Are ETRM systems ready for more reporting?

What will new reporting requirements mean for energy trading technology and is there anything energy companies can do now to develop Dodd-Frank-friendly infrastructure? Pauline McCallion finds out

Back in March, Energy Risk reported that investment in energy trading software systems is on the cards this year for 68% of respondents to our annual software survey. Software budgets for 2011 are the same or higher than those for 2010, according to 77% of participants, and 22% of those planning to invest expect to buy an entirely new off-the-shelf package.

The driving force behind such plans is, in many cases, increased compliance requirements for derivatives traders under the Dodd-Frank Wall Street Reform and Consumer Protection Act. Users of previously unregulated swap transactions will soon be required to report data relating to their activities to regulators via swap data repositories (SDRs). Although much of this data may already be recorded by market participants, the new rules have been designed to inject a sense of uniformity, not only internally across the divisions of a company, but also externally through the use of unique identifiers for counterparties, products and specific swaps. This should allow regulators to effectively monitor the market, enforce position limits and prevent market manipulation.

But energy companies face challenges in bringing trading technology systems up to scratch in time for the new regime. The year-long rulemaking process remains incomplete, leaving many observers scratching their heads as to how the regulatory landscape is likely to pan out and how their company will fit into the new regime.

Entity definitions have not yet been finalised, as well as several other important definitions such as "real-time" in relation to the speed with which transactions must be reported to SDRs. Such uncertainty has made system development difficult for both users and vendors. But many experts agree that the intent of the rules ties in with the general trend towards enterprise-wise data aggregation seen in recent years, providing some clues as to how regulations might be finalised. As such, energy companies can begin to work on their technology infrastructure and get ahead of the curve on compliance.

At the very least, Bill Molnar, director of energy trading and risk management (ETRM) and environmental compliance solutions at Denver, Colorado-based vendor Pioneer Solutions, believes the new regulations are likely to force energy companies with older systems to look for more flexible alternatives. "It might push some people to make a procurement rather than waiting another year or two," he says.

Others believe many energy companies are holding back on software upgrades due to current regulatory uncertainty. Noah Shapiro, director, risk management at Texas-based power generation and marketing company Optim Energy, says: "It is certainly difficult to try to have specific IT solutions to problems that lack definition.

It's easy enough to say we have systems in place, but we need to have details in terms of how that connects to external data repositories, for example, or to understand how real-time reporting might occur, and even to define which types of transactions might be subject to reporting requirements."

This is why Molnar believes flexibility is key. "Systems are available that can already easily comply, they are flexible enough," he says. "So those with older ETRM systems can rest assured that if they do upgrade, template or formula-based technologies that are flexible and malleable should be able to easily comply."

Based on his knowledge of current vendor offerings, Shapiro adds: "I think most vendors have sufficient capabilities in place already, it's just a matter of whether they have toolkits that make the system into more of a turnkey solution. That's something I really haven't seen - the vendors are in the same boat as energy companies in that they don't want to build something that won't solve any problems [under the final version of the rules]."

Identifying the data

The type of data earmarked for reporting purposes under proposals published so far by regulators relates to the creation of a swap transaction and its continuation until termination or expiration. Swap creation data means all primary economic terms data and confirmation data for the swap. The data relating to continuation for commodity swaps will include a daily snapshot of primary economic terms, including any changes since the last snapshot. Unique identifiers will be used by regulators to collate this data and link it to specific companies, transactions and products within different asset classes.

"To be fair, the regulations are really only asking companies to report information that they should already be capturing in automated systems," comments David Priestley, executive director of CubeLogic, a UK provider of IT products and consulting services for companies involved in energy, commodities and investment banking.

But another layer of uncertainty arises from the classification of derivatives users under Dodd-Frank into the swap dealer, major swap participant and end-user categories. At least one counterparty will be responsible for reporting data concerning a swap to regulators via an SDR. In transactions involving a swap dealer, the swap dealer will take responsibility for reporting. Major swap participants will be responsible for reporting if other counterparties are not swap dealers. In instances where counterparties have the same status, they must decide who should report. As such, reporting will be more onerous for swap dealers and major swap participants than for end-users.

"Our hope is that the changes required will be incremental additions to systems we already have in place," Shapiro says. But he admits that this approach assumes the company will be designated as an end-user, with less onerous requirements than major swap participants and swap dealers. "I think a lot of folks are in the same boat in assuming that, as per the intent of the legislation, they should have an end-user exemption," he continues. "But there are many ‘gotchas' in the legislation and, depending on your interpretation, almost everybody could be in a category with substantial requirements."

Without confirmed definitions for each category of swaps user, it is hard to know what the compliance workload will look like for energy companies once the final rules have been voted on and enacted under Dodd-Frank. As such, many market participants are wary of investing in new systems or putting infrastructure in place at a substantial cost if it may not be necessary under the final permutation of the new rules.

Unstructured data

The "in-progress" nature of the rulemaking process at the moment has had implications for other areas as well. The real-time reporting requirement is one that remains unclear in terms of how real-time will be defined. "There may be issues [for energy companies], depending upon what real-time ultimately means," Shapiro says.

For instance, in the case of telephone-based transactions that are not immediately picked up by systems of record, conversations would have to be transcribed and added to the system, increasing the time it could take to report, he says.

Similar problems have been identified with other forms of communication, such as instant messaging. Pulling such information into a data collection mechanism requires someone or something to extract the relevant data from the message text to properly record information and conform with requirements to boost market liquidity and enable price discovery. "Instant messaging is an incredibly important tool for liquidity management and is widely used on the buy, sell and risk sides of many companies," says John Eley, chief executive of Pivot, based in New Jersey, a provider of instant-messaging-based tools for traders.

Pivot offers a parsing tool that reads the content of instant messages, identifies the relevant information and transforms it into a machine-readable format that can be handed off to a database. "Instant messaging communication has a perfect audit trail from conception of idea to execution, particularly when you add parsing technology on top of that. So we've found [our product] really ticks a lot of boxes in terms of what's required for Dodd-Frank regulation," Eley adds.

For those who believe they can avoid mandatory exchange-trading and clearing, other options such as posting more collateral, the use of letters of credit and capital guarantees will still engender reporting requirements. "Even if you get the exemption, you've got to be able to claim it, and that means you have to show evidence that proves you have the relevant credentials," says Sandy Fielden, energy products manager for Logical Information Machines, based in Chicago.

He adds that some energy market participants also feel that even if the reporting responsibility falls with a counterparty, a company should still ensure it can monitor what is being reported on its behalf. "They feel that if information concerns the business, there is a need to ensure it's accurate," Fielden says. "In other words, the implication is that you would be foolhardy to ignore what someone else is reporting on your behalf because then you have no way to track it and make sure it's correct."

Get ahead

Although the final form of the regulations remain unknown, there are ways in which energy companies can start to adjust IT infrastructure now, according to experts. For example, Fielden argues that while moves to implement enterprise-wide data management systems have been fueled by regulation recently, this
has actually been a long-running trend in the sector.

Charlie Sanchez, executive lead, energy at Calgary-based ETRM provider RiskAdvisory, agrees, arguing that the move towards gaining an enterprise-wide perspective on the company portfolio is related to Dodd-Frank, but is also a reaction to the credit crunch and increased links between various commodity markets.

"Suddenly, monitoring market risk across various commodity markets and trade types requires a much more comprehensive at-risk metric because those relationships between those markets have become much more inter-related – either directly or inversely correlated," he says.

But the new regulations will turn this trend into a requirement - even for those who are exempted from the more onerous parts of Dodd-Frank via the end-user exception. "For an OTC trade, you'll need to make all of the agreement data available: CSAs, netting agreements - any sort of collateral against that trade will have to be readily available to report that to the regulators," says Priestley. "So it will be important for people to have ready access to all of their collateral across what tend to be very silo-based systems, where there is one system for oil, another for power, a separate system for gas and so on."

Diana Higgins, director of credit consultancy Crediten, based in London, agrees that aggregating data from different departments is often a common problem among energy companies. "It sounds trivial, but information in a company is kept in different formats in different departments, so a process is needed to ensure information flows to where it is needed in a business as usual way."

This will become more important as regulation requiring more reporting comes into force, she notes. "I'm sure companies have the correct information, but pulling it all into the right place is not easy and often is not happening," Higgins says, adding that instances of this can be as simple as the fact that oil can be traded in tonnes and barrels, or that the US date format differs from the UK version. "Brokers also use different codes for each trading company," she says. "A made-up example [would be that] a company called Oil UK LTD may be called OIUK by one broker, but another broker may call it OUKL."

There are also hurdles to aggregating data on an enterprise-wide basis in terms of the actual systems a company has in place. "There is a language in each database that is unique to that market - the particular commodity, market space, or even software vendor or database type," Sanchez explains. For the latter, problems can arise relating to something as simple as the fact that one database allows users to name a column with six characters while another allows eight.

However, developing a universal taxonomy to unite different databases is not simple and could comprise as much as 60% of the work in aggregating data across an enterprise, according to Sanchez. "And on top of that, you need to make sure there is a thorough scrubbing of the business logic that goes into deriving the data point," he continues. "It needs to be fully vetted with the originator of the data and those who are processing it through to the last stages and then it needs to be at its destination in the same state as it is in the other databases." This is an extremely time-consuming process and can be quite difficult depending on the technology the company in question has in place.

Many vendors offer tools to help with issues such as this. For example, RiskAdvisory offers a data integration studio that allows the user to rename the data and holds a central repository in a clear and easy to understand format. "It's like a universal library that contains the Dewey Decimal System of naming what is going to be sent out or utilised for credit analysis or market analysis and the esoteric database that originates the data," Sanchez says.

Data transformation

Products such as CubeLogic's system and those of its competitors, that sit on top of ETRM systems will be useful in pulling all of that disparate information together and translating it into a common language that can be reported to regulators, according to Priestley. "Every transaction system tends to have its own language for product types and different names for counterparties," he says. "When we load the data into our system we can translate it into a common format that can be reported to the regulators and, more importantly, all of the contractual data such as agreements and CSAs can be readily accessed and reported as well."

The next stage involves transforming the data into the correct format for reporting to regulators. But implementing the perfect infrastructure for this task remains difficult for now since the final rules have yet to be written by the regulator. "The question here is still unresolved in terms of what that is going to be," notes Sanchez. "But the knowledge from technology groups among market participants is that the correct system will allow them to transform the information, which is really the crux of data integration. The precursor is access [to the data], which is copied, but then you've got to transform it into what it's meant to be at its output stage."

The question here, according to Sanchez, is whether current systems have the ability to complete the "extract, transform and load" (ETL) process efficiently and at the volume likely to be required on an enterprise-wide basis under the new regulatory regime.

Developing an enterprise-wide system of collating data will also go some way towards addressing the creation of legal identifiers for specific products, transactions and counterparties. Primarily, this will help regulators keep track of the data submitted to them by market participants about their activities. However, it will also add to the transparency of the market for those who use swaps.

Zak El-Ramly, president and chief executive of ZE PowerGroup, in Richmond, British Columbia, Canada, says his company's ZEMA suite will collect, index and offer access to all available legal identifiers. "We expect all identifiers related to position reporting to be available," he says. "Having access to these identifiers in simple indexes will help simplify both the reporting and data management processes. This will result in our clients having access to more detailed, timely and accurate information on their counterparties. We expect clients will be able to make more timely and informed decisions - particularly in risk and credit - as a result."

The process of collecting data for reporting purposes will provide a platform from which companies can increase credit and market risk management on an enterprise-wide basis. According to Sanchez, even those who are aggregating the data already may experience limitations in terms of the power of their analytic tools. As such, shortcuts are taken whereby data is collected into silos for analysis.

But Sanchez believes technology has advanced and will continue to do so in response to energy companies' needs in this area. "What I say to my potential and current clients is: ‘Remember when you walked in the door and you had this wish-list of what you wanted to do and then you had to let it go because of what you actually had in terms of performance? Well today you can have that wish-list again,'" he says.

High-performance computing capabilities that were previously out of reach are becoming a reality in the market, allowing energy companies to reconsider the possibility of enterprise-level analytics, according to experts. The trend towards enterprise-wide aggregation and analysis of data has been a long-running one, but the new regulatory regime looks set to light a fire under energy companies with respect to aligning technology systems across the business.