Reg Compliance 2019: Tips to Ease Data Pain

When it comes to handling the data challenges inherent in regulatory compliance, 2019 will no exception for middle and back-office buy and sell-side operations, compliance and technology managers. While the rules of MIFID II and EMIR likely took up much of their attention over the past few years, a survey of about fifty operations, compliance and fintech managers at US and foreign buy and sell-side firms recently conducted by FinOps Report indicates that SFTR, CAT, and LIBOR replacement are generating the most angst now.

FinOps Report explains the reasons why and offers suggestions below on what financial firms can do to ease their data management stress.

SFTR: Short for Securities Finance Transaction Regulation, SFTR was the most often cited by respondents to FinOps Report’s survey as a middle-office manager’s nightmare. Sometime in 2020, buy-side and sell-side firms operating in the European Union will need to report to a recognized repository 155 data points on collateralized transactions such as securities or commodity lending deals, repo and reverse repo, margin loans and total return loans to trade repositories in the ISO 20022 messge format. Of the 155 data points, 18 describe counterparties, 99 describe the loan and collateral, 20 describe the margin and 18 the reuse of margin.

The good news is that about half of the data points are also required for reporting under the European Market Infrastructure Regulation (EMIR) which requires reporting of derivative trades. The bad news is that the other half of the data points are brand new and might not be easily accessible. Financial firms will need to pull data from multiple internal front-to-back office sources as well as external lending agents, brokers and counterparties and then enrich the data, explains Keith Marks, executive director of New York-based Compliance Solutions Strategies (CSS), a regulatory compliance technology provider. Post-trade reconciliation will also be post-trade reconciliation will also be difficult, because both sides to the trade must match up the data points before reports are sent to one or more accredited trade repositories such as the US Depository Trust & Clearing Corp.’s GTR and Luxembourg’s Regis-TR.

Trade details which fail to be reconciled before reporting can lead to expensive and time-consuming manual corrections or even regulatory fines. Delegating reporting won’t get absolve firms of the legal liability for any mistakes. Therefore, they must keep track of what is reported and reconcile internal systems with filings to external trade reporting repositories.

“All firms should assess all data that has to be reported and identify all counterparties; then reach out to all SFTR trading counterparties and create processes for sharing unique transaction identifiers,” recommends Nicklas Nilsson, senior SFTR market specialist for CSS in Stockholm. “Finding a reporting partner that’s ready to help start the testing phase for reporting asap is also a good idea because trade reporting repositories will be ready to release their specs in the first quarter of 2019.”

Trade Channel, a subsidiary of CSS, wil be adapting its EMIR and MIFID II Trade Reporting and Transaction Reporting Hub to include SFTR reporting and reconciliation beginning the first quarter of this year. Securities lending trading platform EquiLend and MarketAxess matching and reporting engine Trax have teamed up to automate the entire SFTR reporting process from the point of trade to reporting to trade repositories beginning in February. Trades executed over EquiLend’s NGT platform will receive a unique transaction identifier and timestamp; data reconciliation will be done through EquiLend or Trax while Trax system will reformat data into the required ISO 20022 format to forward to a trade repository.

Securities finance data provider IHS Markit and securities finance software firm Pirum say their combined package can aggregate, enrich and match pertinent data fields before reporting takes place through IHS Markit to a trade repository. The solution is expected to begin testing in the first quarter of this year with a go-live data of October 2019.

CAT: This isn’t the name of the popular Broadway show, but a US regulatory reporting requirement that has operations managers at US brokerages sweating bullets. Under the Consolidated Audit Trail (CAT) reporting requirements, phased in as of November 2019, US broker-dealers will have to submit information about all executed orders by 8AM EST the day after trade execution to a repository operated by Thesys Technologies. The US Securities and Exchange Commission, which wants all the data to improve its market surveillance, has dictated that the CAT reports ultimately include customer identifiable information such as unique customer identifiers assigned by a broker-dealer, identifiers provided by exchanges for broker-dealers, the date and time of the order, the security symbol and price.

The good news is that some of the current data used for OATS, EBS and large options position reporting will evenutally be replaced by CAT. The bad news is that broker-dealers will still need to resolve how they will ensure data integrity and who should own the reporting process. The cause of most regulatory fines related to OATS, EBS and large options position reporting has been missing or inaccurate data, say compliance managers.

Chris Ekonomidis, director of US business consulting for global financial services consultancy Synechron in New York, recommends that broker-dealers don’t rely on simply translating current OATS reporting to CAT formats. “Broker-dealers will need to prioritize data mapping for compliance with CAT to confirm the accuracy of all their data and eliminate any discrepancies to ensure correct and consistent reporting,” he says. Broker-dealers must keep their reporting errors down to a bare minimum — less than five percent from November 2019 to February 2020 and less than one percent for subsequent years– to avoid being fined by the Financial Industry Regulatory Authority, the broker-dealer regulatory watchdog.

Data mapping will require brokerages to ensure that a multitude of internal systems can communicate with each other. Those include order management systems, execution management systems, security masterfiles and customer masterfiles. “Brokerages will need to link client orders with executed orders, cancellations and corrections,” says David Campbell, director of strategy for business operations outsourcing giant Broadridge Financial in New York. “Some orders, such as representative or aggregated orders, will require increased linkages and will generate more reporting events than is the case with OATS today.”

Brokerage operations managers tell FinOps Report that correcting reporting mistakes under the CAT requirements will likely be more difficult than is the case with OATS, because there are more cross-system linkages, fewer exception handling tools from the CAT’s repository, and a faster required correction time. Given the high potential for errors, leaving CAT reporting strictly to back-office operations staff isn’t a good idea, cautions Ekonomidis. “Brokerages will need to establish cross-sectional teams to include experts on trading, risk and regulatory reporting,” he recommends. “It is important to have business and technology expertise paired to provide end-to-end support so nothing falls through the cracks.”

Brokerages which find complying with CAT reporting is too tough to do on their own can ask for consultancies, such as Synechron to help create a regulatory and technology program, or they can outsource all the hard work to a third party. Campbell recommends that before picking a service provider, brokerages ask about whether its platform can consolidate date from multiple internal sources, how quickly it can scale for large volume transmissions, and how reliable and transparent its audit trail is. Brokerages also need to know how quickly an outsourced provider can respond to questions from regulators on specific transactions and customers and how quickly it can correct errors before and after trade reporting. Brokerages will have only two days after a trade is executed to correct any reporting mistakes. That’s far less than the five days they have under OATS reporting.

Campbell says that Broadridge’s CAT reporting hub can take all of the data from a brokerage’s disparate systems and reformat it for the reporting requirement. It will then notify the brokerage of any discrepancies or ommissions and correct them before submitting the report. Any errors caught after submission can be corrected within T+2.

Replacing LIBOR: One little number can make all the difference to holders of derivative contracts, bonds, deposit accounts, and syndicated loans. In the case of OTC derivatives and many fixed-income instruments, switching from the London Interbank Overnight Rate (LIBOR), the predominant derivatives and fixed-income valuation benchmark to multiple new rates suggested by US and foreign central banks will require lots of contract rewrites, risk recalibration and changes to middle and back office operating systems.

“There is no one-to-one replacement to LIBOR it represents an average of daily estimates of the rates at which banks lend to each other,” says George Bollenbacher, director of fixed-income research for global research firm, Tabb Group in New York. “By contrast, the new central bank rates are based on actual overnight money-market transactions.” The Alternative Reference Rates Committee (ARRC) of the Federal Reserve Bank of New York has selected the Secured Overnight Rate (SOFR) for US dollar derivatives and other financial contracts which is based on the overnight US Treasury repurchase market.

Fund managers, broker-dealers and banks using OTC derivative and other cash products based on LIBOR could find themselves in a pickle because many of their contracts will expire after 2021. That’s when the UK’s Financial Conduct Authority, which oversees the LIBOR’s benchmark administrator, has said that LIBOR will no longer be available. Relying on fall-back or default provisions embedded in some contracts might be unfeasible because they were written to cover a temporary unavailability of LIBOR, not its permanent cessation. Using those default provisions for too long could change the economics of the product allowing one party to an OTC derivatives trade to suffer unintended material losses and the other to receive an unintended windfall.

Bollenbacher recommends that to prepare for LIBOR replacement, fund managers, banks and broker-dealers first understand the extent of their exposure to LIBOR by compiling a list of the products, contracts and processes that rely on LIBOR. Only then can customer service and compliance staff renegotiate the terms of contracts.

Those renegotiations will need to address how benchmark replacements will affect cash flows. Traders will likely be spending a lot of time with risk managers, pricing managers and collateral managers to determine the effect of the replacement benchmark on the economics of existing trades, according to Todd Zerega, a partner with the law firm of Perkins Coie in Washington DC. Industry proposals have suggested that market players replace LIBOR in existing US OTC derivative contracts with expiration dates after 2021 with SOFR and a compensatory spread. However, there is still some debate on how any spread should be determined to ensure the calculation can’t be manipulated and that it achieves the same economic result. “Fund managers, uncomfortable with any industry-imposed spread calculation, will need to renegotiate bilaterally with their counterparties on an acceptable rate and spread,” says Zerega.

IT managers will also have their hands full recoding any systems currently based on IBOR as the reference benchmark to a series of new benchmarks. Buy-side, sell-side and external data providers will then need to coordinate any testing to ensure their systems have accepted any new rates and can make the correct calculations.

Akin to counterparties in the OTC derivativces market, borrowers and lenders in the syndicated loans market must also work out just what to do if LIBOR no longer exists. The New York Fed’s ARRC has accepted industry feedback on two proposed options and is set to make a decision within the next few months. One choice, called the “hard-wired approach.” sets forth predetermined terms for the replacement benchmark rate and a replacement spread to take effect after certain “trigger events”. The replacement rate waterfall includes a term version of SOFR as the primary fallback rate and a replacement spread to make the replacement rate more comparable to LIBOR. Another option, known as the “amendment approach,” recommends a streamlined amendment process to select a replacement rate in the future upon specific trigger events if LIBOR became unavailable. The “amendment approach” is similar to fallback language included in new credit agreements last year.

Because many of the comment letters to the ARCC were published without revealing the identity of the authors it is impossible to say which approach borrowers or lenders prefer or to predict which one the ARCC will select.Each option has its benefits and shortcomings, so ultimately the ARCC could come up with a variation of either. In their comment letters, advocates of the “hardwired approach,” say that option eliminates the need to amend a large number of contracts when LIBOR is unavailable because the replacement rate waterfall has been agreed upfront. However, the specified amendment rates and replacement rates are not yet available. The amendment approach, say its advocates, allows for greater flexibility in contract changes, but could be more more operationally difficult to implement on a case-by case basis and unintentionally benefit either lenders or borrowers depending on market conditions.