Adapting To Data Centralization Directives

Two data centralization projects established recently under the European Market Infrastructure Regulation (EMIR) directive will change the way financial market participants submit over-the-counter derivatives reference data, even as they already are reckoning with how to manage and distribute that data, said executives working with OTC derivatives data compliance issues, who spoke in a webcast hosted by Inside Reference Data on June 18, sponsored by S&P Capital IQ.

Under EMIR, the European Securities and Markets Authority (ESMA) announced in April, a Trade Repositories Project will go live in 2016 and an Instrument Reference Data Project will go live in early 2017.

"These will create an opportunity for regulators to have a unified global view of the derivatives market exposure, and also standardize and harmonize all this information," said Cristiano Zazzara, vice president and EMEA head of application specialists at S&P Capital IQ in London. "This shows that regulators realize they're not able now to properly aggregate data and monitor it. This creation of a unique centralized database is a step in the right direction that also allows market participants to submit and report with less noise. One single platform will allow participants to have a unique identifier for transactions and entities."

Following Multiple Directives

In recent years, asset managers have not wanted to build connectivity and technology to manage OTC derivatives reporting themselves, said Judson Baker, a senior vice president at Northern Trust in Chicago, which serves as a third-party delegated reporting agent for those managers.

Certain OTC derivatives data elements have been perplexing, as Baker said-the Unique Trade Identifier (UTI), which ESMA itself issues, and the legal entity identifier, now supervised by the Global Legal Entity Identifier Foundation (GLEIF). Also, data fields such as confirmation time stamps, when not adequately captured and filed, create problems, added Baker. Finding the right mechanism for generation and dissemination of the UTI, in particular, has been challenging.

"The UTI has so many downstream consequences," said Baker. "If you don't get that right, right up front, you will have a challenge, as will the trade repository and the regulators, to try to pair up those trades."

Indeed, clients don't necessarily have data management systems that can respond exactly to what regulators demand, and that's not necessarily their fault, observed Neil Monaghan, global head of OTC clearing client solutions at Citi in New York.

"North America is better defined on what we need to capture and send down," he said. "I don't see that happening in EMIR, at least not with any legs. With EMIR, you are dealing with each region potentially wanting its own set of data. Even though it's one [European] Union, there are still independent jurisdictions. So we find ourselves spending a lot of time trying to figure out what's the right scheme and then we're constantly fearful that scheme will change without enough time for us to make amendments."

Aside from contradictions within EMIR, Europeans managing OTC derivatives data are contending with multiple regulatory directives that can all come into play, unlike in the US, according to Zazzara.

"In Europe, the situation is slower and much more difficult to find agreement," he said. "The system in the US is much more simple because, for example, the majority of the financial market is regulated by one single act, Dodd-Frank, while in Europe, you have EMIR, MiFID 2, AIFMD, UCITS, Basel III and Solvency II. There's a
multitude of regulations and a number of regulators. That's not helping find agreement on important issues. The two models are very different. That's where the problems are."

ESMA's Pending Review

Along with ESMA's centralization projects, the authority has been reviewing OTC derivatives systems development to possibly yield improvements. While firms have already had a long time to comply with relevant rules set out by the authority in February 2014, as Baker noted, in an informal poll conducted in the webcast (see chart), only 13 percent of respondents said they were completely compliant. ESMA's review should consider the challenges firms have, especially with transmission of the OTC derivatives data, he added.

"There has to be a big reason that ESMA is in forbearance mode and anecdotally we're hearing they're not penalizing firms," said Baker. "Those conversations are starting with trade repositories themselves: What are the biggest challenges? Why aren't we getting inter-trade repository matching rates up to a normal level? [The industry] is trying to understand whether it's data or transmission challenges for the sheer volume of firms trying to adhere to the rules."

ESMA's review should also consider differences in the pieces of data being submitted for different repositories, which would also help with consistency for compliance in the US, according to Monaghan.

"I'd like ESMA to work globally with everyone to make sure it's consistent, because on the buy side you don't want an asset manager or a client doing something in one region and something different in another," he said. "It's detrimental to the liquidity of the market. That's why we would like them to make sure they understand how these rules are impacting the liquidity of the market by potentially creating silos of trading, which concentrates risk and then unfortunately creates a problem in managing clients' portfolios and growing their revenue."

The executives do see opportunities and possibilities for getting commonalities in OTC derivatives reporting, and improving the quality of the data in the process. "We need to realize that the derivatives process is very complex and difficult to analyze," said Zazzara. "We're moving from a complete reporting environment to one where we standardize the terms and conditions of this process. We need to realize this is not a trivial task. It would be unjust to say regulators are making mistakes. ESMA is definitely listening to the industry. I'm 100 percent sure that we will simplify the system down the road."

ESMA's centralized repositories are a step in the right direction, Monaghan acknowledged. "You shouldn't end up with reporting driving the market," he said. "The OTC derivatives market is much different than the equity market or futures market. Therefore, regulators have had a huge learning curve on how these markets work and report, and where the data and risks are."

Higher data quality ensures better reporting, Baker stated. "The biggest issue is what people want to see and determine is important," he said. "The concept of the LEI is great. There are other identifiers that need to be put into place because the LEI can go across asset managers, but it also can skew data sometimes, if you haven't linked identifiers correctly all together."

The key, at least on the US side, may be that making an effort is half the battle, as Baker described. "The CFTC is trying to understand what the challenges are. If a firm just isn't trying, there's a good likelihood they will be penalized," he said. "If they are trying and have the burdens that all the other dealers are facing, like working with the trade repositories and large dealers to make sure they have the right data elements, they make positive strides."