MiFID II: the Catalyst for a More Strategic Approach to Trade Reporting
By Jim Bennett, Sapient
Originally published on TABB Forum
As new requirements proliferate, established in-house trade reporting solutions often lack the automation and governance necessary to ensure compliance long term. But MiFID II provides an opportunity for firms to review their long-term strategy around compliance, data and risk management. And more and more market participants are seeking third-party providers’ help.
Irrespective of the final deadline (at the time of writing, a 12-month delay is expected but has not been confirmed), MiFID II is acting as a catalyst for change for trade and transaction reporting. Many of the firms we speak to are taking a step back and looking at how they can be more strategic in the way they meet the requirements. Of particular concern are the implications of creating a “quick fix” to meet the latest set of requirements that lacks the necessary governance to ensure compliance long term, a lack of automation and the impact of data standards.
As such, one of the main considerations is whether firms should continue doing the reporting in-house or opt for a partner or managed service. Our own research earlier this year indicated that 72 percent of firms had built their own regulatory reporting solution, but now the increasing cost curve is forcing them to look at other alternatives. That same research revealed that more than a quarter (26 percent) of in-house system users expect their trade reporting costs to increase by 50 percent or more over the next two years, while all vendor solution users anticipate their increase to not exceed 25 percent over the next two years.
With many of the systems currently implemented, there is no clear path to efficient tracking, reconciliation and remediation of trade data. The time is right for firms to re-evaluate the ongoing business-as-usual outlay for trade reporting and determine whether the cost for compliance will be sustainable into the future.
The governance challenge
When examining existing reporting environments in an EMIR context, it is clear that governance needs to be tightened. They are addressing three main issues: reporting, traceability, and confirmation/affirmation within the market of trade repositories to ensure that reporting is tied to the right rules and regulations. The challenge with this three-pronged approach really comes down to technology. Organizations put in-house systems in place so that they could meet the regulatory reporting deadlines as part of the first phase of the EMIR regulation.
Even though the compliance window was pretty tight, financial institutions did a good job in meeting this requirement. However, now the game has changed and focus has shifted to the quality of the reporting. The output is being analyzed more thoroughly, and many firms are finding that their systems aren’t scalable and extendable. What’s more, these environments have many manual processes instead of the automation that is needed to meet the rising governance and quality standards.
As a result, firms need to focus on ensuring their transaction reporting systems are of a sufficiently high quality, and will remain so, to avoid regulatory censure. Disjointed, siloed systems provide little visibility to regulators and participants into the transmission of data between entities, causing reporting errors, limited trade pairing and low matching rates.
The need for greater automation
A lack of automation means manual touch points that often lead to errors and omissions. The problem is exasperated by the lack of documentation or recordkeeping of manual activities, making them difficult to trace, recreate or do a root-cause analysis in the future. The post-trade environment is still highly people-dependent, with only basic recordkeeping at best. Some of the regulatory requirements under MIFID II around pre-trade and post-trade transparency present a data quality issue for firms, and in most cases might also create data-capture issues. Some firms are not even currently capturing information that might need to be reported to the regulator.
A lack of automation and a dependence on people and manual processes directly translates to high rates of data reconciliation errors, low confidence on what is being reported to the regulators and a higher risk of receiving fines for noncompliance. To avoid these issues, firms will need to keep transparency and assurance as the overarching benchmarks as they address the MIFID II challenge.
Standards are always imperative, but there are so many different committees, such as the European Central Bank (ECB), Financial Conduct Authority (FCA) or the British Banking Association (BBA). They all are trying to create standards that everybody agrees on. While there has been progress, the reality is that getting any sort of agreement in a workable timeframe for MiFID II will be impossible. There needs to be an environment that is flexible and can automate the convergence of the various standards of these different entities in order to create a common standard.
Understanding your data has always been essential for reporting, and MiFID II reinforces that. So many firms have attempted to establish internal data warehouses, essentially “skinny transaction data warehouses” to normalize the data from various sources and support trade reporting. The problem with this approach is that it is very difficult to institutionalize and very expensive to build and maintain as regulatory change continues. In fact, it is the combination of those challenges—needing to normalize data, managing the complexities of regulation and conducting ongoing maintenance to keep up-to-speed with changes in the industry—that are driving some firms to think strategically when they view MIFID II reporting.
The lack of data standardization is a key challenge for firms developing a trade reporting solution. By leveraging an approach that normalizes all data into a cross-asset class, cross-product common data model, firms can more efficiently and effectively source data from various source systems to improve transparency and provide end-to-end compliance assurance for users.
Taking the long-term view to reporting
Increasingly, firms are looking at trade reporting with three key considerations. First, they now have come to the realization that they no longer can do trade reporting in-house; it is not optimal, nor does it offer a competitive edge.
Second, they need to explore alternative options for reporting, such as mutualization of core functions. For example, with the Money Markets Securities Reporting (MMSR) in Europe, it is easier if there is a common data dictionary in place to use instead of each of the banks having to build their own system.
Third, there is trade execution. Financial institutions are increasingly looking at collaborating with their peers by forming working groups to jointly interpret the rules and come to a common understanding on the response; agree on common messaging standards for data exchange; and establish industry standards around unique trade identifiers, unique product identifiers, etc. The end objective is to collaborate, standardize and create efficiencies and, in the process, reduce the ongoing cost of compliance.
With previous regulations, driven by tight deadlines, most firms discovered it was too difficult and time consuming to build a single, enterprise-wide solution to comply with regulations. As a result, many are using disparate, often disjointed systems that fuel duplicative and contradictory processes and documentation, which lack transparency and increase risk.
While there is no doubt an operational directive to meet regulatory requirements, MiFID II provides an opportunity that firms should grasp to review their long-term strategy around compliance, data and risk management. The scope of that work means firms must determine how they will address the significant reporting challenge—be it tactical or strategic. Now is the time to take a more considered and planned approach to the regulation and also learn from the mistakes from MiFID, Dodd-Frank and EMIR projects.
Since trade and transaction reporting is becoming a significant cost burden, firms are also increasingly looking outside of their own organizations for cost-effective solutions or options that now exist to help tackle these requirements and they are evaluating them against existing in-house solutions.