Clearing brokers retreating from delegated reporting
Clearing brokers are likely to retreat from providing buy-side clients with delegated reporting services for over-the-counter (OTC) derivatives and exchange traded derivatives (ETDs) as required under the European Market Infrastructure Regulation (EMIR).
Unlike Dodd-Frank, EMIR does not permit for single sided reporting and requires both counterparties to a derivatives transaction to report. While some clearing members mellowed in their approach towards reporting ETDs in the run-up to EMIR’s February 12, 2014 deadline, a number of smaller buy-side clients did struggle to convince banks to report OTC instruments on their behalf. Many clearing brokers retorted delegated reporting of OTC and ETD instruments had little – if any – commercial upside and a lot of liability on the downside. Nonetheless, many simply acquiesced and reported on behalf of clients. This limited goodwill, however, appears to be waning.
“In the short to medium term, I would expect them to continue to offer delegated reporting but I do not expect the service to be viewed as a distinct revenue stream. It is tied to execution and clearing fees. We are hearing anecdotal feedback that some clearing brokers are less willing to offer this service and others may follow suit in the future,” said John Southgate, senior vice president at Northern Trust.
The initial challenge for clearing brokers was further compounded if fund managers were clearing with multiple brokers. Clearing brokers can only report trades which are on their books and not transactions being processed by other counterparties. In other words, a buy-side firm with six trading counterparties would have to have those six counterparties reporting their trades. Some have argued a technology vendor or custodian bank would be well placed to aggregate this data and report to the trade repositories. Nonetheless, there was an inherent bias among clearing brokers to report on behalf of larger, and more commercially important clients.
Fund managers had predicted clearing brokers would distance themselves from delegated reporting. Some buy-side firms were already in discussions to port reporting to other service providers in the likely event that their clearing broker ceased offering delegated reporting.
EMIR implementation has been mired with difficulty since it came into force in February 2014. European regulators have yet to clarify which counterparty to a trade is required to produce the Unique Trade Identifier (UTI), an alphanumeric code designed to enable trade repositories to match trades with other repositories. Predictably, both counterparties are producing UTIs, which can often be wildly different. As a result, barely any OTC derivatives and ETDs that are being reported to trade repositories are being paired. This has hindered regulators’ ability to monitor build ups of systemic risks in the derivatives markets.
However, local regulators have been sympathetic of firms struggling to report. Nonetheless, Northern Trust doubts this goodwill is to last long. “Local regulators have yet to begin policing firms’ compliance. The industry had many challenges hitting the deadlines and it was prudent for the regulators to allow some breathing space for these issues to bed in. As we move through 2015, I would expect individual regulators to begin to look at compliance monitoring more closely with phased in policing and penalties for failing to comply over the following 12 months,” said Southgate.
Further reporting obligations are likely to take effect over the next few years. Regulation of securities financing transactions (SFTs) is likely to mirror EMIR and will affect financial as well as non-financial institutions engaging in SFTs, and will require them to report details of their SFTs to trade repositories. However, central banks and public bodies managing public debt will be exempted from these reporting obligations. The rules are extra-territorial and will impact non-EU branches of EU entities. SFTs include repos, reverse repos, securities lending and borrowing transactions, buy-sell backs, sell-buy backs and derivative transactions such as total return swaps, liquidity swaps and collateral swaps.
Service providers are already preparing for these rules. “Northern Trust is mindful of these potential requirements and has built flexibility into the solution that will allow us to address these reporting requirements on behalf of clients, although we have yet to see any detailed requirements. We have built the service in a manner to ensure maximum flexibility and would look to leverage it for future requirements,” said Southgate.
COOConnect will host a webinar on Tuesday, October 14 on “Is it time to change your trade repository?” The details can be found here.