Since August 2012, as part of the aftermath of the global financial crisis, market participants in the European Economic Area have been required to comply with the European Market Infrastructure Regulation (EMIR). EMIR, an EU regulation, aims to improve the oversight of over-the-counter (OTC) derivatives markets, and it has made a few significant impacts:
Increased transparency: Through the reporting of all derivative transactions to trade repositories, market participants and regulators have access to a more comprehensive view of the derivatives market.
Reduced counterparty risk: By mandating central clearing for standardized OTC derivatives, EMIR reduces counterparty risk and helps to ensure the stability of the financial system.
Improved risk management: EMIR imposes higher standards of risk management on market participants, including daily margin requirements for non-centrally cleared derivatives.
Harmonization: EMIR harmonizes the regulatory framework for OTC derivatives across the EU, reducing the risk of regulatory arbitrage and promoting a level playing field for market participants.
Regulatory Technical Standards (RTS) and Implementing Technical Standards (ITS) are the technical protocols developed by the European Securities and Markets Authority (ESMA) and the European Banking Authority (EBA) to implement EU financial regulations. Under EMIR, RTS specify the criteria for determining which OTC derivatives contracts are subject to the clearing obligation, while ITS provide technical specifications for the reporting of derivative transactions to trade repositories.
EMIR Refit, launched in 2017, is an initiative to review the functioning of EMIR and to address some of the challenges posed by its implementation. In particular, ‘Refit’ (Regulatory Fitness and Performance Program) is intended to simplify the original regulations and in turn improve the quality of reporting data. Since being published in May 2019, it has been implemented with a stepwise approach, with the latest development being the publication of new RTS and ITS in October 2022, for implementation in 2023 and 2024. A number of these changes significantly alter the way that firms must report:
Reportable, repeatable and reconcilable fields: The number of reportable fields has increased from 129 to 203 and repeatable and reconcilable fields are each set to approximately triple. There will also be changes in the name and definition of some fields. EMIR Refit expectations present a more significant challenge on this particular requirement than for example MiFIR, which has far fewer fields.
Data element harmonization: The definition, format and usage of reportable OTC derivatives data elements is being aligned with the global guidance developed by CPMI-IOSCO, on new identifier fields such as Unique Product Identifier (UPI) and Unique Transaction identifier (UTI), for example.
Reporting format: ISO 20022 XML is a fully standardized format for reporting which is already used for other regulatory regimes, and which is familiar to the financial services industry. Reporting under EMIR Refit will need to align to this format.
What do firms need to do to prepare?
Though EMIR Refit was positioned as an initiative to simplify regulations, some have argued that its revisions in fact increase complexity. At the very least, it is true that firms must be prepared to report more fields, and to do so in a new format. This is compounded by the fact that all outstanding derivatives at the point of going live with EMIR Refit measures will need to be reported based on the new technical standards, all within a maximum of 6 months. Added to this are staggered go-live dates across regulatory authorities such as ESMA and the FCA implying the need to concurrently support both legacy and new standards. Underlining this is an expectation that reporting issues and major errors are detected well in advance with requisite remediation plans that will satisfy regulators. Efficiency dictates several dimensions along which firms should measure their preparedness.
If a firm’s resources are already stretched, with regard to capacity or expertise, then the additions and transitions required to comply with EMIR Refit will be extremely difficult to achieve. Though capacity and skill-gaps are otherwise generic problems, they are especially relevant to EMIR Refit due to the time elapsed since EMIR was originally implemented. Over a 10 year period, firms are likely to have lost some, if not most, of the individuals who developed the internal infrastructure, had the relevant subject matter expertise and accumulated the hands-on experience of managing EMIR’s first implementation. As well as repositioning and upskilling current resources, firms may benefit from enlisting the help of outside experts who have developed dedicated expertise in reporting regimes and who are now well ahead of the curve on EMIR Refit. It’s worth highlighting that, among other reasons, one particular financial institution was fined under EMIR in 2017 for “failing to allocate adequate and sufficient human resource to undertake its obligations”.
The above case sheds light on how, despite widespread use of technology in derivative reporting, firms have still been found to report incorrectly under EMIR. The FCA’s final notice elaborated on that particular firm’s technology challenges:
‘The configuration of the trading data system used by the bank meant that the market leg of ETD transactions was not recorded as a separate trade.
It therefore had to be artificially generated by the bank’s EMIR reporting system. This required additional coding within the system’
Inadequate technology solutions for regulatory reporting can lead to misreporting, and consequent fines. The notion that many firms report incorrectly without understanding the nature of their obligations and the deficiencies in their reporting infrastructure demonstrates a more fundamental problem. They are often unaware of the latest available technological solutions and industry best practices. The latest reporting technologies not only clarify reporting eligibility, but also check subsequent submissions for errors and have wide-reaching regulatory coverage. By underpinning technological solutions with industry consensus interpretation of the complex reporting rules to be navigated, an extremely robust, low-risk solution for managing reporting obligations can be realized. Modernizing systems in this way can do much to automate and clarify an otherwise complex process.
Most financial institutions face daunting challenges in sourcing, refining and operationalizing their data, limiting their ability to respond quickly to data-intensive problems. EMIR Refit is well characterized as a data-intensive project, given that more data must be reported in new ways at scale. This presents an opportunity to commence or accelerate data transformation projects, for which data lakes and reusable data assets have been gaining traction.
The importance of getting it right
Time wasted correcting reports, and the accumulating cost of resubmissions
Cross functional inefficiencies and duplications of data
Regulatory enforcements, fines and reputational damage with subsequent loss of business
EMIR Refit will inevitably expose weaknesses in current processes and existing regulatory infrastructure. Firms who prepare and take the appropriate measures can use EMIR Refit as a catalyst to establish a much more robust, automated reporting infrastructure. This will serve a firm well for other fast approaching directives and rewrites from regulators, including ASIC and the JFSA. By investing in sufficiently dynamic technology which deals unequivocally with new and existing regulation, firms can effectively future-proof themselves. This should also prove to be much more cost-effective in the long term.
EMIR Refit is just the tip of an iceberg of global regulatory change, driving towards the implementation of consensus requirements and standards. It can also represent an opportunity to enhance a firm’s existing regulatory infrastructure with the right technology to adapt to rapidly evolving regulatory requirements. As the clock ticks down to 2024, firms who haven’t appropriately positioned themselves to respond will struggle to adapt to the increasing pace of regulatory change.