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CESR Outputs Two More Papers on OTC Derivatives: New Transaction Reporting Data Requirements and Standards on the Table

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To add to the veritable cartload of recent papers issued as a part of the ongoing review of MiFID, the Committee of European Securities Regulators (CESR) has added two more into the mix, this time on the subject of OTC derivatives, thus increasing the number of potential data requirements for firms on the regulatory reform list. The consultation paper on transaction reporting for OTC derivatives proposes to increase the scope of firms’ obligations to report these instruments, including key reference data items, whereas the paper on the standardisation and trading of derivatives adds in new standardised data requirements.

The proposals contained in both consultation papers would result in firms being required to get a much better handle on the reference data underlying their OTC derivatives transactions. Given the issues that have plagued firms producing transaction reports for the equities markets – if fines handed out by the UK Financial Services Authority (FSA) are anything to go by – the reporting of OTC derivatives will likely result in a significant reference data challenge in meeting these proposals in particular. After all, these transaction reports typically contain data including details of the product traded, the firm that undertook the trade, the trade counterparty and the trade characteristics such as buy/sell identifier, price and quantity; all of which are subject to an additional layer of complexity in the derivatives market.

This consultation paper on transaction reporting therefore sets out CESR’s proposal for the possible organisation of transaction reporting on OTC derivatives, as well as for the extension of the scope of these transaction reporting obligations. The proposals are based on the assumption that all persons not exempted from European Market Infrastructure Legislation (EMIL), which includes MiFID authorised firms, would have to report their OTC derivatives transactions to trade repositories after these have been established and registered under EMIL.

However, investment firms reporting their transactions to a trade repository, supporting MiFID standards, would be exempted from direct reporting when they communicate to the competent authority their decision to report their transactions through a repository. The MiFID regime would therefore apply to reporting obligations but these could be dealt with by trade repositories for the account of investment firms in order to avoid duplication. In other words, trade repositories would be recognised as a valid third party reporting mechanism under Article 25(5) of MiFID. As long as EMIL has not been finalised and implemented, OTC derivatives transactions would be reported under MiFID rules, where applicable.

The data provided to the repositories will need to be “reliable” and provided in a “timely” manner, according to CESR and this is at the heart of the related derivatives data management challenge. The repository will take the data that is generally held by counterparties and often stored in proprietary systems in various formats with different data fields and turn it into standardised and complete data sets. However, this data will not replace that being used by individual counterparties, counterparty data will instead need to be reconciled with the trade repository data, adding another layer of data processing to the data supply chain.

The consultation paper notes: “Information received by regulators should be in a specific unified format, to be defined pursuant to the provisions of MiFID/EMIL. Data quality should be paramount, since it impacts the quality and accuracy of supervision.”

This means that regardless of whether it is directly reported to a regulatory body or via a trade repository, the underlying reference data of these OTC trades will come under intense scrutiny. The regulators are already concerned about issues such as the correct identification of counterparties and the fines slapped on Barclays Capital and Commerzbank are proof that they will be taking action against those found wanting. CESR has mooted the Bank Identifier Code (BIC) as a potential solution to this problem, but a lot of work is needed to get it into shape before it can be used as such and banks will then need to invest in the systems to be able to meet these requirements.

The transaction reporting paper asks firms to provide some degree of feedback on its proposals, although it only poses three direct questions to be answered and none of them adequately take into account a possible impact assessment. The deadline for these responses is 16 August (the paper is available to download at the bottom of the page).

As for the other consultation paper, CESR is aiming to provide the industry with some degree of guidance about the standardisation required in order for OTC derivatives, in particular credit, equity, interest rate, commodity and foreign exchange derivatives, to be traded on exchange and centrally cleared. It is therefore asking for feedback from the market on where its priorities should lie: should the focus be on a certain aspect of standardisation (messaging or counterparty identifiers, for example), or should it focus on a particular asset class?

Unlike the other paper, CESR is directly asking for a cost and impact assessment of how difficult it would be to move to these new standards in order to be able to trade these derivatives on regulated markets. This takes into account standard transaction documentation and definitions, the automated processing of derivatives and standard valuation, payment structures and dates. The paper notes: “The use of standardised reporting fields (as a result of standardised products) eases the reporting of information. This is more difficult to achieve for bespoke products.” The deadline for responses to the 28 questions contained in the paper is also 16 August.

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