Trade Identifier Tangle

It is more than a year since market participants began submitting reports on their swaps transactions to swap data repositories, as part of implementation of the Dodd-Frank Act in the US. Casual observers might assume that such experience would make the introduction of trade reporting requirements for derivatives in Europe earlier this year easier to manage. However, the approach taken by the European Securities and Markets Authority (ESMA) differs significantly from that adopted by the US Commodity Futures Trading Commission (CFTC), and has created a lot of confusion and additional work for those who trade in Europe. Nowhere is this truer than in the case of the unique trade identifiers (UTIs), which must now be included in reports on derivatives trades in Europe, as part of the European Market Infrastructure Regulation (EMIR).

The first issue with the UTI is its format. In the US, when the CFTC decided it wanted market participants to report trade identifiers, the agency was prescriptive about the form its so-called unique swap identifiers (USIs) should take. In contrast, ESMA's guidance on the appropriate format for its UTIs was far more ambiguous, and it was only on the day before reporting came into effect on February 12 that it released a Q&A document outlining how UTIs could be created in four different scenarios.

A spokesperson for ESMA says the regulator aims to produce Q&As in response to industry queries "in as timely a fashion as possible based on when queries are received and the time taken to develop appropriate responses." The spokesperson says ESMA "could not be prescriptive [about the format for UTIs] as UTIs need to be agreed internationally so that they may be used worldwide."

Lack of Clarity

The upshot of the delays was uncertainty for industry participants, many of whom turned to trade organizations and working groups to share their views on possible UTI formats that could satisfy the requirements of the regulation. Lack of clarity about the format made it more difficult for firms to prepare for trade reporting because they did not have a specification around which to design their systems, and there were concerns, particularly among smaller players, that their technology might not accommodate all of the characters that would be needed.

"Once you have decided how to construct the UTI and you take a structured approach to it, it is not the hardest thing in the world [to generate UTIs]," says Chad Giussani, London-based project manager, business transformation at Lloyds. "We will use the legal entity identifier (LEI), which means that anything we do is unique to Lloyds; we can then embed a system identifier, which means the systems are uniquely identified, and then the trade IDs, which are unique to those systems. It is the best way to guarantee uniqueness. If you were just to generate random 52-character strings, at some point two banks in the City are going to do the same thing and reach the same conclusion."

In many cases, market participants will now have to revise the UTI formats they have implemented, in light of the Q&A released by ESMA before reporting began. "A peer at another bank has said the Q&A will keep us in work for the next year," says Giussani. "For example, one of the four UTI options outlined in the Q&A can only be used as an interim measure for the next year, but it would probably take half that long to implement. Overall, only two of the questions in the Q&A cover the UTI—there is still a lot more to debate than that. So there are all sorts of things on which we in the industry are going to have to go back to the drawing board."

Uncertainty about the format UTIs should take has been an inconvenience, but market participants say the most serious challenge presented by EMIR reporting is agreeing who should generate the UTI for a particular trade and how parties should exchange UTIs in a timely manner.

Double-sided Reporting

In the US, the CFTC's regulations mean that only one of the parties to a swaps transaction must report it to a repository. In Europe, however, as part of EMIR, both parties to a derivatives trade are obliged to report. Both parties are eligible to generate the UTI for the trade, but they must ensure they both submit the same identifier to the repository.

Some market participants are choosing to delegate their reporting to their counterparty or a third-party, which will also take care of generating a UTI. However, market participants who decide to do their own reporting will have to come to an agreement with their counterparties about who should generate the UTI they will both use in their trade reports.

Market participants are likely to be reluctant to rely on their counterparties to generate UTIs because it was will give them less control over their operational flows and their ability to submit a complete report on time. "If you send out a fax confirmation for your customer and are then waiting for the return of that with the UTI on it, which you are going to consume, you can see the kind of operational overhead and extra risk you are building in with the additional processing," says Richard Norman, London-based head of foreign exchange and money market operations at Royal Bank of Scotland (RBS). "There is a risk that you will start to degrade timely reporting—and therefore compliance levels—if you are not getting some of your core information through quickly enough."

UTI Generator

Norman says RBS considers several factors when deciding how it should source a UTI. "If trading on an electronic communication network (ECN) where the platform is providing the UTI and both parties are able to consume, then we are happy not to be the UTI generator because there is already an earlier point at which a common UTI is generated," he explains. "In situations where both parties would like to generate the UTI and they are not using industry protocols, however, the decision about which party will generate it is being handled on a case-by-case basis, starting with the existing nature of the relationship at the firms."

Norman continues: "We believe our being the UTI generator provides an effective flow for us and our customer. But if the confirmation is through Swift already, we can be more flexible because there is an existing mechanism for both parties to consume it on an automated basis. Generally, we are looking to avoid building complexity where we can. Let's consume that single source where it is available. But outside of that, it becomes a question of: is it physically possible for us to support and what is the impact on our customer? So there is no hard-and-fast rule at the moment."

Giussani says a multitude of approaches are emerging for the exchange of UTIs. "This is one of the most social regulations I have ever come across because it is forcing us to talk to people. We have to talk to the repositories, regulators, our peers and our clients in a way that we probably haven't done for another regulation," he says. "These are not just one-off conversations—they are ongoing. Some clients say they want to email us their UTIs every day. Others say they want us to generate them every time and then let them know by sending over a spreadsheet or putting the data onto a portal or via file-transfer protocol. There are so many bespoke and variant options. Trends emerge, but there is no convergence on a single way at the moment."

Multiple Methods

It is "incredibly complicated" for market participants to handle such a variety of approaches to exchanging UTIs, explains Giussani. "It is easiest if smaller clients decide to delegate reporting to us and let us get on with it," he says. "Whenever we have to accept an inbound UTI and it has not gone through Market Wire, an ECN or a Swift message, that is always going to be more difficult for us because, at some point, it is somebody scraping it from a paper confirmation. It feels easier to always be sending UTIs out, but it is just not sustainable. The market won't accommodate it—not everyone can generate the UTI."

Giussani doubts the number of approaches used for exchanging UTIs will be reduced. He says that once they have become embedded and part of ‘business as usual,' they become difficult to change.

The industry, it seems, will just have to get used to greater complexity.