Reporting and Governance

Changes that are part of the review of the European Market Infrastructure Regulation have the potential to cause a number of unintended consequences, particularly for Trade Repositories. By Ian Thomas, Regulatory Specialist at Quorsus

Since the European Market Infrastructure Regulation (EMIR) was drawn up in 2012 to regulate over-the-counter (OTC) derivatives, central counterparties and trade repositories, it has gone through a number of refinements which are collectively known as EMIR REFIT (regulatory fitness and performance) programme. The most recent of which, due to take effect from June 18, relates to mandatory delegated reporting and has been designed to reduce the burden on non-financial counterparties who are not subject to the clearing obligation (also known as NFC- in EMIR client classification terms).  

While this change is just one component of the comprehensive regulation and has been modified in good faith towards NFC-s, it also has the potential to create several unintended consequences, most notably for reporting parties and Trade Repositories (TRs). Some of the most significant impacts include: 

Porting of trades: Under the upcoming REFIT, a financial counterparty (FC) becomes legally responsible for reporting on behalf of an NFC-. The European Securities and Markets Authority’s (ESMA) belatedly released Q&As make it clear that existing trades must be ported (transferred) to the FC’s TR (unless of course the FC decides to become a client of the NFC-’s TR, which is extremely unlikely). The NFC- must indicate to its FC what it intends to do (it may choose to opt out and retain some or all of its reporting obligations). These bi-lateral agreements must be in place by the June 18.

Risk of over or under reporting: There is a real risk of duplicated reporting, should an FC undertake its new obligations and the NFC- continues to report. This is especially likely to occur where the preparatory actions have not been completed e.g. the NFC- has not switched off its legacy obligations and continues to report. But the bigger danger here is the risk of under reporting. If a FC and NFC fail to agree on a way forward before the June 18, reporting could slip through the cracks entirely, leaving the FC to be legally liable

Data attributes: FCs can only successfully report if they are provided with certain data attributes by the NFC- that the FC “cannot be reasonably expected to possess”.  There are 10 such fields mentioned in the recent ESMA Q&As, which require validation by either party. Any legislation containing such wording presupposes an element of ambiguity that can lead to confusion. The NFC- and FC need to ensure this data is shared ahead of mandatory delegated reporting commencing on the 18th of June.

Future classification changes: Going forward, there is a grey area when a party moves between NFC+ and NFC- status. ESMA have now advised that the NFC- should advise the FC of a change in state in advance of a classification recalculation. There is a real risk of an FC not being made aware of a change to its legal reporting obligations in a timely fashion. Following any such classification change, if the NFC decides to take the reporting back in-house, or the FC is not willing to continue offering the delegated reporting when it is no longer mandatory, then the coordination challenges mentioned previously will arise. Worst case scenario is that the NFC’s trades might need to be ported back from the FC’s TR to the NFC-’s TR and exacerbate the potential issues around the trade history.

LEI (legal entity identifier) management: Where an NFC- has not opted out and fails to update its LEI, submissions by the FC will be rejected by its TR. There is an onus on both parties to liaise in a timely manner to avoid such issues.

An even more immediate concern are the practical requirements that need to take place before the June 18, especially considering current world events. Several trade associations have even published a joint letter asking for ESMA for more flexibility with the rules, at least up to November 21, 2020, stating that "the Covid-19 crisis is creating impediments to the ability of market participants to comply with the EMIR Refit requirement for FCs to be responsible and legally liable for reporting (as of June 18, 2020) on behalf of non-financial counterparties that are not subject to the clearing obligation (NFCs-) with which they trade, These issues arise if:

  • those NFC- clients are unable to provide the data needed by the FCs in order to report and/or
  • FCs have been unable to make the required preparations to support taking on this additional reporting obligation."

Whether or not ESMA and National Competent Authorities (NCAs) go full steam ahead on June 18, for smooth transition, firms need to be ready sooner rather than later. Paperwork between FC, NFC and the TR(s) all has to be in place and any details relating to the OTC derivative contracts that the financial counterparty cannot be reasonably expected to possess must be made available.

Finally, it is critical that the FC ensures that all existing trades that it is obliged to report post June 18 are paired in advance, to avoid data integrity issues going forward.

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