Bottleneck in buy-side reporting feared

Already burdened by the sheer volume of information to be reported under Emir, hedge funds have postponed decisions on whether to delegate the role leading to predictions of onboarding bottlenecks at trade repositories

With the deadline for reporting derivatives trades for some hedge funds only a matter of weeks away under the European Market Infrastructure Regulation (Emir), there are serious concerns that hedge funds have taken too long to decide whether to delegate reporting and this will be compounded by the ability of trade repositories to onboard new clients in time.

Six trade repositories are currently registered in Europe. Spain-based Regis-TR launched its system in January 2013 which has been tested by nearly 1,000 entities of which about 10% are hedge funds. David Retana, managing director of Regis-TR, says: “We are experiencing that final rush. We are seeing many small entities still struggling to define who is going to report the data. They are still going through the decision-making process of deciding if they are going to report or delegate.”

Some hedge funds are only just starting to feel the pressure to facilitate reporting. Ed Gouldstone, London-based head of hedge fund product management at technology provider Linedata, says: “We started talking with hedge fund clients earlier in the year about the Emir trade reporting requirements. They have systems that store all their records and trade data but some were a little slow to come round to the idea that there was real work to be done, although this has gained momentum since the first trade repositories have been registered.”

In Emir’s dual-sided reporting regime each counterparty is held liable for reporting and funds may choose to keep this function in-house, partly because they want to ensure correct compliance with regulation and want to have control without reliance on specific broker relationships. GAM, with $123 billion assets under management, is one hedge fund that has not delegated reporting to any third party “at this time”. It says it has worked with its counterparties to be prepared to fulfil the reporting obligations and made the necessary arrangements with the relevant trade repository.

But while larger hedge funds are geared up, many smaller entities are trailing. London-based Mark Husler, chief executive of trade repository UnaVista, says that with the reporting requirement for exchange-traded derivatives (ETDs) and over-the-counter all going live at same time for hundreds of thousands of counterparties, it won’t necessarily be a rush for every institution to be 100% ready on day one. He says: “The reality is some organisations will probably be reporting after the February deadline.”

The requirement to report will affect European Union (EU) alternative investment funds (AIFs) managed by EU alternative investment fund managers (AIFMs) authorised and registered under the alternative investment fund managers directive (AIFMD). They will be deemed to be non-financial counterparties – since the AIF is established in the EU – until they become financial counterparties, which will occur following authorisation or registration of an AIF’s AIFM under AIFMD. They would, therefore, be required to report relevant trades as of February 12, 2014, as would an EU AIF managed by a non-EU AIFM.

However, the situation for non-EU AIFs managed by non-EU AIFMs is different. As these funds can never be a non-financial counterparty under Emir – as they are not established in the EU – they will only be required to report when they become authorised or registered under AIFMD. Most offshore funds will not become authorised until the AIFMD transition period expires on July 22, 2014, the exception being firms that cannot take advantage of the transition period because they were established after July 22, 2013.

Reporting no easy task The requirement to report all OTC derivatives to trade repositories might have appeared one of the more innocuous demands of the Group of 20 (G-20) nations in September 2009 when they put together a package of reforms for the OTC market. But in the US, the Commodity Futures Trading Commission (CFTC) was forced to issue no-action letters postponing the implementation of swap data reporting rules, and when it did eventually receive the information found itself drowning in big data. In Europe, Emir calls for reporting that captures the economics of a trade, extending to a minimum 85 fields that consist of economic data, unique product and trade identifiers and proprietary data such as internal identifier, financial status, valuation and collateral. But, globally, divergences exist between domestic reporting requirements, and a lack of standard data formats and local privacy laws conspire to prevent supervisors from getting a clear picture of the overall systemic risk posed by derivatives. That means cross-border trades represent a particular challenge for consistent regulation to be applied. For example, while in the US a foreign swap can be reported on a leg-by-leg basis – the nearer leg and then the far leg – in Europe Esma has defined the reporting of a swap in just one record containing both legs. This has ramifications for achieving uniformity among the unique identifiers assigned to trades; a unique product identifier for Esma should be something related to the swap while in the US it could be something more related to the legs.

Virginie O’Shea, senior analyst at UK-based consultant Aite Group, agrees a lot of top-tier asset managers have made inroads to prepare for the February deadline, but a large majority of small to mid-tiered firms have not woken up to what the requirements of them will be. “There’s quite a lot of confusion about who will be responsible for trade reporting,” she says. “In the US the brokerage community is under the cosh of regulators, but in Europe it’s both parties.”

The European Securities and Markets Authority (Esma) itself had concerns over the industry’s readiness to meet the deadline under Emir for reporting ETDs and in August 2013 proposed a year’s delay to allow sufficient time for the development of relevant guidelines and their implementation by counterparties, trade repositories and regulators.

The European Commission (EC) rejected that move, with the effect that all derivatives trades have to be reported three months from the registration of the first trade repositories in Europe. Esma did this in November, effecting a reporting start date of February 12, 2014. However, answering questions at a Risk conference on September 26, 2013, a senior EC official suggested the scope of the rules would be dramatically narrowed. The reporting obligation could be handed to just one party to a trade instead of both, he said, reducing the need for it to be delegated.

Yet in its December 20 Q&A, Esma says the requirement to report without duplication means that each counterparty should ensure that there is only one report (excluding any subsequent modifications) produced by them (or on their behalf) for each trade that they carry out. Their counterparty may also be obliged to produce a report and this also does not count as duplication. Where two counterparties submit separate reports of the same trade, they should ensure that the common data are consistent across both reports.

The process of implementing Emir has left many feeling frustrated by an apparent lack of coherent coordination. Jon Anderson, managing director at US-based alternative fund administrator SS&C GlobeOp, says: “I’m a little bit curious why there wasn’t more work, organisation and collaboration between regulatory bodies and the financial community on sorting out the standards as we’ve moved over the past few years towards the implementation date. It surprises me we’re naming trade repositories 90 days before putting in the reporting requirement and haven’t actually specified what that requirement is in sufficient detail such that there is no question in everyone’s mind what they have to do.”

Delay is missed
The Alternative Investment Management Association (Aima) shares concerns at the failure, more generally, to delay reporting of ETDs, believing there are particular issues reporting trades “subject to the rules of a trading venue and executed in compliance with those rules”, as noted in Esma’s request for a delay. The association was also in favour of phasing-in, both in terms of derivatives asset classes and in terms of whether trades were executed on or off exchange. This would have been consistent with Emir’s original approach of requiring credit and interest rate derivatives to be reported first, then all others later.

Given that trade repositories have only been approved relatively recently, Aima thinks that, given the reporting obligation impacts on all counterparties to a trade, including many hedge funds that have hitherto not been required to report, funds will try to sort out their reporting arrangements – either with trade repositories and/or their prime brokers – all at once, including connecting with trade repositories at the same time, thus creating a ‘bottleneck effect’ in establishing relationships.

Wesley Lund, London-based associate director, markets regulation at Aima, says: “We are concerned that the capacity of trade repositories to deal with this will impact on the ability of funds to report before the impending start date in February.”

The sheer volume of data to be reported requires significant investment in terms of infrastructure, personnel and time. With hedge funds, this investment in some cases does not build on existing structures and processes. Hedge funds are, therefore, looking to service providers and prime brokers to assist them. But Lund maintains that service providers need to do more to ramp up their efforts to educate their clients about what their offerings and increase processing times with respect to setting up any potential delegation arrangements. Aima would also like to see more communication and education from trade repositories on what hedge funds need to do to ensure quick turnaround times in terms of establishing connectivity with them.

UK-based Elspeth Goodchild, a specialist in delivery/operations management at consultant Rule Financial, agrees that onboarding turnarounds are a very real concern: “For our clients we’re been doing beauty parades of middleware providers and a few trade repositories. One trade repository is saying it’s first come first served because people have left it so late they don’t have the capacity to get everybody in and through the process on time.”

Barriers to communication Communicating data to trade repositories requires systems that speak the same language, but this cannot be taken for granted. For example, Regis-TR uses CSV and XML but does not support FpML which it says would have been too expensive to install and is only used by a small number of big banks that are just as capable of building files in XML. Many funds trading high volumes will utilise message-based systems such as FpML through trading systems or their own development teams. This will avoid the need to conduct bulk extracts of CSV data on a real-time basis – as not-so heavy users of derivatives will have to do – that make exceptions more difficult to manage. DTCC says it does not prescribe any language form to report, but does limit the character set to an ASCII one. UnaVista also claims an asset class and format-agnostic platform, accommodating CSV, XML, FpML, FixML and Swift. Its Rules Engine takes data from proprietary systems and helps with mapping and creation of the record. ICE, meanwhile, utilises FixML and FpML; CME says it accepts data in FixML, FpML and CSV; and Poland’s KDPW uses XML.

The Depository Trust & Clearing Corporation (DTCC) says in a simple case online onboarding can be completed in 24 hours, but more complex cases involving large volumes and established electronic messaging capabilities could take longer. TriOptima, a provider of post-trade infrastructure, claims onboarding for its triResolve platform takes a week or two once all documents are signed. However, business process outsourcing firm Broadridge says allowing for additional post-implementation configuration, which may be required on a case-by-case basis for its solution, could take two to three months to bed down.

A lack of timely guidance from Esma on certain key issues has contributed to hedge funds delaying the decision on whether to delegate reporting. Linedata’s Gouldstone says some funds have told him they were waiting for Esma to clarify whether for trades given up to the prime broker there is a requirement to involve the execution broker. In its December 20 Q&A, Esma states: “Where a give-up occurs from the investment firm to the clearing member within the T+1 reporting deadline and there has not been any change of the economic terms of the original trade the trade should be reported in its post give-up state.”

Gouldstone says this is good news for hedge funds. It means only the trade between a fund and the prime broker to which it has been given up needs to be reported. If this had not been the case, then potentially trades done with a broker and then given up to the fund’s prime broker might have had to be reported twice, adding more complexity to the process.

It varies by product type, but Gouldstone expects that around half of Linedata’s hedge fund clients will depend on their counterparts for reporting. He adds another quarter, which have many counterparts and trade lots of different asset classes and are slightly bigger with more infrastructure, want to be responsible for their own reporting, not just delegate it because it is easier.

He concludes: “The other quarter, trading in what I would call true OTCs – rates, credit and total return swaps – are looking for platforms where they will get the timely confirmation required by Emir, the electronic matching and trade reporting into a trade repository.”

Shifting goalposts
For EU-based hedge funds, the requirement to report trades to repositories has been complicated by a move forward in the deadline for dealing with back-loaded trades. An anticipated three-month grace period has not transpired for back-loading reporting of derivatives contracts to trade repositories that were executed after August 16, 2012 and that are still outstanding on February 12, 2014.

Esma’s final technical standards – published on September 27, 2012 – state: “Those derivative contracts which were outstanding on August 16, 2012 and are still outstanding on the reporting start date shall be reported to a trade repository within 90 days of the reporting start date for a particular derivatives class. Those derivative contracts which were entered into before, on or after August 16, 2012, that are not outstanding on or after the reporting start date shall be reported to a trade repository within three years of the reporting start date for a particular derivatives class.”

Many believed the wording implied a 90-day delay allowed for open trades conducted after August 16, 2012. But in December a spokesman for Esma clarified: “The 90-day delay envisaged in the implementing technical standards was only applicable to trades that were outstanding on August 16, 2012 and are still outstanding on the reporting start date [February, 12, 2014]. There is no delay foreseen in the regulations for trades that were executed after August 16, 2012 and are still outstanding on February 12, 2014.”

Rule Financial’s Goodchild says: “My interpretation is that it was widely understood that there was a 90-day exemption. Clearly there has been a misinterpretation and Esma has confirmed it wants the open trades in. I think it will come as a surprise to people and obviously adds to the burden of what they’ve got to do.”

However, she adds: “An asset manager client we’re working with actually wasn’t overly bothered because it doesn’t think it will have many long-dated trades. The majority of its trades are FX forwards and that sort of thing, so it won’t be affected too much. But that probably varies from client to client. Generally, everyone had hoped there would be a leeway with the back-loading but now it needs to be done straight away.”

Goodchild says some trade repositories had told clients not to worry about back-loading trades and to concentrate on trades occurring after February 12, 2014. Filing legacy trades will necessitate finding the historical data in, quite likely, different databases, and possibly trades that used a non-electronic confirmation process and getting the results online.

One trade repository states: “From our perspective we’re not so focused on historic reports. We’re most focused on people loading the full open portfolio they have at February 12, 2014. Our understanding was there was 90 days to load the open positions. For anything open there was a 90-day window and anything historic up to three years. To the extent that we’ve now got clear guidance, we can point clients to it.”

SS&C GlobeOp has more than 20 customers, mostly hedge funds, that are looking for its help with daily trade repository filing. Anderson says the recent rules clarification by Esma may be problematic for market participants.

Identity crisis
In Europe, both sides must agree a common identifier for the trade, but further difficulties are anticipated in achieving this. Whilst in the US, the Dodd-Frank Act mandates that trades should reach repositories in as little as 30 minutes, Emir’s T+1 reporting deadline is less demanding, but challenges remain in the timing of when counterparties get the information necessary to report and who has responsibility for generating unique identifiers. Anderson says: “On a cleared trade participants will have the information that next morning. On an uncleared trade participants may have to report without a universal ID or other information that the trade repositories are asking for and will have to amend their reporting later, making for a more cumbersome process.”

The Global Financial Markets Association has been looking at solutions while in September 2013, – updated December 10, 2013 – the International Swaps and Derivatives Association published guidelines on the construction of unique trade identifiers (UTIs), outlining that electronic trading platforms would generate UTIs for ETDs. When trades are bilateral, but matched electronically, the matching platform would issue the UTI. And for bilateral, manually confirmed trades, the responsibility would fall on the sell side.

But in its December 20 Q&A, Esma says it has not yet received any formal request to endorse a UTI framework and there are no details yet on how these will look like. As it stands from Emir, if there is no endorsed UTI, a code should be bilaterally assigned by the counterparties and be allocated by the venue operator in the case of platforms.

Almost universally, the buy side will allow counterparties to assign a UTI, believes Gouldstone, but some very big asset managers are bucking that trend, and pointing out that Emir does not specifically state prime brokers must assign UTIs.

Gouldstone explains: “If you allow your prime broker to generate the UTI and notify you of what it is, you have to have a process of booking a trade into your system, notifying your prime broker who generates a UTI and then you must pick up an update back from them. It is a slightly more involved process for you as a hedge fund, also because prime brokers don’t always send you back your own reference and you have to figure out what that trade has to be matched off against and stamped on to.”

One European hedge fund with assets in excess of $3 billion says it agrees that the assignment of UTIs could be a problem. This is especially so in relation to FX swaps/forwards. Most entities in the FX world confirm trades exchanging Swift MT messages and match the trade unilaterally within their system once they have received confirmation from their counterparty. That makes generating the UTI complex because no central infrastructure exists for matching trades – counterparties have to agree who will generate the UTI and how to communicate it to the other counterparty.

Legal entity identifiers (LEIs) are another essential component of reporting, and the $3 billion hedge fund is considering where it can store LEI data. Its head of operations says: “I suspect most funds have not collected the LEI info for their counterparties yet but will need to do so before they begin reporting.”

The expectation in Europe is that there would need to be at least 100,000 LEIs issued, according to Stewart Macbeth, UK-based chief product development officer at Deriv/SERV. He says: “I think it’s true that number of LEIs has not been issued in Europe at this stage. If firms don’t get LEIs in time for the reporting obligation there’s going to be an issue with reporting compliance, simply because Esma guidance calls for an LEI to be used.”

While the DTCC’s trade repository will not reject a trade reported with a client code instead of an LEI, the party without the LEI may find itself in regulatory non-compliance.

Macbeth says the potential knock-on impacts that could result from the lack of standardisation of reporting need to be recognised and resolved up front. He concludes: “Trade repositories are required to reconcile with each other and if there is some dispute about the definitive trade identifier then that reconciliation process is going to have a much higher number of exceptions than it would otherwise, or give the appearance of non-reporting by the parties. What is required is a level of agreement on an industry convention that people can follow.”