EMIR regulation - Recent Go Live of transaction reporting
The 2008 financial crisis led the European Commission to improve the regulation, functioning, and transparency of financial and commodity trading. As a direct reaction to the crisis the ESMA (European Securities and Markets Authorities) proposed to regulate the derivatives market through enhanced market supervision. In this context EMIR, which stands for European Market Infrastructure Regulation, has been designed to improve the transparency of derivatives markets and reduce counterparty risk.
The main EMIR requirements are articulated around 1) Clearing obligations, 2) Risk mitigation of non-cleared trades, and 3) Reporting. The latest developments around EMIR occurred on the 12th of February this year when the reporting obligations came into force. In this article we focus on these reporting obligations.
Figure 1 - EMIR requirements for OTC derivatives (OTCD)
Objectives of Transaction Reporting under EMIR
The main objective of reporting to ESMA is to increase transparency in the derivatives markets and to facilitate identification and mitigation of systemic risk (i.e. the risk that the entire system/market collapses). This also represents a step further towards being compliant with G20 transparency commitments made at the 2009 Pittsburgh conference. Since non-financial (NFC) parties generally enter into derivatives contracts for hedging the risk associated with conducting their business, they are exempt from certain EMIR requirements. However non-financial parties have to comply with transaction reporting.
"There are no exemptions to this requirement and each counterparty - being financial or non-financial - must report"
As a result the details of all OTC and exchange traded derivatives transactions will have to be reported to a Trade Repository: an entity that will centrally collect reports of derivative transactions in a transaction register. In this way Trade Repositories provide regulators with a better insight into the (OTC-) derivatives market. These details have to be reported at the latest on the working day following the execution date of the transaction, or the date of clearing or change of the agreement. There are no exemptions to this requirement and each counterparty - being financial or non-financial - must report. This obligation falls on both counterparties which can delegate reporting to a third party including CCPs (Central Counterparties).
Transaction Reporting Challenges
The Transaction Reporting (TR) Go Live has provided quite some attention points around the reporting obligation. The devil is found in the detail:
Scope - Various interpretations possible for the legal text from an operational and IT perspective. For example: what is an Over-The-Counter Derivative? This sounds like a no-brainer for 99% of the cases. However, how to define OTC derivatives concluded with a counterparty outside of the EU (known as third country entities)?
Process unclarity - the roles and responsibilities from a TR perspective: e.g. who should generate the Unique Trade Identifier (UTI) and how should this be generated and confirmed by the back-office?
System impact - After having clarified the scope/definition and process side, the real tricky part kicks-in: How to retrieve the data and report it in the correct communication standard (CpML) to the trade repositories? For the larger trading organizations with a sophisticated IT landscape the challenge is to find the right IT architecture supporting the TR requirements in an efficient and "inexpensive" way. While for smaller organizations the challenge lies more in if and if so where the required data is stored.
ESMA has provided the required guidance based on multiple Q&A sessions with the market participants. This has brought clarity to the key questions raised (like for the examples listed above). Furthermore, the Energy Trading organisation EFETnet has also proposed and introduced multiple market standards under which Transaction Reporting can be categorized to support the electronic reporting regulation (eRR). Example can be found in the UTI generator and the harmonization of communication protocols towards the reporting platforms.
REMIT, the next regulatory challenge
Figure 2 - Interdependencies between financial and energy regulations (source: ACER)
The next challenge is already imminent: Transaction Reporting under REMIT (Regulation on Energy Market Integrity and Transparency). The objective of REMIT is to prohibit insider trading and market manipulation in wholesale energy markets. REMIT requires market participants trading wholesale energy products to comply with reporting obligations and disclosure obligations regarding inside information such as the availability of production, storage and transportation assets.
Noteworthy is to highlight that reporting under energy regulation (e.g. REMIT) differs in scope with reporting under financial regulation (e.g. EMIR and MiFID II). The differences lie in 1) another product scope: REMIT also covers wholesale energy contracts, and 2) the mandate of the regulators ACER (Agency for the Cooperation of Energy Regulators) and ESMA: the first monitors market abuse while the latter monitors systemic risks. Under REMIT market participants will be asked to report to ACER the details of their transactions and orders to trade related to wholesale energy products.
Defining your strategy
With moving timelines and new requirements the impact of increasing financial and energy regulations on energy companies is complex. Given the time and effort required to get Transaction Reporting live, trading organizations impacted by the legislation need to make up their mind or reconsider their "make-or-buy" strategy. Organizations can 1) create a separate compliance Business Unit, 2) integrate a compliant function within the affected Business Units or 3) outsource the compliance function to one or several third parties.
The experience shows that a multidisciplinary team is a must have. Such a team would typically consists of:
- Legal representatives who can interpret the legal text from the regulators and draw the correct legislative boundaries for the specific trading organisation.
- Traders, Risk Managers, Treasury and Back Office employees to bring in the process knowledge and to provide input on the organizational impact.
- Senior IT architect(s) and development team(s) who can provide input on feasibility of any IT requirements and data availability.
- A Project organisation with a PMO as a "driver of the change" assuring a "soft-landing" of the project impact towards the business units.
Trading organizations have implemented the change required in their business processes and supporting tools, and (hope to) have become compliant with the Transaction Reporting obligation. In view of the complexity in terms of 1) effort required to interpret legal text and assess operational impact and 2) IT costs associated with fulfilling the regulatory requirements, we hope that the affected trading organizations have received a wake-up call and start OR continue to take these regulatory changes seriously.
Sia Partners can support in driving the project, steering the multi-disciplinary team and effectively bringing the required changes into operations.