Since the onset of the global financial crisis, policymakers and regulators have been working on a system to improve the transparency and integrity of the global financial system. The need for timely access to detailed and accurate data on global derivatives activity led G20 finance ministers in 2009 to create a regulatory framework mandating reporting of over-the-counter (OTC) derivatives trades to trade repositories. Major derivatives jurisdictions such as the U.S., Canada, Europe, Japan, Australia, Hong Kong and Singapore have put in place regulations which require derivatives transactions to be reported to trade repositories.
While the implementation of such regulations has been gradual, and the scope of the reporting requirements has varied across each jurisdiction, almost five years on from the G20 summit, we have a reporting framework which is global. This article reviews the progress of the implementation of trade reporting and analyses the challenges ahead in enabling trade repositories to act as a key risk mitigation tool.
Trade Reporting Goes Global
The U.S. was the first jurisdiction to implement derivatives trade reporting. The Commodity Futures Trading Commission (CFTC) began the implementation of derivatives trade reporting under the Dodd-Frank Act in October 2012. The implementation was phased in by asset class and type of participant. Future reporting includes reporting to the SEC on security-based swaps.
In Europe, trade reporting was enshrined into law with the European Market Infrastructure Regulation (EMIR), and reporting for all five OTC derivatives asset classes as well as exchange traded derivatives, began on February 12, 2014.
EMIR did not only mandate that reporting for all derivatives asset classes begin in a single day, but it is also the regulation which impacted the largest number of derivatives users including sell-side and buy-side firms.
With back loading of derivatives trades outstanding on the reporting start date and outstanding on August 16, 2012 completed by May 13, 2014, the next reporting deadline in Europe concerns reporting of collateral and valuation information, which begins on August 11, 2014.
Trade reporting requirements in Europe apply not only to EMIR, but also to other regulatory directives. For example, the Alternative Investments Fund Managers Directive requires non-EU domiciled hedge funds to register their funds by July 2014 to gain access to EU investors. To do so, such funds need to demonstrate they have met their reporting requirements under EMIR.
The region has seen a flurry of activity in trade reporting, beginning from April 2013, the deadline set by the Japan Financial Services Agency for Japanese Financial Business Operators to report their equity, FX, interest rate and credit derivatives transactions.
Japan was followed by Australia in October 2013, where five of the major Australian banks active in OTC derivatives trading and other banks with total gross notional outstanding positions of over AUD 50 billion have already started reporting interest rate and credit derivatives trades as prescribed by the Australian Securities and Investment Commissions rules. Other deposit-taking institutions, Australian financial services licensees, and exempt foreign licensees with total gross notional outstanding positions of below AUD 50 billion will begin reporting interest rate and credit derivatives trades from October 2014.
In Singapore, under the auspices of the Monetary Authority of Singapore, the reporting regime for OTC credit and interest rate derivatives trades was launched on October 31, 2013. Singapore licensed banks started reporting in April 2014. The next reporting phase will see buy-side firms and insurance companies report interest rate and credit derivatives trades from July 1, 2014. The reporting mandate for remaining asset classes, including equity, commodity and FX derivatives, will be introduced at a later phase.
The Hong Kong reporting regime designed under the Hong Kong Monetary Authority (HKMA) began in August 2013 when Hong Kong licensed banks began interim reporting of interest rate swaps and FX non-deliverable forwards. HKMA and the Securities and Futures Commission are preparing the detailed rules for implementing the new regulatory framework, and will conduct public consultation on the draft detailed rules. Subject to the passage of the relevant legislation, the new regime is expected to take effect in the second half of 2014.
In Canada, the Ontario Securities Commission, the Manitoba Securities Commission and the Autorité des marchés financiers recently published rules requiring derivatives trade reporting with respect to transactions involving local counterparties.
Buy-side firms have until June 20, 2015 to comply with reporting requirements (amendments implementing these reporting dates are expected to be approved and effective July 2, 2014).
Nova Scotia, Alberta and New Brunswick have legislation pending allowing supervisory authorities in each of those provinces to regulate trade repositories and derivatives.
Lessons To Be Learned
While trade reporting requirements continue to be implemented around the world, there is an opportunity to reflect about the experiences to date.
First, divergent reporting requirements around the world are creating regulatory overlaps, duplication or omissions in reporting, and have increased the cost of compliance for market participants. Efforts should therefore be made to ensure that regulations are cohesive and coherent.
Second, in some markets trade reporting represented a significant commercial opportunity which resulted in data fragmentation and overcapacity in the system. It is likely that over time, market forces will act to reduce the number of providers and market participants will consolidate their reporting with a global trade repository. But for now market participants and regulators are faced with a complex and costly structure for trade reporting.
Third, the absence of globally agreed standards hinders the fulfilment of the trade repository potential. For regulators to be able to monitor the build-up of systemic risk, global reporting standards must be agreed upon. The entity, transaction and product identifiers are an important starting point, but the divergence in the requirement for such standards across jurisdictions and the number of providers offering them hinders the implementation of an effective global regulatory framework.
Market participants have made significant strides in meeting new regulatory mandates. However, regulators and the industry recognize that convergence on reporting practices is crucial for the trade repository function to reach its full potential as a risk management tool and enhance market transparency.
This article first appeared on the Alternative Investment Management Association (AIMA) website on June 30, 2014.