As the OTC derivative business shifts from profitable bi-lateral transactions between investment banks and fund managers to trading platforms backed by clearing houses, and even excess collateral is being segregated, clearing brokers have found it hard to make the business case for helping fund management clients report their trades to trade repositories.
One of the two biggest differences between the Dodd Frank Act and the European Market Infrastructure Regulation (EMIR) is that in the United States only one side has to report, while in Europe both sides have to report. In the United States, that means the task of reporting naturally fell to the clearing broker. In Europe, by contrast, EMIR launched a series of awkward conversations between fund managers and their clearing brokers over whether the clearing brokers would take responsibility for reporting the buy-side half of trades as well.
Although EMIR allows fund managers to delegate the task, the real alternatives to using the clearing broker amount to the same thing: incurring the cost of building the systems and controls to do it themselves, or incurring the cost of building the systems and controls to ensure that the data passed to a third party service provider is accurate. The only difference is that the third party provider would charge an additional fee on top of the investment cost. After all, EMIR makes it clear that the fund manager is ultimately responsible for the accuracy of what is reported.
Of course, even using a clearing broker still obliges fund managers to retain or build the capability to assemble and share the necessary information with the broker. But the operational and technological costs of establishing and maintaining direct links with multiple trade repositories – few fund managers can guarantee that all their trades will be reportable to a single trade repository – and managing reconciliations of data between repositories, are too large for doing-it-yourself to make sense for any but the largest and best-equipped managers.
It follows that the obvious solution is to outsource the job. The logical choice is the clearing broker. The clearing broker has an obligation to report themselves. It has a complete record of the transactions. It has systems in place to reconcile trade information with buy-side clients already, especially if it is already conducting exchange-traded derivative business with a fund manager, and it cannot escape building systems that enable it to reconcile trades across multiple repositories. The only problem is that many fund management houses, especially of the smaller variety, found their clearing broker was not prepared to help.
In the run-up to 12 February 2014, the larger clearing brokers made it clear (without necessarily being explicit) that they regarded reporting trades on behalf of fund management clients not as a profitable line of business but as part of the price of being in the business at all. Although they let it be known that their largest clients could count on them, not one actually advertised it as a service. Some hinted at prices clearly designed to persuade managers they were the uneconomic option.
“We had clients in the run-up to the EMIR deadline ask us if we could do the delegated reporting of OTC and ETD instruments for them,” said the head of clearing at one investment bank shortly before the 12 February 2014 deadline. “There is no money to be made doing delegated reporting for clients, and potentially some additional liability, so it will be a value-add service we offer. Our focus on delegated reporting will be to work only with key clients to help them through a difficult period. Our intent is to provide delegated reporting to our largest, most commercially important clients.”
Tim Reucroft, a director at Thomas Murray Investor Data Services in London, thinks this selective approach is understandable, and doubts attitudes will change even as trade reporting beds down. “Clearing brokers will make it very expensive for clients to outsource their trade reporting obligations,” he says. “They will probably not even offer this service to their mid to smaller sized clients. OTC instruments traded by fund managers will be reported either through an outsourced vendor or directly to the trade repository.”
Gary Kaminsky, managing director, global regulatory and compliance at ConceptONE, adds that clearing brokers are understandably reluctant to accept the responsibility of trade reporting on behalf of clients. On this view, the fund managers are ultimately liable for the accuracy of what is reported, but may not be well-equipped to give their clearing brokers the information they need to fulfil their obligation in a timely fashion.
Prior to 12 February 2014, fund managers made much of their need to select as their reporting agent a clearing broker that had the necessary systems and controls in place, but in reality clearing brokers were asking the same questions of fund managers. Although EMIR states quite clearly that managers cannot absolve themselves from the liability of reporting, clearing brokers did not wish to open themselves up to the possibility of being blamed for inaccurate reporting.
Clearing broker views did mellow in the last weeks before the deadline. Managers transacting mainly exchange-traded derivatives in particular found it easier to get their trades reported by clearing brokers, partly because clearing brokers were reporting their trades already, but mainly because clearing brokers did not want to put relationships at risk by a mean-spirited approach to OTC derivative reporting.
Gary Kaminsky reckons this more accommodating approach is unsustainable on regulatory grounds. “Initially, large brokers are accommodating client counterparty demand for trade repository reporting, but their service offering is limited in nature and may not be a long term solution for financial counterparties,” he explains. “The Financial Conduct Authority (FCA) in the United Kingdom has made clear that the ultimate liability for EMIR reporting lies with the financial counterparty and they are expecting the financial counterparty to conduct regular reconciliation of all trades reported pursuant to EMIR, whether delegated or not.”
The challenge of getting reports right for buy-side clients is compounded if a fund manager clears with multiple brokers. “We can only report the trades which are on our books, not those with other counterparties,” says a clearing broker. “If you have ten trading counterparties, then you will need ten counterparties reporting.” There is certainly scope for aggregators to intermediate the reporting of cleared and un-cleared trades on behalf of fund managers. The logical providers of that service are either technology vendors or custodian banks.