REPORTING FOR EMIR: firms that assume they are covered because of Dodd-Frank implementations may need to reconsider
Through most of 2012, derivative dealers across the globe have been frantically making efforts to become compliant with the Commodity Futures Trade Commission (CFTC) implementation of the Dodd-Frank Act’s Title VII reporting regulations. On February 28, 2013, most of the approximately 70 registered Swap Dealers1 stumbled across the finish line for the last asset classes to be reported (Equities, Commodities, and FX). While undoubtedly a major milestone, the CFTC implementation of Dodd-Frank was one of the first of the G20 reporting commitments to go live with many more to follow, and there is enough difference in its European Union (EU) equivalent, the European Market Infrastructure Regulation (EMIR), to stand up and take notice. Alpa Rajai and Mark Steadman look into some of the differences between the two regulations and the challenges that an EMIR implementation could create beyond Dodd-Frank.
There are similarities in the reporting requirements between Dodd-Frank and EMIR, but, there are some important differences as well. It is likely that these differences will present implementation challenges for the Swap Dealers that have already implemented Dodd-Frank under the CFTC and, due to their global footprint, will likely need to implement EMIR.
One of the fundamental differences between Dodd-Frank and EMIR, as it relates to reporting regulations, is the product scope. Dodd-Frank regulates OTC derivatives, whereas EMIR, taking its product scope from the Markets in Financial Instruments Directive (MiFID), covers both OTC and listed derivatives. There are several points to consider, including:
- Recognizing the role that central counterparties (CCPs) and/or exchanges might play in reporting, the range and sheer number of fields to be reported (while familiar to those in the OTC world) are not typically communicated as part of a futures transaction life cycle.
- The inclusion of futures could significantly increase the implementation effort, depending on how many trading systems an organization uses.
- The number of stakeholders will increase across functional areas, which will contribute additional complexity to governance and the reporting control framework.
- Dodd-Frank is being enforced in the United States by two different regulators: the CFTC and the Securities and Exchange Commission (SEC). The enforcement is being segregated by product, with the CFTC regulating swaps and the SEC regulating security-based swaps. The CFTC has finalized and implemented the reporting regulations for swaps, but SEC regulations are still in the proposed phase. As such, much of the industry has understandably de-prioritized SEC-regulated products. So for some organizations, EMIR, which is regulated and implemented by the European Securities and Markets Authority (ESMA), may also cover OTC products not yet implemented under Dodd-Frank. An example of this is credit default swaps, which are not in the CFTC’s scope and therefore not currently being reported. However, EMIR will now bring credit default swaps into scope by the middle of this year.
- Given that the expanded product scope includes futures, scaling of current reporting solutions (i.e., a reporting hub) may be required to allow for the significant volume increase.
Each regulator requires a minimum set of data fields to be reported, and while there is significant overlap, the fields outlined in the final technical standards for EMIR expand on those required under the CFTC. Of the additional data fields required under EMIR, a few examples are listed in Figure 3 with their potential impact to the existing reporting infrastructure that firms may have in place for reporting under CFTC rules.
The collateral data requirements under EMIR are far more extensive than those required by the CFTC. ESMA has recognized the likely implementation effort for most organizations and has allowed an additional six months after the initial reporting date to comply with collateral reporting. In its impact study, ESMA estimated that, on average, it would take large financial institutions two to three man-years to comply with just collateral reporting —and this is assuming financial institutions already have collateral management systems in place to monitor the level of collateral they hold with a given counterparty on a portfolio basis.
In addition to the extra data fields required, ESMA has different formats and acceptable values for some fields already reportable under Dodd-Frank. These changes may impact the extract, transform and load logic in a way that is similar to the impact of new data attributes.
Under the CFTC, there is the concept of a “reporting counterparty”—making only one party of the trade responsible for reporting based on a hierarchy of market participants. This same party is responsible for generating a Unique Swap Identifier (USI) for the trade. By comparison, ESMA has adopted a slightly different model. Although the reporting obligation can be delegated within EMIR, the legal obligation for accurate reporting remains with both parties. Thus, under EMIR, smaller organizations carry the same reporting burden.
It is important to note that EMIR impacts smaller organizations far greater than Dodd-Frank under the CFTC, where the onus has been on the major dealers to register as Swap Dealers and to be responsible for reporting. However, under EMIR, due to the responsibility of both sides to report, even non-financial entities have some responsibility to report (or verify the accuracy of the data reported by their counterparty). Business decisions will need to be made as to whether an organization will be willing to report on behalf of its client. Providing this service could mean additional costs to source the extensive amount of counterparty data that needs to be reported, which adds more cost to a transaction. As a result, dealers may prefer for their counterparty to provide this data to the repository. Conversely, failure to provide this service may result in lost business as clients select dealers who will be willing to report on their behalf.
Also, given the apparent legal requirement to validate that a firm’s counterparty has correctly reported the data on its behalf, organizations may feel it is just as easy to report their own data rather than attempting to validate their counterparty’s report.
In order to support all of the above scenarios, firms may need to build connectivity to multiple trade repositories registered under EMIR if their clients are specific about which repository to report to on their behalf—or if they need to verify their counterparty’s reports.
Another important distinction is the requirement to report the valuation of cleared trades. This is one of the few instances where dealers have been offered some relief—albeit while creating an additional layer of logic for the reporting implementation. Unlike Dodd-Frank, where mark-to-market valuations have to be provided by the CCP and the dealer reporting the trade, EMIR requires only the CCP to provide mark-to-market valuations for contracts cleared by a CCP. There is also relief for non-financial counterparties who are not required to report daily valuations or collateral, providing they have not breached a threshold.
Finally, dual-sided reporting will require the use of market best practices around the generation and exchange of unique transaction identifiers to eliminate duplication in reporting. The industry is currently trying to define standard process flows to address the challenges this brings and ensure accurate reporting. Whatever solution is developed, it is likely to require some implementation effort.
Requirements under the CFTC are for near immediate reporting of new trades and changes to price forming key fields, with an end-of-day report for non-price forming fields.
ESMA is far less prescriptive than the CFTC on the timeframes for providing data. While ESMA still requires trade life cycle reporting, there is no need to report new trades or amendments instantaneously via a real-time message. Instead, new trades and any amendments can be reported the working day following the day the change or new trade was executed. It should be noted however, that a real-time reporting requirement may be introduced for some types of derivatives by other EU regulations such as MiFID 2.
There is also a subtle, yet important, difference between the focus of ESMA versus that of the CFTC. While both are concerned with the gathering of data to monitor systemic risk, the CFTC seeks reporting that is achieved as quickly as possible so that price data may be distributed onto a price ticker. That is, the CFTC is very focused on price and volume transparency to the market, believing this will fuel healthy competition and increase market participants. In theory, the more market participants, the less concentration of risk. But with T+1 reporting, ESMA is less focused on this. However, and in keeping with MiFID 1 reporting, ESMA seems to be paying more attention to market abuse. This focus is specifically called out in the ESMA technical standards, which require a reporting log that records the following:
- Modifications of data already reported
- The identification of the person or persons that requested the modification
- The reason or reasons for such modification
- A clear description of the changes
With regulations coming into effect in additional jurisdictions, logic will need to be implemented in the source systems and/or hubs built for Dodd-Frank reporting to determine eligibility for reporting trades under EMIR. Reporting eligibility determination must be provided to the trade repository in order for the trade repository to expose the data to appropriate regulators.
Trade repositories are trying to make reporting to multiple jurisdictions as easy as possible for reporting entities by allowing one submission for multiple jurisdictions. For example, the data field requirements mandated by the Japan Financial Services Agency (JFSA), which firms need to comply with by April 1, 2013, are a direct subset of the Primary Economic Terms (PET) and snapshot fields required for CFTC reporting to the DTCC. However, there is enough difference between ESMA field requirements and those of the CFTC to suggest that this may not be so straightforward. And while one message for multiple jurisdictions may appear to be the obvious and best method of implementation, there is a downside to this approach as it may require a significant amount of regression testing anytime a change is made in existing requirements or the firm onboards another jurisdiction. Firms will want to take this into consideration when designing their reporting solution—and they may need to strike a balance.
Some firms are also trying to come to grips with local jurisdiction data secrecy laws. This has been a challenging situation for dealers under the CFTC. If they report a trade, they may be breaking local laws; yet if they don’t report the trade, they will be under-reporting to the CFTC. This has been somewhat overcome by masking sensitive counterparty information under CFTC reporting. However, for multijurisdictional reporting, where one regulator is in a data-sensitive jurisdiction and the other regulator is not, a single reporting message clearly will not work; instead, a message will need to be provided for each jurisdiction, and in some cases to different repositories in different countries.
With the international effort, focus and attention placed on global harmonization, many in the industry might assume that European reporting requirements will tie closely with their US counterpart. Though there are similarities, the differences between the two sets of regulations are likely to represent additional challenges—as described above for the implementation of EMIR—even for those institutions that have already implemented for Dodd-Frank. Latest dates provided for implementation of EMIR reporting rules by ESMA are given as September 23 for Rates and Credit derivatives (but could be later depending on when the trade repositories register). Given the important differences and associated challenges identified in this article, the industry has initiated several EMIR compliance programs.
Firms that assume implementing reporting under EMIR will just be an incremental build on their Dodd-Frank reporting solution will need to reconsider. It would be wise to begin planning and budgeting for a similarly lengthy and costly reporting implementation for EMIR as they have done previously for Dodd-Frank.