EMIR: One Little Number Can Make or Break Reporting

With the European regulatory requirements for reporting exchange-traded and over-the-counter swap transactions less than a month away, fund managers can’t afford a leap of faith that they will be ready, warn regulatory and operations experts.

There is a key nagging issue they must resolve before February 12: just who will create the 52-character unique trade identifier (UTI) regulators require for each transaction. The answer naturally leads to the associated questions of where, when and how they will incorporate UTIs into their operations and reports.

While the identifier populates only one of about 85 data fields of the required reporting to trade repositories, the UTI is the most critical element to European regulators tracking systemic risk. Knowing the UTI of a specific trade supposedly helps them focus on the size and asset class traded by specific financial organizations with each other.

“Financial firms will need to find the necessary data and then reconcile, or match reports ensuring they have the same unique trade identifier for both sides of the transaction in the reports,” explains Richard Young, head of regulatory affairs for message network provider SWIFT.

Akin to the US Dodd-Frank Wall Street Reform Act, the European Market Infrastructure Regulation (EMIR) requires financial firms to report their transactions in exchange and over-the-counter derivative trades to a recognized trade repository one day after the trade is executed. Those repositories include Regis-TR — the derivatives trade repository joint-ventured by Iberclear and Clearstream — and repositories operated by DTCC, ICE and CME. However, there is one key difference between the US and European measures: the US puts the reporting onus squarely on broker-dealers and banks, while Europe mandates that fund managers also take on the task.

Over 100,000 financial firms are expected to be affected by the new European requirements and the number of fund managers greatly outweighs broker-dealers and banks. When EMIR’s reporting rules go into effect, fund managers had better pray that their operations are up to snuff if they do the work on their own. Likewise, they had better pray that their broker-dealers can also rise to the occasion. The reason: even if fund managers outsource the reporting work, they are on the responsible party for any errors.

ISDA Sets Rules

The International Swaps and Derivatives Association (ISDA), the lobbying group for the US$650 trillion swaps market, has recommended that broker-dealers and banks be responsible for issuing UTIs when swaps trading platforms or confirmation systems don’t. In a pinch, says the trade group, firms could use internal or dummy numbers to make the filing deadline, and then resend the transaction reports when UTIs were obtained.

So far, the European Securities and Markets Authority (ESMA) has provided no guidance on the matter, leaving fund managers scrambling to make some tough decisions if they don’t have a UTI, automatically generated by a third-party source such as a trading platform or electronic confirmation system. It’s a far easier task to access UTIs for exchange-traded derivatives, as they will likely be generated by clearinghouses. Without UTIs being generated for them, fund managers can either create the UTIs on their own, or rely on their broker-dealer to do it.

 If fund managers and their sell-side counterparties aren’t prepared for transaction reporting and get the UTI wrong, then regulators won’t be ensured they have a correct view of systemic risk. They won’t know if they are looking at the same trade or a different trade between counterparties. Such a scenario naturally defeats the purpose of reporting, but it’s a pretty likely occurrence given that there are no regulatory requirements for who should generate the UTIs and when, say reporting experts.

“Trade repositories will need to look at both sides of the same trade,” says Geoffroy Vander Linden, head of product management at Xtrakter, the post-trade services and transaction reporting firm owned by global fixed-income trade platform operator MarketAxess Holdings. “But that won’t be easy if different UTIs are used for the same trade or one of the two counterparties have yet to report to a trade repository.”

Some solutions are being offered. SWIFT says that its Accord matching system can align the respective details of OTC trades between counterparties and extract UTIs from counterparty confirmations. TriOptima also just launched a service to provide UTIs for both historical and future OTC trades which are not electronically confirmed. However, to use the UTI service fund managers must also sign up to use its TriResolve reconciliation service which matches up the details of portfolios in over-the-counter derivatives. TriResolve won’t break out the number of fund managers using its service, saying that about 80 rely on the UTI functionality. Those include broker-dealers, corporations and fund managers who combined have submitted over 800,000 trades to receive UTIs so far.  As of February 12, financial firms using the TriResolve service will also be able to reconcile their UTIs with counterparties to ensure they match up.

Fund managers who decide to create their own UTIs will have to provide them to their broker-dealer and hope that their broker-dealer doesn’t forward details of the trade to a European trade repository without a UTI or using its own UTI. If fund managers decide to obtain UTIs from their broker-dealers, they must still hope to receive them by T+1 — in time to incorporate it into their transaction reports.

“When it comes to UTIs, there is a need for documentation to catch up with market practice,” says Michael Beaton, managing partner at the London-headquartered Derivatives Risk Solutions, a consultancy specializing in legal and operational matters for derivative contracts. “Looming deadlines dictate that responsibility for generating UTIs is now a matter of a gentleman’s agreement between counterparties, but this can’t last for long.”

A Major Headache

Not only will fund managers have to find or create UTIs, but they will also have to amend multiple front-office trade capture systems to store the UTIs, then feed them to trade confirmation, reporting and collateral management systems. Fund managers aren’t willing to say just how many platforms are affected, but if figures publicly disclosed by Commerzbank are any indication, they will have a major headache on their hands.

The bank recently said it will need to enhance and test interfaces with 25 third-party UTI generators, amend nine deal-capture systems, and store UTIs in about eight position-keeping systems, which also have to be prepared to generate UTIs. That coding work doesn’t include integrating UTIs into other applications. Broker-dealers as large as Commerzbank might be able to do that integration work seamlessly, but there is plenty of concern fund managers might actually need to rekey information each step of the way along the data distribution chain.     

Making matters even more complicated for fund managers is the need to generate UTIs for any outstanding trades as of February 12, 2014. If the trades were conducted after August 16, 2012 they must be reported as of February 12, but if they were outstanding as of August 16 they can be reported within about three months. Trades conducted after August 16 but not outstanding as of February 12 are given far more leeway — they can be reported within three years. Bottom line: a hefty backlog of trades will need to be reviewed and made compliant with EMIR.

Of course, the regulators presume that each trade will be assigned only one UTI. This sounds like a reasonable assumption. But to financial firms, it isn’t a given. “A trade executed between two counterparties might ultimately be assigned — or transferred by one of the two firms to yet another, which could ultimately cause some of the terms of the trade to be changed,” explains Beaton. “Regulators think it is the same trade, but even if there are no changes to the economic terms of the trade, the counterparty will be changing at the very least.”

As a result, securities watchdogs might not have a correct understanding of the counterparty risk of the trade. Middle office operations experts will also be quite burdened in needing to keep track of the same trade through a single UTI which has changed multiple hands.

Problems Amass

No one is willing to publicly speculate just what percentage of trades will fall short of being assigned UTIs or will have mismatched UTIs — either different ones from counterparties or only one from a single counterparty. Some fund managers privately tell FinOps they expect at least fifty percent of trades included on transaction reports to be flagged by trade repositories as breaks.

Concerned about the backlog of trades for which they may not have UTIs, C-level operations executives at five fund management shops in London say they are scrambling to come up with them in time for the February 12 reporting date. It’s a scenario leading to plenty of overtime. “We are in constant discussions with our broker-dealers on how we will come up with the UTIs,” one operations executive tells FinOps Report. “It’s likely we will have to do some of the assigning ourselves as there is no uniform agreement, but better now than later.”

So what will happen if UTIs either don’t appear on a transaction report or counterparties send regulators different ones for the same transaction? Currently, EMIR leaves penalties up to the regulators of the affected nations. However, counterparties will feel the pain, even without enforcement action.

Messy and costly manual cleanup work which will likely be assigned to middle office reconciliation staff, and not the traders who actually executed the orders. Expect lots of emails and phone calls between counterparties and trade repositories. The reason: when the trade repository sends an error report to the counterparties, it will only flag the transaction. It won’t tell  either counterparty just what the error is. If a third-party reporting firm is involved, that firm will be notified, not its client.

“Reporting firms — including fund managers — will face lots of reconciliation work to do when the trade repository or regulator finds breaks or errors,” predicts Vander Linden. “If they don’t get it right up front, they will have to get it right after the fact.”

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