Jonathan Mott, managing consultant, and Tom Lucey, monitoring consultant, at Cordium, the regulatory consultancy, look at some of the latest developments in the European Union arena and how this affects those charged with complying with new rules.

Jonathan Mott, managing consultant,
and Tom Lucey, monitoring consultant, at Cordium, the regulatory consultancy,
look at some of the latest developments in the European Union arena and how
this affects those charged with complying with new rules. While technical
issues surrounding derivatives dealing typically do not directly concern wealth
managers, the issues presented here are put up for readers' information. Comments, as ever, are
welcome. To view more articles on compliance issues, readers can also register for our new sister publication, Compliance Matters. 

Late
last month we learned that February 2014, after all, will be the likely start
date for Europe’s new reporting regime for
exchange-traded derivatives. The industry had been expecting the Regulator to
stay its hand, following ESMA’s [European Securities and Markets Authority] proposal
of a one-year extension to resolve a number of practical issues. Now, much to
its horror, the industry has just a few short months to prepare to implement
onerous new reporting rules, which form a part of the EU’s incoming European
Market Infrastructure Regulation, or EMIR.

To
recap, the regulation is designed to reduce instability within Europe’s derivatives market (perceived to have been a
contributory factor to the 2008 banking crisis) by bringing over-the-counter
derivatives trades into the light and under regulatory purview. It aims to
replace a tangled web of derivatives exposures with a system in which each
market participant is exposed only to the credit risk of a central
counterparty. Where central clearing of OTC contracts is not possible,
strengthened risk requirements will seek to manage operational and counterparty
credit risk.

It
is understandable that firms are concerned about the timeline for
implementation, as the new requirements imply a profound shift in how firms go
about meeting their regulatory obligations.

In
particular, reporting and risk management under EMIR will force firms to place
greater reliance on their back offices to collect an expanding array of
data.  This, together with the
increasingly technical nature of regulatory compliance, means that compliance
personnel may have to develop a better understanding of back office operations.
When preparing for EMIR, compliance and operations may have to work alongside
one another much more closely than they have done in the past.

Much
is still uncertain, even at this late stage. When it comes to exchange traded
derivatives, there are question marks over which parties to a trade should bear
the reporting burden. And with reporting in general, there are issues yet to be
resolved around information sharing and confidentiality.

Aside
from uncertainty over the rules, there is also a cultural challenge to be
negotiated, in that there has traditionally been a “language barrier” of sorts
between compliance and operations. This must be overcome if the two are to work
together in a far more integrated, day-to-day fashion.

All
in all, it is unclear whether the industry will be ready to comply with the new
reporting rules come the New Year, deadline or no.

EMIR
isn’t just causing a convergence of compliance and operations; legal will be
thrown into the mix as well. Segregation and reporting procedures under central
clearing will necessitate contractual agreements between counterparties,
brokers and clearing houses. It could take months to get these agreements
signed and in place, but without a single CCP authorised as yet, it will be
difficult for firms to get this process started.

All of this would be challenging enough in isolation, but
EMIR is just one part of a deluge of reform facing the industry. With so many
new regulations bearing down upon the market in tandem, firms will face real
difficulties in prioritising objectives and finding sufficient resources to
meet all of their deadlines. The fact that Europe
has yet to provide clarity, for example, on how to comply in practice with the
reporting of ETDs, doesn’t make things easier.

This
convergence of operations and compliance is not just about EMIR. It is part of
a wider regulatory trend that can be observed across all of these reforms.
Whether it is the Alternative Investment Fund Managers Directive or EMIR,
regulation is headed in the direction of greater transparency and oversight.
Keeping tabs on financial markets means reporting, and reporting means data.

Compliance
personnel and regulators alike will therefore need greater operational
knowledge if they are to make sense of their data reporting requirements,
blurring the conventional lines between the two functions.

This
trend will not have an equal impact on all firms. It is difficult to predict,
but larger businesses (such as banks) with more formalised internal structures
and sophisticated IT systems may be best placed to adapt to these new
requirements. The challenge could be far more acute for smaller firms within
the alternative space. And whereas investment banks will potentially see an
upside to all this in the form of new profit opportunities, it is unlikely that
the same could be said of smaller asset managers and other affected market
participants.

As
some key deadlines are fast approaching, it is important for all affected
firms, large or small, to get on with their preparations. Consulting with
compliance experts – in order to figure out precisely what the regulator needs
– is often a good first step.

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