Buy-side firms and other market players want to expand the scope of transaction reporting to comply with European legislation on best execution to over-the-counter derivatives and introduce position reporting for OTC derivatives as well .
But there are some caveats: the onus should fall on broker-dealers and market makers and the reporting should be done either through trade repositories or directly to regulators, say financial firms. Depository Trust & Clearing Corp. , (DTCC) the U.S. umbrella organization for clearing and settling U.S. securities, already offers a trade repository to store data on credit default swap transactions in the U.S. and is planning one for Europe.
Bolsas y Mercados de Valores Espanoles, the operator of Spain’s stock exchanges, is building one for interest rate swaps and other asset classes with the help of Clearstream International in Madrid. TriOptima already operates a repository for interest rate swaps.
Over a dozen fund managers, securities depositories and trade groups representing fund managers responded to a consultation paper published on July 19 by the Committee of European Securities Regulators in Paris which asked if and how transaction reporting should be expanded for OTC derivatives. The comment period ended on Aug. 24.
In its role of harmonizing financial regulations across Europe CESR is guiding the European Commission on how to overhaul the Market in Financial Instruments Directive (MiFID). The legislation, adopted in late 2007, outlines how fund managers and broker-dealers have to prove they are providing end investors with the “best deal” on their trade executions. Since its passage, there has been plenty of market criticism about the high cost of compliance and the lack of consistent and timely data to make trading decisions and evaluate systemic risk.
Under MiFID, buy- and sell-side investment firms must forward transaction reports on bonds, exchange-listed equities and all exchange-traded derivative transactions to regulators in their home market or elsewhere. Reports must be delivered within one day of the execution of trades. So far firms have not sent transaction reports for OTC derivatives nor do they file any reports on the positions in OTC derivatives they hold.
The CESR’s request for comment about transaction reporting for OTC derivatives couldn’t come at a worse time for financial firms. The London offices of some of the world’s largest financial firms have come under fire for their poor transaction reporting and the Financial Services Authority has been swift to levy plenty of fines for either mistakes in transaction reports or not receiving any reports for equity trades.
Transaction reports are more detailed versions of typical intraday trade reports and must include not only an identification code of the security or financial contract involved, but also a description of the transaction, where it was traded and each firm trading it. Currently, firms can send the reports to regulators directly, through the trading venue or through an accredited organization such as Xtrakter in London. Xtrakter is owned by the Euroclear SA family of securities depositories.
Transaction reports are used by so-called competent authorities – aka regulators – to detect market abuse. Position reports allow regulators to more easily view the current outstanding market exposures of given market participants to detect the concentration of systemic risk in the financial system. While transaction reports are prepared daily, position reports could be prepared far less frequently.
“The obligation to transaction report, either under MiFID or to the trade repository should attach to the market-maker or broker-dealer; it should only attach to the end user if there is no market-maker or broker-dealer involved,” wrote Peter De Proft, director of the European Fund and Asset Management Association (EFAMA) in an Aug 16 letter to CESR. The Brussels-based group represents the European investment funds industry.
The German fund management association Bundesverband Investment and Asset Management (BVI) in Frankfurt added that the most important goal was to achieve a single reporting standard and message formats between the reporting parties and regulators. “A reduction in the number of required report receiving parties is also needed. Otherwise cost and complexity of the system may become unmanageable,” wrote Rudolf Siebel, managing director, and Marcus Mecklenberg, senior vice president, in an Aug. 16 letter to CESR.
The Alternative Investment Management Association, the London-based trade group representing hedge funds also seemed to agree that reporting to too many venues could become cumbersome. Instead, firms should firms should only report to a trade repository. “It is unclear how firms that choose to report directly to the competent authority [as currently required by MiFID] will get the information to the trade repository, which is intended to be a source for all national regulators, competent authorities and other relevant bodies,” wrote Mary Richardson, director of regulatory and tax department in an Aug. 16 letter. Duplicative reporting to competent authorities and the trade repositories is inefficient and should be avoided.”
The Society for Worldwide Interbank Financial Telecommunications (SWIFT), would not comment on whether the EC should extend transaction reporting to OTC derivatives but offered up the International Standardization Organization-compliant 20022 message formats as the appropriate way for transmitting information on OTC derivatives. SWIFT, based in La Hulpe, Belgium operates a global network which transports ISO 20022 compliant securities messages
“SWIFT has supplied CESR with full documentation on the transaction reporting ISO 20022 messages in the past, but we would be pleased to supply the material again if needed,” wrote Richard Young, director of securities market management for SWIFT, in a letter to CESR. “We are willing to meet with CESR to discuss how these formats would work in the context of any extension of OTC derivatives transaction reporting.”
Xtrakter agrees that CESR should extend the scope of transaction reporting to include OTC derivatives but questioned whether commodities, interest rate and foreign exchange trades would be covered. That is because CESR has previously indicated that it wants to include only derivatives whose underlying instruments are traded on a regulated market.
In an Aug. 18 letter to CESR, Euroclear and Xtrakter said that while they understand the merits of sending transaction and position reports to either a regulatory agency or a trade repository it would be preferable for firms to send their transaction and position reports to a regulatory agency through an approved reporting mechanism. They also suggested that CESR consider another option – to allow firms to use a single reporting mechanism to send their reports to regulators.
“The Competent Authority will extract positions and send them to the relevant Trade Repository,” wrote Xtrakter and Euroclear. However, they noted that this alternative approach would require adjustments to TREM (The Transaction Reporting Exchange Mechanism), a private network which transmits data between European regulatory agencies, so that TREM could send reports on positions to the relevant trade authority.
In its Aug. 13 letter to CESR, the DTCC recommended that financial firms send transaction and position reports to trade repositories which could be accessed by regulators. However, it reiterated its consistent stance that a single global repository be used and suggested it could be the DTCC’s.
“Regional repositories would not, in practice, allow regulators to complete the tasks they have been set, i.e. the identification of systemic riak and market abuse,” wrote Andrew Douglas, head of public affairs for DTCC in Europe. “Of considerable more value to the regulator is a solution where regional mandates are combined to form a global mandate and therefore a global database. Such a combination of mandates into a global solution [as opposed to a single global mandate] does not necessarily mean the emergence of a monopoly provider, but could lead to one.”
To reduce market concerns about the possible abuse of the repository’s monopolistic position, Douglas advocated the creation of an at-cost cooperative model. He also recommended the adoption of the financial products markup language (FpML) message standard for transaction and position reporting.
Last year, the International Swaps and Derivatives Association (ISDA), the trade group for the OTC derivatives industry, launched a new (FpML) working group to extend the use of the current FpML standard – popular in trading and processing OTC derivatives – to reporting OTC derivative positions to regulators and market participants.