Regulation forces trend to daily reconciliation

Market participants are becoming increasingly pro-active in their use of portfolio reconciliation for OTC derivatives, according to a report from consultancy Celent.

Market participants are becoming increasingly pro-active in their use of portfolio reconciliation for OTC derivatives, according to a report from consultancy Celent.

In the past, portfolio reconciliation – where counterparties to a trade ensure both have the correct contract information within their portfolios – had largely been done on an ad hoc basis when problems arose. But more firms are now performing regular reconciliations.

Buy-side firms have been particularly keen to increase their portfolio reconciliation capabilities and, last year, trade reconciliation specialist TriOptima told the that buy-siders made up a substantial portion of a 152% increase in client numbers seen since European rules on portfolio reconciliation were published in February 2013.

Celent cites a recent International Swaps and Derivatives Association survey, which found that the share of reconciliations done on a daily basis increased from 30.9% in 2011 to 48.4% last year. Similarly, the proportion of risk-based and need-based reconciliations more than halved, from 42.2% to 19.8% over the same period.

Regulation is the key driver of this change, according to Celent, with both Dodd-Frank in the US and the European market infrastructure regulation (EMIR) in the EU. Dodd-Frank will require one counterparty to a trade to report to a trade repository, an obligation which will largely fall to the sell-side. Under EMIR, the buy-side will also face new obligations as both counterparties to a trade will need to report to a trade repository and reconcile their trades.

However, technological developments have also been key to increasing the use of portfolio reconciliation.

“Technology and automation has enabled firms to meet the regulatory requirements while allowing them to rationalise their legacy systems,” said Anshuman Jaswal, senior analyst at Celent and author of the report.

“At the same time, the tough economic environment and need to reduce costs has also been instrumental in causing the firms to make drastic changes to their portfolio reconciliation processes in a short period of time.”

Despite the increased use of regular portfolio reconciliation, there remain a number of outstanding issues that may further broaden its use.

One of the most hotly debated is the implementation of universal legal entity identifiers (LEIs). The introduction of the LEI would help to rationalise the reconciliation process and reduce duplication, according to Celent, but there remains a lack of international consensus on how LEIs can be implemented, though the Depository Trust and Clearing Corporation recently received global regulatory approval for its LEI utility.

Data fragmentation is also a core concern. European OTC derivatives trade reporting under EMIR is due to begin in February and the European Securities and Markets Authority (ESMA) has approved six trade repositories.

However, with both counterparties to a trade required to report individually under EMIR, critics are concerned that data will be spread across repositories and frequently duplicated, making it more complex and costly to identify and reconcile trades.

Celent suggests that, in time, the development of industry utilities could generate economies of scale that would reduce the cost burden on firms. But, data security concerns among market participants mean it may be some time before the market is willing to trust a single entity with such a large amount of crucial information.

Jaswal said: “We believe that this [utility] could be an important innovation that might help the industry cope well with the wave of international regulations and the aftermath of the financial crisis, in which profitability is under severe pressure and cost minimisation has come to the fore.

“Also, with collateral management requiring much more resources than ever before, a multi-user utility could be a crucial in reducing resources required to meet a firm’s operational requirements.”