By Iain Scott, Solution Lead, Treasury & Capital Markets at Finastra

Accurately calculating and mitigating risks in European financial markets has become increasingly more challenging, yet far from less important. In an environment where change is the only constant, timely, accurate and standardised reporting is critical to drive transparency and provide fiscal decision makers with an accurate picture of the marketplace.

Over the last decade, new regulations have been introduced in an attempt to harmonise reporting. For example, the European Securities and Markets Authority (ESMA) introduced the European Market Infrastructure Regulation (EMIR) in 2014, with the aim to increase transparency in the over-the-counter (OTC) derivatives and exchange-traded derivatives (ETD) markets, and reduce credit and operational risk. It created the framework and processes to communicate transaction data. However, challenges still exist. The lack of standardisation in the format, completeness and quality of data has meant the information hasn’t been delivered in a format that the regulator can properly use.

In response, ESMA has mandated the second phase of EMIR: EMIR Refit. The Refit is a regulatory rewrite enabling interoperability across jurisdictions and the standardisation of data elements common to all transaction reporting and trades. It aims to improve data quality and increase regulatory scrutiny of institutions, set to go live in April 2024 for the EU and Q3 2024 for the UK.

While this is a good move to increase transparency and mitigate risks, ensuring compliance with the new rules will be a significant undertaking and the short timeframe could place considerable pressure on banks if they don’t act now.

How will regulatory reporting change?

One major change is the number of data fields that need to be reported to trade repositories (TRs). The adoption of the new ISO 20022 messaging standard expands the number of fields and, depending on the instruments traded, there could be up to 203 reportable data elements. Firms will be required to include these new fields within their reporting workflows. The regulation updates the definition, format and usage of key OTC derivatives to be reported to TRs, which includes the Unique Transaction Identifier (UTI), the new Unique Product Identifier (UPI) and other critical data elements which will need to be sourced and included in each reporting record. Once the data is sourced, it can and should be stored for further use.

Refit requires firms to provide explanations of where the data is coming from, why they took action within the lifecycle of a trade and communicate that effectively within the current reporting deadlines. Additionally, banks will be obligated to report on collateral and valuations for financial counterparties daily. European entities who are designated financial counterparties are also now legally liable and responsible for reporting all OTC derivatives (Note 1). The format in which the data is submitted is also changing. Whereas firms can currently submit data in any form they want, under Refit they are required to comply with the ISO 20022 XML message format, mirroring the securities financing transaction regulation (SFTR).

There are major challenges with current reporting, such as firms not reporting all information, not reporting it correctly nor in a timely manner, which can impact major fiscal macroeconomic policies. For example, central banks such as the European Central Bank (ECB) or the Bundesbank look at this data to make decisions around interest rates or monetary policy decisions. It is therefore critical for this information to be accurate, or we risk adverse impacts on economies. These changes aim to improve data quality and create a harmonised approach for OTC derivatives products, enabling regulators to have greater insight into what is being reported.

For banks, preparation starts now

While the rewrite provides additional clarity, it also adds additional complexity and is hugely disruptive for the industry. Enabling the flow of such detailed information is a big ask and undertaking for banks. We don’t have all the answers yet. Important updates are expected to be published before the end of the year, such as the exact data elements required across different regulations and regimes, including for UPI. However, banks need to start engaging with ESMA, the Financial Conduct Authority (FCA) and the Bank of England (BOE) while implementing the building blocks for compliance, now.

Legacy systems are still creating major challenges for many banks, and regulatory updates such as this emphasise just how much they hinder agility. Inefficiencies and the inability to adapt quickly are caused by fragmented, manual, internal processes, such as for managing reporting and compliance. This becomes even more difficult as regulations continue to evolve and become increasingly more complex. For example, many outdated systems do not support the ISO 20022 message format. Major upgrades may be required which can be time consuming, disruptive and expensive.

Fintech partnerships and ecosystems are more crucial than ever. Migrating to the cloud and adopting evergreen SaaS solutions enable banks to seamlessly and quickly complete ongoing upgrades, including adapting to new or updated regulations, while lowering their total cost of ownership (TCO) and improving productivity through automation. They can automate arduous processes such as transaction reporting and compliance with other regulations such as MiFID II.

Through an open ecosystem, banks can seamlessly implement specialist services at speed. For example, maintaining individual regulatory datasets can be a big task for banks, and the wider their trading portfolio, the more risks this brings. Through connectivity to systems and third parties, banks can implement apps that provide unified datasets with all reporting regulations and elements included.

EMIR Refit is a significant undertaking, and the 2024 deadline is extremely tight. Banks need to act now or risk facing penalties and reputational damage for non-compliance. The Refit is all about harmonisation, standardisation of approaches and interoperability. Regulators are telling the industry that they are going to do it better this time around, scrutinising data much more closely and issuing fines for breaches. If navigated correctly, this level of transparency and insight will have huge benefits for the industry and, as other regions take note and potentially follow suit, economies worldwide.

Note 1: The definition of ‘financial counterparty’ has been hotly debated and, without going into pages of details, we refer you to the EMIR Regulations… Let the debate begin!