European Union legislators look set to scrap the proposed relief exempting banks from reporting exchange-traded derivatives (ETD) to regulators, although members of the European Parliament have asked if the requirements can be simplified.
“The industry now acknowledges that no ETD reporting probably isn’t going to happen or work, but we need to reach the right level of compromise,” says Chad Giussani, head of transaction reporting compliance at Standard Chartered.
In May 2017, the European Commission proposed to ease the reporting burden for exchange members – mainly banks – by requiring only central clearing counterparties (CCPs) to report the details of ETDs to trade repositories under the European Market Infrastructure Regulation.
The amendment is part of the EC’s review of Emir under the Regulatory Fitness and Performance Programme (Refit). For ETDs, this would have represented a move away from the EU’s preferred model of dual-sided reporting, where both counterparties to a trade report the details to trade repositories.
However, both the Council of the EU and European Parliament have removed the relief from their drafts of the text in their compromise versions, published on December 11, 2017, and May 23 this year, respectively.
The removal of the exemption by these two legislative bodies means it is highly unlikely the relief will be granted in the final version of the Emir Refit, which will be agreed after trilogue negotiations between the council, parliament and EC – most likely before the parliament’s current term expires in April 2019.
The council and Werner Langen, the parliamentary rapporteur for the Emir review, did not respond in time for publication.
We would like to see the move to end-of-day position-level reporting, rather than individual trades being reported, and a move to a single-sided type [of] reporting modelChad Giussani, Standard Chartered
Industry hopes of any future reprieve are now pinned on the parliament’s prevailing amendment, as it invites the EC to propose future legislation that would “simplify” and “reduce” the amount of ETD reporting for all counterparties, on the condition it can be done without undue loss of information. Dealers would like to see this interpreted as an invitation to move away from both counterparties reporting every trade individually.
“We would like to see the move to end-of-day position-level reporting, rather than individual trades being reported, and a move to a single-sided type [of] reporting model,” says Giussani.
Market participants are now advocating the reporting of positions held against each other at the end of every trading day, either by exchanges or CCPs. The Futures Industry Association has estimated the switch to position-level reporting could reduce the amount of ETD reports submitted to trade repositories by more than 90%.
Numbers add up
But European regulators may be reluctant to support the idea, as they are already beginning to make use of the intra-day trading data.
“Regulators actually like having the data; they like reconstructing the position throughout the trading day,” says Giussani. “If the market suffers some kind of shock, they can reconstruct how that shock reverberates through the working day. I feel like it is easier for them not to change things and that might be an outcome.”
The Financial Conduct Authority demonstrated the insight that regulators can glean from intra-day Emir reports on June 12, when it published data analysis of the flash crash in the sterling/US dollar rate that took place in the early hours of October 7, 2016. The analysis found investment banks exacerbated the crash, while hedge funds, asset managers and high-frequency traders stepped in to provide liquidity (see charts).
Emir reporting was implemented in Europe, after the 2009 agreement, by the Group of 20 nations to increase transparency in the over-the-counter derivatives market so regulators could see where risks build up.
Despite other G20 members, including the US and Hong Kong, only adopting the reporting requirements for OTC derivatives, European Union and Swiss authorities chose to incorporate ETDs into their own reporting regimes.
But experts question whether the benefits that regulators gain from ETD reports actually outweigh the costs for financial counterparties.
“Emir is all about financial stability and the ETD market is not big enough to realistically call into question the financial stability of the EU or any individual member state,” says Nathaniel Lalone, a partner at law firm Katten Muchin Rosenman.
“It is one thing for the swap market, which really can and rightly should be transparent to the regulators, to know where risks are being borne in the system, but the inclusion of ETDs is not justified to the same extent,” he adds.
Mark Kelly, a director at Nex Regulatory Reporting, which helps firms report trades under Emir and other regulations, says there was already a high level of transparency in the ETD market before Emir was introduced, because exchanges disclose the number of outstanding contracts that all market participants have in each ETD.
“The move toward single-sided reporting for ETDs would have been perfectly sensible,” says Kelly. “[The] G20 [commitment] was never about ETDs and the market was transparent before. It has been a vast amount of expense for very little tangible gain.”
Moreover, industry sources argue regulators could instead use data from transaction reports filed since January 2018 to comply with the second Markets in Financial Instruments Directive (Mifid II). These reports contain information on all of the instruments a firm trades and must be submitted to regulators before the close of the following working day.
Market participants say this has led to somewhat duplicative reporting under Emir and Mifid, which is part of the reason why members of parliament have encouraged the EC to re-examine the rules. The parliamentary compromise text explicitly calls on the EC to assess whether any unnecessary duplication of ETD reporting is created by requiring compliance with both Emir and Mifid, and to submit the findings to the parliament and council.
“There needs to be a cost-benefit analysis of the volume of reporting versus the benefits the regulator gets for it,” says Giussani. “Hopefully, for Emir, we will get position-level reporting with a delegated reporting model to CCPs or exchanges.”
No simple fix
While they do not know the exact reasons for the deletion of the ETD reporting exemption from the Emir Refit, sources point to complications over whether and how CCPs would report downstream member-to-client legs of ETD transactions as potentially being to blame.
Usually, an ETD trade between an exchange member and a client is replaced by a trade between the member and a CCP as part of the clearing process.
The EC’s draft text is unclear as to whether CCPs would have to report the member-to-client legs. If so, it would be difficult for the CCP to report those trades, because it does not have information on those downstream legs. If not, then the reporting relief for financial counterparties would be limited, because they would still have to report the downstream leg with the client.
The issue appears to have been considered during council and parliament negotiations, as previous draft versions presented several options to resolve the issue, including indirect clients of CCPs reporting details of downstream legs to them. However, this approach could have overcomplicated the reporting regime and resulted in more errors being introduced in the reporting chain.
“Clients reporting to a single trade repository is fine, but reporting to multiple CCPs in different ways is probably not a feasible approach,” says Nex’s Kelly.
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