The burden of transparency

This month sees the start of buy-side reporting of derivatives in Europe, but many are questioning whether the ends justify the means.

By None

This month sees the start of buy-side reporting of derivatives in Europe, but many are questioning whether the ends justify the means. 

Why do buy-side market participants now need to report derivatives trade data?

After the financial crisis, the leaders of the G-20 countries set out to reform the OTC derivatives market. At the group’s Pittsburgh Summit in 2009, heads of states proposed that all standardised OTC derivatives trades should be traded on exchanges or electronic trading platforms, cleared through a central counterparty and reported to a trade repository.

The goal was for the opaque OTC derivatives market, which was seen as a major contributory factor to the crisis, to become more transparent and less risky. Regulatory reform is intended to give regulators insight into what’s happening in the market and help them flag any potential hazards. In the US, the new rules were passed in the form of the Dodd-Frank Act in 2010, requiring the sell-side to OTC derivatives trades to provide data to repositories. In Europe, the European markets infrastructure regulation went into force in 2012, requiring both sides of the trade to report – including buy-side firms – all derivatives trades, OTC and listed. Six trade repositories have since received regulatory approval to accept trade data in Europe.

What are the potential problems for institutional investors?

The lead up to Europe’s reporting deadline on 12 February has not been a smooth ride, particularly for buy-side firms which need to report their derivatives trades for the first time. With 85 data fields required, including legal entity identifiers (LEI), buy-side firms had to follow up with pension funds and other clients to ask whether they have an LEI or  want the firm to get one for them. Asset managers choosing to delegate reporting also had to liaise with clearing members or custodians to get agreements in place.

The International Swaps and Derivatives Association published a reporting agreement template in association with the Futures and Option Association, but for some that came a bit too late, leaving some signing delegated reporting agreements that they weren’t particularly happy with. Trade repositories have also been swamped with queries, while seeking guidance from the European Securities and Markets Authority on how to reconcile trades amongst each other. There is widespread consensus that the industry overall is not entirely ready for reporting, with many expecting the first loads of data to not be 100% accurate. Market participants in the US began reporting early last year, and the immediate problem that popped up there was that the regulator, the Commodity Futures Trading Commission, could not make sense of the pool of mismatched data being submitted. There are fears that the same thing could happen in Europe.

What are the long-term benefits of reporting?

Despite worries about data discrepancies, most market participants are hopeful that things will only get better with time. Regulators will eventually end up with accurate, high-quality data that will allow them to keep a close eye on the market – although rows between countries on access to each other’s data are lengthening timelines on this. Will the promise of better data for regulators justify the effort? After the heavy workload market participants have had to deal with, many are hoping national regulators will be able to provide high-level data that can shared with the industry to get a better idea of what is being traded in OTC derivatives in Europe.

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