EMIR’s first implementation deadline. And what a difference a year makes … or does it?
This time last year, banks and their customers were busy determining who had passed certain thresholds (determining who would be classified as NFC or NFC+), along with implementing confirmation processes for uncleared OTC trades and preparing to implement EMIR’s risk mitigation techniques. Even back then, client classification was threatening to create a bilateral paper trail that would make the Andrex puppy proud. To address that problem, it seemed that establishing a multilateral central utility for client classification was a no brainer.
But moving on five months to August of last year, the client classification issue had still not been resolved – at least not in any common-sense manner. At that time, it seemed regulators, banks and their customers were facing each other down in a Mexican standoff. Some banks were even facing the prospect of ceasing trading with clients that had not self-certified their classification.
But luckily, when the 15 September deadline arrived for banks to have portfolio reconciliation and dispute resolution agreements in place with non-financial counterparties, the OTC markets did not grind to a complete halt, even though the issue of client classification had not been fully resolved.
With Dodd-Frank in the US having made more rapid progress, the issue of substituted compliance was also gathering steam and, in July of last year, regulators changed the game by declaring certain sections of Dodd-Frank and EMIR to be equivalent. The agreement broke a worrying stalemate between the EU and US which had threatened to leave US entities unable to clear through European infrastructure and vice versa. But while the chosen way forward settled the dispute between the US and EU, it still left a number of questions unanswered.
In the meantime, the next big deadline on the horizon for EMIR was trade reporting. To prepare for the flood of trade data that would soon be coming its way, ESMA budgeted €6.5 million to upgrade its IT infrastructure. That deluge was due to come in, not only from banks dealing OTC and exchange traded derivatives, but also from their buy-side and corporate customers, who had been brought into the regulatory fold by EMIR’s dual-sided reporting regime. Given that these constituents were relative novices at reporting trade data to regulators, the industry’s focus was also drawn to delegated reporting services, even though it was clear those services would not absolve the responsibility of having to verify and validate data that was being reported on their behalf.
The penalties of failing to comply or for reporting inaccurate data had also become a hot topic, after Italian financial services regulator, Consob, declared it would issue fines of between €2,500 and €250,000 for breaching EMIR’s requirements. Why such a wide range of possible fines? Well, because of the wide range of ways firms could be deemed non-compliant. A breach could mean anything from failing to clear trades to reporting a data item inaccurately, or even in the wrong format.
On the theme of data quality, issues around client identification and classification continued to pose difficulties and, given the continued absence of a utility-style model, and relatively limited uptake of ESMA’s chosen identification standard – the LEI, firms were still scrambling to send letters and emails to their customers to define their counterparties’ status.
And that was about to get worse as, on 7 November, as planned, ESMA approved the first four, of what would become six, registered trade repositories (TRs). Those TRs would soon be responsible for collecting all the derivatives trade data required to be reported under EMIR, and the authorisations paved the way for what would become a mad dash to get ready for the February 2014 reporting deadline.
Adding fuel to the fire, any hopes that the requirement to report exchange traded derivatives trades would be granted some form of reprieve, were dashed when the European Commission announced that it had rejected ESMA’s application for a delay.
With the reporting deadline set in stone, all relevant parties were kept busy for the next couple of months getting ready for D-day. And just as they thought they were ready for take-off, ESMA decided to throw a spanner in the works by releasing a set of Q&As providing clarification on various technical issues on the eve of the reporting go-live date. Although not legally binding, those Q&As only served to cause greater confusion, calling into question certain standards and leaving other questions unanswered.
So that brings us to where we are now. EMIR trade reporting is live, but issues still remain over the quality of data being reported and the value regulators will be able to derive from that data. LEI adoption is still flagging, thereby turning what could, or should, be a universal client identification scheme into just yet another code that needs to be mapped and validated. And a definitive KYC utility – still a good idea and, potentially, valid for not just EMIR compliance but also the upcoming fourth Anti Money Laundering Directive (AMLD IV) – has not yet come to fruition.
In short, a lot has happened over the last year, but many of the same challenges still remain. That’s why ESMA has already begun thinking about how to whip the industry into action, using trade repositories as a proxy. But these TRs could lose up to 20% of annual turnover in fines should they be deemed in breach of their requirements.
Let’s hope all of these issues are addressed by the time EMIR’s clearing obligation comes into force later this year because, while failure to report trades accurately can cause headaches for regulators and potentially fines for market participants (some way down the road), problems with clearing will have a serious impact on business operations. And that impact will be measured in Pounds, Euros and other European currencies.
The problem of trade reporting data quality is not unique to Europe. In the US, where Dodd-Frank’s reporting regime has been bedded down for the best part of two years, regulators have now announced an overhaul of the regime to improve the quality of data it collects. Perhaps EMIR will be asking for the same thing to celebrate its second birthday.