As ill-fated regulatory encounters go, few can rival the star-crossed introduction of derivatives reporting in Europe. Repo and securities lending participants have taken comfort in the fact that their own entrée to the Securities Financing Transactions Regulation (SFTR), which governs repo reporting, was not quite as disastrous.

Even so, reconciling counterparty reports for the same repo trade, known as pairing and matching, has troubled the SFTR’s debut, sources tell WatersTechnology’s sister publication Risk.net. A list of issues maintained by the International Capital Markets Association (Icma) is said to contain more than 50 separate items that either causes rejections in reports or breaks in reconciliation when pairing and matching trades.

And while reports are failing to reconcile for a whole host of reasons, the blame has been squarely placed on two main culprits: Brexit and collateral. The first is beyond counterparties’ and trade repositories’ control, but the second has firms remediating errors and seeking clarification from regulators.

“Pairing and matching are still much higher than expected, especially compared to the relevant precedents we’ve seen,” says Alexander Westphal, a director in market practice and regulatory policy at Icma, “but clearly there are still significant issues, especially on the collateral side, that need to be sorted out.”

The head of regulatory reporting at a European asset management firm agrees, “[Collateral would be a] good topic to get some light on, as this is burdensome for doing the reporting.”

Sources say pairing and matching rates took a knock following the UK’s exit from the European Union. Jonathan Lee, a senior regulatory reporting specialist at technology provider Kaizen Reporting, estimates that, based on public data released by repositories, pairing rates dropped from between 40% to 50% to mid-20% between November 2020 and February 2021. A senior compliance manager at a European bank concurs with those figures.

Risk.net submitted a freedom of information request to the European Securities and Markets Authority (Esma) to verify these figures, which the watchdog denied on the grounds that it does not maintain the figures in an internal document. Esma has granted a Risk.net FOI request for the derivatives reporting regime’s pairing and matching in the past.

“We have seen some firms, even to this day, have good pairing rates at 90% paired, but that doesn’t seem to be standard across the board. Pairing and matching rates are still very low,” says Joanne Salkeld, SFTR product manager at the reporting arm of MarketAxess. “I think throw Brexit into the mix and it has caused additional trouble for pairing and matching.”

Every, single, day

Reporting under the SFTR requires parties to a repo or securities lending transaction to submit information on the trade to repositories before the end of the following working day. Repositories must then reconcile critical fields within reports of the same trade in the process. For banks, central counterparties, and non-bank firms regulated under the second Markets in Financial Instruments Directive, this began in July last year. Fund managers not authorized under Mifid II began reporting in October 2020 and corporates in January 2021.

Pairing is the first step and requires repositories to ensure reports of a single trade have the same unique code identifying the specific trade (a unique trade identifier), the same type of governing master agreement, and that the reporting parties have listed each other as counterparties in their reports.

Matching is the second step, once reports have been paired. Reconciliation requires more than pairing for a successful match—reports must match information in 62 fields describing key attributes of the trade.

Dual-sided reporting allows regulators to verify the information they receive is correct. Reports that fail to successfully reconcile indicate to regulators something is inaccurate in the reports, which repositories and counterparties must figure out and remediate.

I believe matching will receive more attention after summer, once SFTR has been live for a year

Jesper Lerche, Arbejdernes Landsbank

Many acknowledge that pairing and matching rates are higher than they were at the outset of derivatives reporting under the European Market Infrastructure Regulation (Emir) (see box: Learning from Emir). But others strongly disagree. One source even describes the rates as “really grim”.

Jesper Lerche, a senior business analyst at Danish bank Arbejdernes Landsbank, says failure of reports to pair or match happens every trading day. He estimates that it typically takes one to two weeks to resolve with counterparties, but the worst cases can take as long as a month.

And not everyone is trying to resolve breaks in pairing and matching. The senior compliance manager at the European bank says it is focusing on remediating issues with pairing for now and will turn to improving its matching statistics in the future.

Says Lerche, “A lot of entities have had trouble with stabilizing the whole SFTR setup, so I think some banks have not had much spare energy to deal with matching issues.” He adds, “I believe matching will receive more attention after summer, once SFTR has been live for a year.”

Brexit breakdown

A major factor in Brexit’s effect on the decline in pairing is the increase in the number of single-sided reports being submitted separately to EU and UK trade repositories (TRs). Post-Brexit, EU and UK regulators no longer have access to reports submitted by counterparties in one another’s jurisdictions, which means trade repositories keep reports of EU and UK firms separate.

But, because cross-border trading between EU and UK firms still occurs, trade repositories are unable to reconcile their reports. This is good news for banks, as it means they have finally been granted their wish for single-sided reporting.

“Now, all of a sudden, you’re not sending your UK transactions to EU TRs but the EU entity you are trading with is still sending its EU transactions to the EU TR,” says the senior compliance manager at the European bank. “Those reports are single-sided now and they’re not going to pair with anything—which in effect is not a bad thing, because then you have less to worry about—but the noise is going to cause pairing rates to skew towards the bottom.”

The fall in pairing rates will be particularly high for reports where buy-side firms in one jurisdiction had been delegating their reporting to their dealers in the other—the details of these were more likely to reconcile as they are submitted by the same entity. But as dealers now only need to report their side of the trade in their jurisdiction, where those trading relationships still exist, there is no longer a guaranteed match but a guaranteed failure.

“Where you have delegated reporting, I would hope they would both pair and match on the basis that there is only one party responsible for reporting. That was where the strength in the rates was,” says Lee of Kaizen Reporting. “Now both sides aren’t reporting to one single regime, so those pairing and matching rates have fallen because of that. Additionally, there is simply a great deal more single-sided reporting.”

Although repositories are unable to reconcile these reports and don’t attempt to do so, they still count towards pairing and matching rates.

“The pairing rates are literally a yes-or-no binary calculation,” says Nicholas Bruce, head of business development at Regis-TR, a trade repository. “So, whilst in practice we only pair eligible trades, excluding one-sided trades from the process, the overall pairing rate is typically calculated based on the total universe of trades reported. Clearly the rate would be very different if you only looked at the trades available to pair.”

Branches of EU firms in the UK have also caused an increase in the number of single-sided reports, as they are required to submit reports to both the UK and EU repositories for trades they execute.

Because they are reporting trades to repositories on both sides of the channel, one side will always have a single-sided report. If the UK branch of an EU dealer trades with an EU firm, UK regulators will receive only the report from the UK branch—not from the EU client. Correspondingly, EU regulators will see only one side of the report when the UK branch of an EU dealer transacts with a UK client.

Trades with branches also cause breaks in matching rates, as their counterparties don’t always identify that the dealer is acting through its branch in the fields describing the counterparty.

Collateral damage

Brexit aside, many different reasons prevent reports being fully reconciled—the high number of fields that needs to be paired and matched increases the chances of a break. According to the senior compliance manager at the European bank, “It could be anything.”

One issue, says Arbejdernes Landsbank’s Lerche, is including the type of master agreement that governs the trade.

“It was a surprise that master agreement type, along with UTI and LEI [legal entity identifier], should be part of the pairing, and frankly somewhat impractical, since master agreement type is a field where there could easily be matching differences,” says Lerche.

Meanwhile, far more issues cause breaks in matching than in pairing due to the high number of fields that must be reconciled, which will increase from 62 to 96 fields from April 2022.

Two separate sources—Kaizen’s Lee and the senior compliance manager at the European bank—say matching rates are as low as 10 to 11%.

It was a surprise that master agreement type, along with UTI and LEI [legal entity identifier], should be part of the pairing, and frankly somewhat impractical

Jesper Lerche, Arbejdernes Landsbank

A wide range of sources point to the matching fields for collateral being a big culprit behind reports failing to match.

“If you look at the collateral reconciliation results, there are many fewer fully reconciled reports than the loan reconciliation,” says Catherine Talks, SFTR product manager at trade repository Unavista.

Sometimes, the breaks are caused at the level of the trade repository. One issue is the messaging format that trade repositories use to communicate updates to reports with each other.

Two repository sources say the current messaging standard doesn’t recognize negative values, which it needs to do for circumstances in which a counterparty is giving collateral. Instead, trade repositories submitting reports in which both parties show positive values cannot match—the report of the collateral giver needs to be negative.

“When reports are sent through the inter-TR process, there is a schema problem for repo and securities sell/buy-backs that means nominal amount will always break,” says Talks. “This is because the rules require a positive to reconcile to a negative value; however the schema does not allow for a negative sign.”

Ian MacKay, product owner for global post-trade services at SFT infrastructure provider EquiLend, says one reason collateral can result in breaks is that firms often use baskets of collateral for the SFTs. As baskets can contain many different securities and be used for many separate transactions, it means there are greater chances of a break.

“The regulator is looking to be able to review the collateral against those trades to monitor market exposure,” says Mackay, but if there is a problem with reporting the collateral basket because the mandatory data fields are not populated, there can be instances where the collateral file would not be processed, he adds. The TR will therefore reject the file and will not be able to match or pair the collateral, resulting in the lack of transparency that the regulator is looking to address.

Are we a match?

One of the discrepancies the senior European bank compliance manager singles out is in the Legal Entity Identifier, the unique code used to identify companies, specifically for the issuer of the collateral used in a repo transaction.

They say they often find mix-ups with a security issuer’s LEI if it is a multinational with many LEIs corresponding to legal entities in different jurisdictions. That problem should abate over time for European securities due to a partnership between the Global LEI Foundation and the body responsible for generating identification codes for individual securities, known as the Association of National Numbering Agencies.

The collaboration links the LEIs of issuers to the corresponding International Securities Identification Number (Isin), a unique identifier given to newly issued securities, which means firms can more easily identify the LEI of the issuer of a particular security.

Most European national numbering agencies have joined the initiative, but not many outside Europe, which means there is no mapping of LEIs and Isins for securities in those jurisdictions.

A further issue affecting both collateral and loan reconciliation occurs among fields for describing the type of collateral or security on loan. There are eight different options to identify collateral received, but some securities fall into multiple categories, such as government bonds that have been repackaged as structured products.

Additional reporting by Rebekah Tunstead