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People and MarketsComment

Learning Curve: lessons for SFTR from EMIR

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Nearly six years ago to the day the European Commission adopted the technical standards for the European Market Infrastructure Regulation (EMIR) that, among other things, mandated the reporting of derivatives contracts to trade repositories.

by Val Wotton, managing director, product development and strategy, derivatives and collateral management at DTCC

EMIR was the European regulatory community's first response to the G20 mandate established in Pittsburgh in 2009 to increase transparency in the OTC derivatives market. It was designed to address some of the weaknesses in the financial system which surfaced following the 2008 Global Financial Crisis (GFC).

EMIR was a long time in the making, with many months spent consulting with the industry before the reporting component of the mandate began on February 12, 2014. Derivatives trade reporting is now running smoothly. But at the time of implementation, many smaller market participants, particularly those with less resource in the middle and back office, were not adequately prepared. That led to delays in regulatory compliance.  

Fast forward five years and the market is getting ready to implement technical standards for a new set of reporting rules as mandated by the Securities Financing Transactions Regulation (SFTR), recently adopted by the European Commission. The SFTR reporting requirement applies to repurchase agreements (repos), sell-buy back and buy-sell activities, securities and commodities lending and borrowing, as well as margin lending and borrowing.

The implementation of SFTR is not likely to take place until late Q1 / early Q2 2020. But the securities financing industry should look back at the way in which EMIR reporting unfolded to ensure that the same mistakes around lack of preparation and non-compliance are avoided. 

The securities financing industry arguably also has more work to do in comparison to the derivatives industry when it first faced trade reporting regulation, in relation to both data availability and workflows.

Among the larger industry participants, such as the global broker dealers and large agent lenders, efforts are mobilising around SFTR preparations.

Market participants are especially focused on which data elements they are missing. The quantity of SFT data which firms should report under the regulation is considerably greater than they have reported in the past.

Firms are examining workflows, ascertaining how SFTR data will be obtained. For that data which is not available, they are determining exactly how it will be sourced. 

SFTR will also require the validation of messages when accepting and storing them, to ensure message completeness as well as accuracy of data formats. That includes reference data validation, including Legal Entity Identifiers (LEIs), International Securities Identification Numbers (ISINs) and International Organization for Standardization (ISO) country codes. 

Market participants who are not familiar with the derivatives trade reporting regimes may not be aware that critical to the success of SFTR implementation is the ability to report in an accurate and timely manner — in other words, reporting must occur no later than T+1.

As well as addressing the data requirements of SFTR, firms are beginning to recognise how important the pairing and matching process will be to successful implementation of the reporting mandate. 

When it comes to pairing and matching there are lessons that can be drawn from EMIR, where inter-trade repository reconciliation presented a challenge for market participants. 

This process reconciliation has two stages. First, a trade is paired with the other side of the trade, after which the rest of the trades are reconciled (matched). To avoid the problems which beset market participants in EMIR trade reporting, firms need to prioritise the four fields which are required to pair the trade — Unique Trade Identifier (UTI), reporting counterparty, other counterparty and master agreement type. If there is no consistency in the reporting of these fields by both parties, then matching cannot take place. Typically, the generation and sharing of the UTI poses the biggest challenge and the industry is looking to existing matching services to provide this identifier. 

It is encouraging that a significant proportion of the industry has kick-started the process of considering their approach to SFTR requirements. But as was the case with EMIR reporting, many market participants such as tier two banks and buy-side firms have yet to start considering their response to the forthcoming regulation.

Many of the tier two banks will now begin their preparations as the European Commission has approved the technical standards for reporting, while the buy-side is mainly waiting to see if the large sell-side firms are going to offer delegated reporting, much like they did for EMIR reporting. 

While both these motivations for a 'wait and see' approach are valid, looking back at EMIR, it was these smaller market participants which struggled to comply with the reporting requirements as preparations had simply not started early enough.

The securities financing industry has far more work to do, particularly around data availability and workflows, than the derivatives industry first faced with the EMIR trade reporting regulation back in 2014. 

SFTR is not likely to be implemented until the end of Q1 / beginning of Q2 2020. But now that the technical standards for SFTR reporting  have been approved by the European Commission firms need to kick start their preparations, making important decisions such as whether to build their own in-house reporting capabilities or to outsource the function and, if so, who to work with. 

If firms take a more strategic approach to addressing the requirements of SFTR they stand to achieve a lot more than simply complying with the regulation. With the right approach, firms can ensure increased levels of pairing and matching, less trade fails and more collateral efficiencies. 

That will result in significant benefits such as balance sheet optimisation. If the story of EMIR reporting tells us one thing, it should be that it is never too early to start preparing for such a transformative piece of financial regulation.