Europe is about to take another big step on the road to over-the-counter (OTC) derivatives reform with the start of mandatory reporting on February 12. From that date, all derivatives conducted by European firms will need to be reported to regulators via a repository authorised by the European Union, bringing further transparency to the market – a goal that ISDA fully supports.
It hasn’t been an easy journey, though. The major derivatives dealers have been reporting to repositories for some time, well before the mandates came into force, and market participants had to meet reporting obligations under the Dodd-Frank Act last year. But European derivatives users have had to get to grips with a set of rules very different to those implemented in the US. For one thing, both counterparties to the trade have an obligation to report, creating all manner of challenges over who generates the unique trade identifier (UTI) for each transaction and how it is communicated to the other counterparty in time to meet the T+1 reporting time frame. Firms can delegate their reporting to a dealer or to a third party, but they still retain the obligation to ensure those reports are accurate. Any mistakes by the delegated party and the counterparty is on the hook – a potential liability many are uncomfortable with.
The scope of the rules is also much, much broader, capturing all asset classes without any phasing and both OTC and exchange-traded derivatives – the latter inclusion requiring huge amounts of work to adapt the systems and processes developed for Dodd-Frank. This had to be completed in a relatively short amount of time too: it was only confirmed the reporting mandate would apply to exchange-traded derivatives from day one in September 2013.
A number of technical issues have also plagued preparations. There has been little regulatory guidance on a system for UTI generation, leaving the industry to develop its own proposal. That proposal hasn’t been formally endorsed by regulators, however, causing some counterparties to develop idiosyncratic approaches. On top of that, only a fraction of the derivatives user base has applied for a legal entity identifier, a 20-digit code essential for continued trading of derivatives from February 12.
The reports themselves are also proving challenging. Several required data fields are unique to European rules, such as the type and version of any master agreement used – and this information is not currently supported by middleware providers. A lack of guidance over whether to report data subject to strict privacy laws, how to treat uncleared trades that are subsequently cleared and therefore split into two new transactions, whether the notional amount field should be updated over time, and how to deal with complex and bespoke trades where firms may use different booking models have all added to the challenges.
But there are bigger issues here: the sheer volume and inconsistency of data collected by global repositories all over the world. Commodity Futures Trading Commission commissioner Scott O’Malia frequently raised concerns last year about a lack of consistency in how US firms are reporting data and differences in how the various repositories collect their information. This is likely to get worse as more reporting mandates come online, all with their own, unique requirements, and new domestic repositories are authorised.
An initiative championed by the Financial Stability Board (FSB) will hopefully pull together all this data in a consistent format, enabling regulators to get a clear view of the market and spot a build-up in systemic risk – the original intent of the original Group of 20 mandate. The FSB published a consultation document on February 4, which outlines some of the potential models for data aggregation. But until a viable mechanism is up and running, no-one will have the full picture. Given the time, expense and resource that everyone – dealers, end-users and infrastructure providers – have put into meeting the mandates, it is disappointing a global framework for consistent data reporting wasn’t put in place by regulators from the start.
ISDA has tried to help throughout the process, proposing that the ISDA taxonomy be used as the basis for product identifiers and coordinating work on the industry UTI proposal. A further initiative will also help increase transparency, with the launch of a new portal (see screenshot below) that pulls together information currently available on interest rate and credit derivatives in a easy-to-digest and transparent format. You can access the ISDA SwapsInfo website by clicking here.