Buy-side struggling to report collateral of transactions according to new report

One year has passed since the finalization of the entirely overhauled rulings on OTC derivatives in North America, with the Commodity Futures Trading Commission (CFTC) and Securities and Investments Commission (SEC) having ended three years of consultation, bureaucracy and Senate meetings. This year is Europe’s turn to finalize its continental rulings, conforming to the global standards spearheaded by the United States last year.

Although great steps have been taken so far with regard to establishing a framework for trade reporting and processing, the buy-side is struggling to report details of the collateral of their non-clearable derivatives transactions as mandated under the European Market Infrastructure Regulation (EMIR) while trade repositories are unlikely to reconcile the data they receive.

According to a report today by peer group network for senior operations officials COOConnect, financial counterparties and non-financial counterparties above certain thresholds began reporting on August 12, 2014 details of their daily collateral posted against open positions and its value on a mark-to-market or mark-to-model basis. Given the haphazard implementation of EMIR, this has not been without its challenges.

“The buy-side has found reporting collateralized trades very difficult. The biggest challenge lies with the valuation of collateral of bilateral swaps. Who does it? Should it be done in-house or will the fund managers’ clearing broker perform the valuation? The fund administrators may not be equipped to carry out this task as they generally do not house all of the necessary data or possess the skill-sets to value level three assets or non-cleared over-the-counter (OTC) derivative instruments,” said Gary Kaminsky, head of global regulatory and compliance at ConceptOne in New York.

Obtaining agreement on the valuation of collateralised trades is not clear-cut. “For exchange traded derivatives (ETDs), this is reasonably straightforward as the central counterparty clearing house (CCP) can perform the valuation, but for bilaterally un-cleared swaps, it is hard. At present, valuation is done by the ISDA counterparty and the fund manager, and at the end of the month, both parties reconcile the valuations, and there are usually disagreements over the valuation. Performing this undertaking on a mark-to-market or mark-to-model basis will require an investment in regulatory enterprise risk management including operational infrastructure,” continued Kaminsky.

The multitude of collateral valuation methodologies will also make it an onerous task when the trade repositories exchange the data. Even reconciling data on ETDs and OTCs that have been reported since February 12, 2014, is proving complicated for the six trade repositories approved by the European Securities and Markets Authority (ESMA).

A senior executive at the Depository Trust & Clearing Corporation (DTCC) told delegates at the International Derivatives Expo (IDX) Conference in London that just 30% of inter-repository OTC derivatives and 3% of ETD transactions that were reported are being paired successfully. “Trade repositories have struggled to match swaps being reported since February, so it is a tough ask for them to match collateralised trades. The trade repositories have different systems, which is stymieing their ability to match trades,” said Mr. Kaminsky.

However, regulators are likely to be tolerant of the challenges facing fund managers. ESMA, was of course, pragmatic when firms struggled to report derivative transactions in good time back in February. “Regulators should be understanding as EMIR compliance has been a steep learning cycle,” concluded Mr. Kaminsky.

COOConnect published a guide to derivative reporting in Europe, which can be viewed here.

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