With an EMIR deadline once again looming, firms will be hoping that second time around they are fully ready for the stressful demands of compliance. As many fell short of the 12th February EMIR traded report deadline they should now, in theory, be far better
prepared for the next key EMIR deadline of 11th August 2014. With Financial Counterparties (FCs) and Non-Financial Counterparties over the clearing threshold (NFC+s) now also having to report valuation updates and details of collateral posted. How can overall
EMIR compliance across the sector finally be achieved?
Most institutions seem to have gained a foothold on the ladder to EMIR compliance, or at least none will knowingly and publicly admit that they don’t. However, firms now need to objectively review their market position and plan for the next phases of EMIR
The five steps
The five main challenges facing firms in the coming months are collateral reporting, delegated reporting, clearing, product standardisation and finally the behaviour in which these processes are carried out. These are formidable challenges which continue
to create problems for all market participants, including trade repositories, service providers and CCPs.
1. Collateral reporting
Compiling a compliant trade report will involve gathering and collating information from a number of separate systems; the trading systems and a suite of collateral valuation systems.
Trade and collateral linkage will be the biggest hurdle to compliance as most collateral is pledged on a portfolio basis rather than an individual trade or basket level, which means that the counterparty to a contract could be applying a different pricing
model, collateral mix and or haircut to the portfolio.
If a contract or portfolio is collateralised with cash only then will it be relatively straight forward to use a third party’s valuation. If, however, there are non-cash collateral pledges then it becomes much harder for third parties to know how firms’
internal risk departments would value that collateral based on internal haircuts, concentration limits and thresholds. Users of tri-party collateral facilities will need to take this into account when reporting.
If a contract is centrally cleared then there is no choice to make; the valuation used is always that supplied by the CCPs, whom have very sophisticated margin models and collateral valuation models that are publicly available.
Ultimately, regardless of who is doing the collateral reporting, a process of linking the collateral to the portfolio will need to take place and there are many links in the chain that may be required to fulfil the collateral reporting requirement.
2. Delegated reporting
Firms need to know and track which contracts are being reported by which delegated party, and this will require internal system enhancements from a routing perspective. It is important that firms understand exactly who is reporting on their behalf and what
they are reporting, as they are ultimately accountable for the reports submitted. In order to avoid contravening regulation, firms must ensure that any existing gaps in their reporting capability are plugged, perhaps with a manual reporting mechanism, until
they have either established their own reporting capability directly or have resolved any delegated responsibility issues.
3. Clearing obligations
The clearing obligation has not yet come into effect, however ESMA will publish the Regulatory Technical Standards on the clearing mandate in September, then firms can start to assess their portfolios and start the clearing calculation game. These changes
could eventually force firms to make some large and fundamental decisions around their execution behaviour.
4. Product standardisation
Firms should be ready for an influx of new product static data, either to standardise their current derivatives product codes or when new products are on-boarded for central clearing.
All new trade reporting mandates require that the trade is reported with a unique product identifier (UPI). There is a general desire to see the Financial products Markup Language (FpML) format used across the board for derivative products. Currently FpML
supports many centrally cleared contract types and there are many more which will be developed over the next two years as the CCPs start to on-board new products for clearing.
5. Execution behaviour
Firms may decide to cap the volume of trades in a particular product to keep themselves below the clearing thresholds. Creative inter-group and inter-company trading may increase as they attract a degree of exception under certain circumstances, but ultimately
the OTC derivative market that we see today will be more standardised and streamlined.
All of the changes to how firms execute, clear, and report trades as well as how they manage their collateral will change with the full implementation of EMIR. This in turn will force change on how derivatives are traded and settled in the future, ultimately
achieving the overarching goal of the European regulators; to create a more stable and transparent marketplace.
The long road ahead
Although trade reporting under EMIR is currently the primary cause for concern amongst most market participants, it’s important to note that this is just the first roll of the dice in the EMIR compliance game. Over the next 12 to 18 months firms will need
to negotiate many more deadlines, obstacles and challenges on their long road to compliance.