Validating Trade and Transaction Reporting with Confidence: Why ‘Good Enough’ Is No Longer Good Enough

By: Ofir Reichenberg

The 2023 Report on the Quality and Use of Data by the European Securities and Markets Authority (ESMA) is essential reading for anyone involved in transaction reporting for over-the-counter (OTC) derivatives contracts.

It serves as a crucial reminder of why accurate, timely data gathering, formatting, and presentation are vital to ESMA’s core mission—ensuring global financial stability, orderly market functioning, and preserving market integrity. The key takeaway is that if reporting entities are to avoid a call from the regulator, they need to go above and beyond the prescribed minimum reporting requirements, ensuring data submitted is coherent and useful to market supervisors. And while ESMA has been prescriptive in their commentary, other regulators are also headed in the same direction and beginning to look for more robust report submissions.

Data Quality is Mission Critical

ESMA’s report explains that aggregated data helps monitor risk and identify potential threats, while the granular detail contained in each transaction report enables it to investigate behaviors or analyze events. Data quality is mission critical and ESMA identifies cases where unidentified reporting entities got things significantly wrong and flagged these for action by national authorities. Recommendations for improving transaction reporting have led to new guidance on position calculations under the EMIR REFIT, issued by ESMA to trade repositories. Compliance is effective from October 2024.

As part of its 2023-2028 Data Strategy, the report clearly outlines ESMA’s expectations for market participants and the future direction of market regulation in the European Union. Not every regulator is as transparent and explicit.

What the report highlights is that financial institutions reporting OTC derivative transactions should not regard trade repositories as independent checkers of their submissions, since they are the agents of the regulators. This conclusion is probably familiar for those who manage the step-by-step remedial work. As they probably know, one NACK flagged by the trade repository may not flag all of the errors contained in a transaction report.

A low NACK-count, therefore, is no longer good enough in terms of regulatory reporting. The possibility of false-positives in reports that have cleared the automated four-step trade repository validation process does not provide them with an all-clear from potential sanctions. A report may be correct in terms of data entry and formatting to gain validation from the trade repository, yet ESMA is telling us that there is a higher level of correctness to which reporting entities should be aiming.

Inaccurate Reporting Has Consequences

ESMA cites in its report a “significant issue related to the reporting of valuation updates,” where one entity’s 640,000 reports of late valuations since July 2023 accounted for around 32% of the EU total. In another example, it identified an institution reporting an “implausibly high number of outstanding CFDs” (contracts for difference) with a notional value of around 170 billion euros.

Beyond the costly follow-up actions by national authorities, these errors require significant resources for regulatory engagement and remedial actions to fix reporting systems.

The Need for a Rigorous, Long-term Approach

In this environment, financial institutions need a more rigorous approach to their report production chain. This ensures that any errors or contradictions in the thousand-plus fields are flagged before the report’s submission to the trade repository. For example, ensuring an early termination date does not exceed the contract expiration date—something that trade repository validation might not catch.

Financial institutions must choose: a short-term approach that meets minimum regulatory requirements but risks potential sanctions, or a long-term approach shaped by best practices, focusing on quality submissions and minimal remediations.

Droit’s Enhanced Validation for Trade and Transaction Reporting is informed by the best practices of our sophisticated client base covering all jurisdictions so that reporting entities can demonstrate their proactivity to regulators through the provision of additional information. It identifies issues that may not raise a NACK, but will attract the attention of regulators or auditors. An example is to act on regulatory guidance that has yet to be implemented at a venue level. It provides a holistic overview of all the issues that need to be addressed to ensure efficient compliance instead of an issue-by-issue approach.

Demonstrating Proactive Compliance

Droit’s Enhanced Validation offers complete transparency on the source of supplementary reporting requirements, which can be presented to relevant authorities. For compliance officers, Enhanced Validation provides clear explanations on the rules. Its unique pre-submission insight allows users to address reporting errors in real-time prior to or post-submission as well as for financial institutions to run test reports to optimize the report production chain.

Other areas of Enhanced Validation include ensuring consistent product classification. For instance, entering a Classification of Financial Instruments (CFI) code prompts users to populate additional information fields. Another feature is the inclusion of information beyond standardized fields for all jurisdictions. This ensures cross-jurisdictional compliance for authorities such as the SEC, Japan Financial Services Agency, ESMA, and others by filling in fields where no overlap exists.

ESMA’s report indicates that transaction reporting is constantly evolving toward greater transparency, which in turn requires greater volumes of data for reporting. Droit’s Enhanced Validation keeps pace with these changes, so that financial institutions can report OTC transactions with confidence.