Emily Cates is a specialist in operational processing at Rule Financial, a London-based IT consulting firm specializing in global financial markets. In January 2014, Rule Financial released a white paper written by Cates and her colleague Amrik Chawla on the progress of the European Market Infrastructure Regulation (EMIR), which came into force in 2013.
Cates spoke with John Lothian News editor-at-large Doug Ashburn on the status of EMIR implementation, how it compares with U.S. rules, and the challenges that lie ahead.
Q: Your recent EMIR paper is subtitled “Full steam ahead.” Is that an accurate reflection of what is happening in Europe?
A: The first real date of importance last year was the 15th of September whereby the business conduct rules came into effect. The business conduct rules were about being able to show that you are reconciling portfolios on a regular basis, that you have good pricing models and that you can escalate up any dispute resolutions in a timely fashion. Although the rules came into effect in September of last year, I think a lot of the effort is being placed on the trade reporting deadline on the 12th of February.
Many think of EMIR as the same implementation as Dodd-Frank was to the U.S., however there are some key differences. Under Dodd-Frank, a trade report must be submitted within 30 minutes (in the first year), whereas under EMIR it is on a trade-plus-one (T+1) basis, so we have an additional time period in which to report. Regarding the trade obligation, in the U.S. you have designated reporting people to whom you can delegate the reporting or have the ownership to make sure the reporting gets done. Under EMIR it is not that specific. It merely says that each institution has the duty to report and if they choose to delegate that reporting they still have the legal responsibility to make sure it gets done.
In the U.S. you have dedicated swap dealers, but that is not the case under EMIR, so everybody has to report, even non-financial institutions. In the U.S. you have a specific exchange of a unique swap identifier (USI) and under EMIR we have the unique trade identifier (UTI), but EMIR is not as explicit about who should produce that and how you exchange it between your counterparties. There is an awful lot of debate about where it gets produced and who takes ownership of it.
Q: And who is “on the hook” if something does not get produced properly?
A: What we are seeing is the large institutions across the European jurisdictions are lobbying ESMA hard for a clearer definition of how this should work out. From the 12th of February, everyone will try to report something, and I think the authorities will be relatively happy provided something is reported even if the UTI is present on the report from day one.
Q: Does that mean the data coming into the repositories is even less standardized and organized than here in the U.S., where some regulators have acknowledged is a problem here?
A: I believe it is a much bigger challenge. In the U.S. you have about 26 fields on which to report, and in EMIR it is something like 86 fields (although not all of them mandatory). So there is a wider set of data that EMIR requires.
Q: So is there this understanding from regulators that not everything is expected to be reported perfectly from the outset?
A: Not publicly, but there is a feeling in the market that everyone has the same issues, and to start assessing fines on people when it is still shaking out would be rather unfair.
Q: How does that affect the decision of whether to outsource reporting or to do it in-house?
A: It is an economic decision. One – do I need to report myself and hook up to a trade repository directly? What are my costs and how does my infrastructure cope with that? Two – do I delegate my reporting and have I done the relevant due diligence on the people that are offering delegated reporting in order for me to be confident that they can help me meet my regulatory obligation? Obviously it is quite late in the day now to begin thinking about it, but a lot of these third-party providers have been receiving upwards of 100 applications a day lately.
Q: Are there firms that have decided to begin with self-reporting and just “see how it goes” with the expectation that they won’t be fined in the beginning anyway?
A: You may well see some of that. Some of the buyside clients, especially the smaller ones that we were talking to, took that view.
Q: Thus far we have concentrated on the readiness of reporting by parties to a trade. On the other side of the coin, are the regulators ready to accept all this data?
A: Dodd-Frank regulations cover OTC derivatives. In contrast, EMIR covers exchange traded derivatives as well. That is a massive volume and a massive challenge. I think there will be a period of time where the trade repositories that have been approved will have to prove they can extract the data they receive in such a way that the authorities can actually make sense of it.
Q: Let’s move on to some of the other challenges that lie ahead as reporting begins, such as reconciliation and dispute resolution and adhering to the ISDA protocols. Is all of that in place?
A: No. Historically, those areas that have done reconciliations have been manually intensive because the transactions have been bilateral, and what we are seeing is those companies beefing up their reconciliation departments, anticipating that there will not be an automated solution until the UTI issue is sorted out. You will probably see a transition period of about three to six months.
Q: The next challenge for firms is figuring out who to use for central counterparty (CCP) clearing. How has that progressed?
A: There was a big push for non-European CCPs to seek authorization under EMIR so they could still service their European clients without being assessed a two percent risk weighting on assets, which would make margining much more expensive. These firms had to apply to be a qualified central counterparty (QCCP) under EMIR, and right now we have somewhere in the neighborhood of 29 non-European CCPs that have applied. There are many more CCPs across the globe that do not even know they are supposed to apply. In the meantime, if they wish to clear for European counterparties they will get hit with this two percent risk weighting.
Q: Next, we see several collateral challenges ahead. What are the issues?
A: The first issue is segregation. There are these models emerging as to how to port collateral simply and easily from a CCP, without debate, should there be a default. The CCPs are trying to work out their client offering models as to how they will segregate assets and port assets.
The interesting thing on the collateral side is that a CCP must hold collateral with a recognized securities settlement system. Many of the pension funds and larger asset managers will hold their assets with a global custodian such as State Street or JPMorgan Chase. Now, CCPs can no longer accept that collateral held just with a custodian; they have to move it to a recognized securities settlement system. There are really only three in Europe at the moment – Euroclear, Clearstream and CREST (which is part of Euroclear). We are seeing large global custodians now considering from an economic perspective whether it makes sense to become a recognized securities settlement system. So it is changing the landscape.
Q: Is this doing the opposite of the intention of EMIR by concentrating risk at the CCP level?
A: That is the worry – are we putting too much risk in the arms of the CCPs and, should there be a market shock, would they be able to cope?