The chaotic introduction of derivative trade reporting in Europe after 12 February 2014 was worse than predicted, in large part because regulators left too many decisions to the marketplace. With the chaos deterring derivatives counterparties from adding to the confusion, it looks as if the trade reporting process will take a long time to bed down..
The weeks that followed the start of mandatory derivative trade reporting in Europe under the European Market Infrastructure Regulation (EMIR) are widely agreed to have been chaotic. For a regulatory stipulation aimed at reducing systemic risk by increasing the level of disclosure, and so of regulatory understanding, this was, to say the least, an ironic outcome. Regulators can certainly be blamed. Even the definition of a derivative was left open, prompting some counterparties to report rolling spot FX transactions, while others did not. A major source of difficulty was the slow take-up of Legal Entity Identifiers (LEIs), and the lack of firm regulatory guidance on the issue and dissemination of Unique Trade Identifiers (UTIs) and Unique Product Identifiers (UPIs).
“The European Securities and Markets Authority (ESMA) has not endorsed any approach for UTIs or UPIs,” said one trade repository official in the immediate aftermath of 12 February 2014. “They have left it up to the market to decide how they will be issued and agreed.” In the chaotic period immediately after 12 February, all banks and trade repositories faced reconciliation challenges, in which pre-deadline estimates of 30-40 per cent of trades becoming exceptions proved to be under-estimates.In theory, repositories would post `orphan’ Legal Entity Identifier (LEI)-Unique Trade Identifier (UTI) combinations to the other trade repositories, which would then confirm whether or not they had the missing pair. The repositories would then share the data bi-laterally, and reconcile the information.
In reality, reporting started on 12 February with a mixed collection of LEIs, Bank Identification codes (BICs), International Securities Identification Numbers (ISINs) and other identifiers, including random combinations of digits entered by frustrated counterparties.A kinder view is that an initial period of confusion is only to be expected. Even in the United States, where reporting of derivatives trades was a lot less ambitious, it still took six months for the reporting process to bed down. The Commodity Futures Trading Commission (CFTC) found it had understated the size of the swap market due to technical errors at two American trade repositories. As early as March 2013, as trade reporting got under way in the United States, CFTC Commissioner Scott O’Malia noted that the sheer volume of data was overwhelming systems built to receive it. “The problem is so bad that staff have indicated that they currently cannot find the London Whale in the current data files,” he said, in a pointed reference to the derivatives trades that cost J.P. Morgan more than US$6 billion.
More than 12 months on, the CFTC is still grappling with the data challenge. “Just repeating ‘transparency, transparency, transparency,’ as a meaningless mantra will not cut it,” said CFTC commissioner Bart Chilton at the start of 2014.“We have to actually have the correct, concise and useful processes in place and functioning for these reform efforts to have teeth.” In Europe, reporting volume data is not easy to obtain in the detail necessary to understand what is actually going on. The DTCC Global Trade Repository, which was always expected to have the largest volumes, said in mid-March it was receiving 75 million reports a week. The table shows the total number of open derivatives contracts recorded by the repository, broken down by asset class.
ICE Trade Vault, the European trade repository owned by ICE, processed 4.5 million trades across energy, agriculture, metals, credit, rates and equity contracts on its first day of trading. KDPW_TR, which has (commendably) provided a week-by week report of its reporting volumes, had received a total of 5.5 million reports by 7 March, made up of 1.8 million derivatives transactions between 3,774 counterparties. UnaVista, one month after the mandate went live, had received 674,444,614 reports with a total notional value of open positions of €388 trillion.
Other repositories were unwilling to share their volume data. Neither, more curiously, were the regulators. There is no publicly available data on EMIR trade reporting from the Financial Conduct Authority (FCA) in the United Kingdom, or the European Securities and Markets Authority (ESMA), which implemented EMIR. Of course, regulatory delay in publishing any data is understandable in the face of a reconciliation backlog, and uncertainty over whether all entities and asset classes are being reported. No one knows, for example, how many legal entities there are in Europe, but one month after 12 February 2014, there were 135,610 LEIs in issuance in Europe. That is well below industry estimates of a total LEI market of one million.
It means that 14 per cent of entities with a reporting obligation are actually in a position to report at all. No wonder many reporting entities decided not to bother until regulators start imposing penalties. “Counterparties have taken their foot off the pedal because of the inefficiencies of the trade repositories,” admitted one trade repository official in mid- March. “LEI issuance slowed down, and counterparties were not pushing their clients to obtain them because they knew there was a bottleneck.”