*This article represents the opinion of the author and does not constitute legal advice.
The need for derivatives trade reporting came to the fore following the 2008 economic crisis. In 2009, regulators gathered at the Group of 20 nations (G20) Pittsburgh Summit and identified the lack of a reporting infrastructure and global data standards as key impediments to detecting and mitigating systemic market risk.
But the G20 faced a daunting challenge: How to bring transparency and standardization to a global marketplace where firms often report in more than one jurisdiction?
Market participants and regulators have faced that challenge in the years since 2009. We have all become smarter about how, what, and when to report. Now it is time to conquer those challenges.
The Commodity Futures Trading Commission (CFTC) approved three final rule changes in September 2020 as part of its ongoing efforts to streamline regulations and improve the quality, accuracy and completeness of derivatives transaction reporting.
The changes to real-time reporting in part 43, ongoing reporting in part 45 and swap data repository reporting in part 49, and corresponding technical specifications requirements, reflect a necessary move toward adopting global data standards for derivatives and more clarity and efficiency of reporting rules.
The Role of Trade Repositories
Trade repositories collect and maintain records of derivatives trades. The goal behind these repositories was to give regulators a view into derivatives trading activity, thus providing a method to monitor any build-up of systemic risk.
That G20 goal took a significant step forward in the U.S. in 2010 with the passage of the Dodd-Frank Wall Street Reform and Consumer Protection Act, commonly referred to as the “Dodd-Frank Act.” The law established derivatives/swaps reporting to the CFTC and the U.S. Securities and Exchange Commission (SEC). Other countries adopted similar legislation. Dodd-Frank and legislation in other markets established requirements to report derivatives transactions to regulators through trade repositories to improve transparency into the derivatives market. While the creation of trade repositories addressed one aspect of the G20 commitments, the benefits of transparency into what is a cross-border marketplace were not fully realized because the local execution of reporting requirements resulted in a fragmented array of regulations and limited visibility into activities in the global market as a whole.
The goal behind these repositories was to give regulators a view into derivatives trading activity, thus providing a method to monitor any build-up of systemic risk.
Establishing Trade Repositories Is Just the First Step
In order to regulate the derivatives/swaps industry, standards are needed for the reporting of data to trade repositories regardless of the location of trade execution or location of the parties. With each jurisdiction, from the U.S. to Canada, Europe and Asia, establishing its own rules for what must be reported and how, regulators cannot get a global view of a firm’s trading activity.
Regulators soon recognized that to gain a better understanding of the global marketplace, it was necessary to move toward a more harmonized reporting network with standardized terms. The Committee on Payments and Market Infrastructures (CPMI) and the International Organization of Securities Commissions (IOSCO) formed a Harmonization Working Group to create that standardization and identify which critical data elements (CDE) of swaps are most important, no matter where the trades are reported. These international standards, along with standards for unique product identifiers and unique transaction identifiers, are recommendations that must then be adopted locally. The Legal Entity Identifier (LEI) is another standard which went through a similar exercise and is now commonly used for reporting in most jurisdictions.
Such efforts are intended to help evolve derivatives and swaps reporting to become more efficient and transparent by using the same terms to describe the same transactions across jurisdictions, so regulators could have greater systemic oversight. Imagine the failure of a major swaps market participant who engages in derivatives transactions with counterparties in many jurisdictions. Even with memorandums of understanding or other forms of cooperation between regulators, there is no way to aggregate the data to allow meaningful analysis of market impact.
An added benefit of standardization is firms that have reporting obligations in multiple jurisdictions could streamline their infrastructures as they update their systems to be consistent with modernized reporting rules that use a common data set. It is a win-win scenario when standardized reporting elements help both regulators and market participants. The recent revision of the CFTC rules and adoption of CDEs is an important step in the right direction. Further efforts by regulators to harmonize the rules and processes for reporting, and the required data elements, will help to both ease the burdens of reporting and provide data that is consistent across jurisdictions. These efforts are underway in every reporting jurisdiction, including by the European Securities and Markets Authority (ESMA) technical standards under the EMIR REFIT regulation. The Monetary Authority of Singapore, Japan’s Financial Services Agency, the Australian Securities & Investment Commission and Canadian regulators are among those looking at re-writing or updating their reporting rules, adopting uniform transaction and product identifiers and incorporating CDE.
Here in the U.S., the SEC recognized the value of harmonization and recently provided certain time limited reporting relief in order to help align reporting between the SEC and the CFTC.
The Impact on Market Participants: Implementation & Cost Burdens
Harmonization of data elements poses significant challenges for reporting parties and market infrastructures. This includes not only trade repositories, but also trading platforms, derivatives clearing agencies and market participants, as well as regulators consuming the data, all of whom must coordinate making modifications to their internal systems to meet any changes to existing regulations. Market participants, in particular, face complex and costly implementation burdens each time the rules are revised. These costly rounds of system updates will persist if adoption of standards is done step by step or in an inconsistent manner across regimes. The more harmonization that can be accomplished as part of the current rule changes, the better for everyone.
An added benefit of standardization is firms that have reporting obligations in multiple jurisdictions could streamline their infrastructures as they update their systems to be consistent with modernized reporting rules that use a common data set.
Regulators Progress
Establishing this new reporting regimen on a global scale is a gradual undertaking.
With seven years of data collection under its belt, the CFTC reviewed its own rules to find ways to ensure reporting would provide accurate and complete data, culminating in the September 2020 final rule changes (which are effective over time). It is clear from CTFC’s rules rewrite that the regulator recognized the challenges faced by firms reporting in multiple jurisdictions as well as the difficulty regulators would have reviewing data from various jurisdictions. The CFTC technical specifications for reported data adopted many of the CDE.
The coordination between the CFTC and the SEC to harmonize reporting between the two U.S. regulators also took time, but, in the end, creates a more efficient U.S. reporting structure and avoids the need to maintain two reporting regimes under Dodd Frank.
Meanwhile, ESMA is moving to adopt a number of the CDE identified by CPMI IOSCO, as is ASIC. Where the CFTC, ESMA, and ASIC, regulators who oversee large derivatives markets, are adopting the same CDE in exactly the same standardized format, harmonization can be achieved. But the identical adoption is occurring with only about half of the CDE. Does this mean that only half of the proposed CDE are actually common across jurisdictions? Where the definitions, format, and allowable values in data elements are implemented differently, standardization falls short and the benefits of harmonization are unfulfilled. Regulators do not need to adopt all of the same CDE and may even have need of CDE specific to their own mandates or particular market concerns that are a different set than chosen by another regulator. But where the elements identified as CDE are adopted, they should be implemented consistently.
What’s Next?
We are getting close to harmonization but are not yet 100% there. Having large jurisdictions move closer is a giant step, as is harmonization of reporting rules by the CFTC and SEC in the U.S.
Oversight of the derivatives market, and the reporting that is the foundation for such oversight, continues to evolve. The changes occurring today around the world bring us closer to meeting the challenges identified by the G20 just over 10 years ago, but they do not go far enough. Now is the time to close the transparency gap with adoption of standardized reporting elements.