The European Markets Infrastructure Regulations (EMIR) derivatives trade reporting rules went into effect on February 12, 2014. Derivatives trading entities incorporated in the EU and their overseas branches are required to report the details of their derivatives transactions to an authorized Trade Repository (TR). Under EMIR, derivative transactions of all types, whether over-the-counter (OTC) or exchange-traded (ETD), must be reported. Trades, and any trade modifications or cancellations, must be reported by the end of the trading day. In addition, all trades dating back to August 16, 2012 meeting the reporting criteria had to be reported, or “back loaded” to an approved Trade Repository.
Delegated Trade Reporting Under EMIR
EMIR trade reporting rules allow one counterparty in a derivatives trade to delegate its reporting obligation to the other counterparty. This typically occurs when an institution such as hedge fund or smaller bank trades with a global bank. The smaller counterparty “delegates” its reporting obligation to the large bank, which then reports the trade to a designated Trade Repository such as the DTCC’s GTR (DTCC Derivatives Repository Ltd.). This allows smaller trading partners to avoid a large investment in IT infrastructure, and provides a new business opportunity for large institutions to offer delegated reporting services to their clients.
Challenges of Delegated Trade Reporting
EMIR delegated derivatives trade reporting rules pose significant challenges, both from a technical and regulatory compliance standpoint.
1) The definition of a “derivative” is unclear.
EMIR references the Markets in Financial Instruments Directive (MiFID) for its definition of “derivative”. MiFID regulations were adopted at the national level, not pan-European. Several European countries have different definitions for a “derivative”. Neither the European Securities and Markets Authority (ESMA) nor the European Banking Authority (EBA) have direct authority to override these different national definitions with a single EU-wide definition of “derivative”.
As of March 2014, Canada has a similar “derivative” definition issue across its provinces where laws have evolved separately. The Canadian national regulator OSFI does not have authority to specify one definition, but merely acts in a consultative or advisory role.
This issue affects the reporting obligations of all counterparties trading in jurisdictions where there is a question about the definition of “derivative”. If the contract is not a derivative, there is no reporting obligation, either direct or delegated. For example, if a delegating party is located in a jurisdiction where the contract is considered a “derivative” and the delegated reporting party’s jurisdiction does not consider the contract a “derivative”, the reporting party may not report the trade. This places the delegating party in regulatory breach of its own country rules, while the reporting party is in compliance with EMIR. The opposite can also occur where a contract is not considered a “derivative” locally and compliance with local country law causes non-compliance with EMIR for failure to report.
Differences in the definition of “derivative” are particularly significant with FX forwards and physically settled commodity forwards.
ESMA sent a letter to the European Commission on February 14, 2014 highlighting this issue. According to ESMA’s words, differences in the definition of “derivative” across Europe have a “significant detrimental effect on the consistent application of Regulation (EU) No 648/2014 on OTC derivatives, central counterparties and trade repositories (EMIR)”. Given the regulatory structure of the EU, this issue is not likely to be resolved quickly.
Financial institutions delegating their derivatives trade reporting or offering delegated reporting services need to be prepared for potential compliance conflicts, not only within the EU but wherever local law diverges from ESMA, Dodd-Frank or other national or supra-national legal regime.
2) Reporting obligations for the same trade can differ across jurisdictions depending on entity classification.
Institutions which trade in multiple countries are subject to various regulatory incarnations of delegated trade reporting. Global firms offering delegated reporting services must apply a complex matrix of reporting rules to handle these multi-jurisdition interactions.
EMIR requires both counterparties to a derivatives trade to report. One party can delegate its reporting duties to the other but must still report its trades accurately if the delegated party fails to do so. The delegator continues to be responsible for the trade data reported, and must periodically review its delegated reporting data to ensure it is accurate and complete. Under EMIR, both Financial Counterparties (FCs) and Non-Financial Counterparties (NFCs) must report their derivatives trades to a Trade Repository. This is required whether the FC or NFC reports directly or delegates its reporting obligation. Under EMIR, both large and small institutions must make the technology and personnel investments to to enable direct derivatives trade reporting to central Trade Repositories.
Dodd-Frank in the U.S. also allows a form of delegated reporting, but it is based on whether one party has registered as a Swap Dealer (SD), Major Swap Participant (MSP), a Central Counterparty (CCP) or Swap Execution Facility (SEF), and whether the counterparty is a financial or non-financial firm using derivatives to hedge commercial risks. Once a counterparty delegates its reporting obligation, it no longer has the obligation to report its derivative trades directly to a Trade Repository. In addition, exchange-listed derivatives do not need to be reported to a Trade Repository since they are already reported by a CCP or electronic trading platform.
Under U.K. law, foreign currency derivatives trades entered into for “hedging” purposes do not need to be reported to a Trade Repository.
Global banks reporting derivatives trades to multiple Trade Repositories across multiple regions with thousands of cross-border counterparties must catalogue and apply layers of complex regulatory rules. Each set of country- or region-specific regulatory rules must be run both separately and together to ensure full compliance. To achieve this the trade and counterparty data must be captured and normalized from the bottom up, including counterparty records, trade details, legal entity identifiers (LEIs), etc. Even the most sophisticated Tier 1 banks often lack the systems and data orchestration required to achieve this.