Will EMIR move from double sided to single sided reporting?
One of the big gripes against EMIR derivative reporting before and after it was put into effect in February 2014 is its use of double sided reporting. What does this mean, it means that both sides of an exchange traded (ETD) or over the counter (OTC) derivative need to report their trades to be compliant with EMIR.
When creating the framework for EMIR, the European Securities and Markets Authority (ESMA) believed that by requiring both counterparties of a trade to report, it provides better data quality. Specifically, ESMA has argued that dual sided reporting requires both sides to provide their valuation of a derivative position, and allows for a clearer process of discovering pricing mismatches.
As EMIR was created in the wake of the 2008/09 global financial crisis that was rooted in systematic risk of derivatives, position valuation discrepancies is an important item that ESMA and EU financial regulators want to monitor. Therefore, by using a dual sided process, ESMA was able to apply a checks and balance system of handling conflicts of counterparty valuations of positions.
The problem though is that dual sided reporting has created a compliance headache for many market participants; namely non-financial corporates that use derivatives as a hedging device and smaller buy-side firms. As an alternative, they have favored that EMIR change to a single sided reporting structure.
In this model, dealers behind the derivative position and central counterparties would be the main parties required to report positions, but include counterparty data in their reports. With dual sided reporting already sharing much of the same information, namely counterparties and unique trade identifiers (UTI), single side reporting would cover the main risk monitoring that EMIR aims to cover.
Backing the belief that single side reporting is robust, are other reporting frameworks that have decided to rely on single versus double sided reporting. They include the Securities Financing Transaction Reporting (SFTR) rules being created in the EU and Dodd-Frank rules for derivatives reporting in the US.
Despite other regimes relying on single sided reporting and market participant pressure against a double sided structure, ESMA continues to favor the double sided approach. Their most recent public statements made in their EMIR Review Report #4 that was published in August 2015.
Nonetheless, calls for a change to single sided reporting continue to take place and could push ESMA to reopen their review of the process. Among the most notable cases of industry push to single sided reporting was a recommendation from the International Swaps and Derivatives Association (ISDA).
In tandem with 12 other trade associations, the ISDA published a paper earlier in the month to recommended a global single sided standard for derivatives trade reporting. As derivative reporting guidelines similar to EMIR have been created or are in development in other major jurisdictions such as the US, Japan, Hong Kong, Switzerland and Australia, the ISDA’s paper argued that global standards would reduce costs and complexity for end users.
While increased pressure against dual sided reporting among global derivative participants would be expected to create more pressure on ESMA to apply changes to EMIR, one factor that wasn’t covered is the above mentioned valuation discrepancies that can occur from single sided data. Interestingly, in order to lighten the compliance load of non-dealer counter parties, the paper also recommended the removal of counterparty verification of data.
According to the paper, single sided reporting structures that contain guidelines for the non-reporting counterparty to verify trade data associated with them is “dual sided reporting in disguise”. As such, this system also poses undo compliance burdens.
In replace, the ISDA and accompanying trade associations believe that in replace of utilizing counterparty matching to verify accuracy of reports, risk mitigation processes should be used instead for single side reports. They include using data from trade confirmations, settlement and portfolio reconciliation. According to the ISDA’s research, these risk mitigation techniques can correctly analyze derivative trades at a better than 90% rate. This compared to a 60% success rate of trade repositories reviewing dual sided reporting.
Featured image source Charles Clegg (Flickr)