Delta Capita commentary on SFTR challenges for go-live
03 July 2020
Julian Eyre, of Delta Capita, examines how the sell side should best approach SFTR and avoid falling foul of regulators by learning the lessons from previous rules frameworks
Image: chanut iamnoy/shutterstock.com
All banks have been proactive and fully engaged in their Íø±¬³Ô¹Ï Financing Transaction Regulation (SFTR) transaction reporting compliance programmes. It is fully recognised that the reporting obligations for the securities finance sector have created challenges in sourcing data (such as master agreement versions and dates) and aligning non-standard business process across many market participants.
The International Íø±¬³Ô¹Ï Lending Association (ISLA) and the International Captial Market Association’s (ICMA) European Repo and Collateral Council have made significant contributions to aligning data and process through the publication of their industry best practice models. However, it is unclear how many banks have a consistent interpretation of these best practices and have been able to implement them in the time window available.
The regulatory obligation requires accuracy, timeliness and completeness in SFTR transaction reporting. The additional three-months extension effectively provided by the European Íø±¬³Ô¹Ï and Markets Authority (ESMA) to finalise reporting may now reasonably require all SFTR reporting to fully meet the criteria. It is likely ESMA and the national competent authorities (NCAs) will have little sympathy for any incorrect SFTR reporting – the UK’s Financial Conduct Authority (FCA) has a clear record of fines for enforcement of transaction reporting obligations under the European Market Infrastructure Regulation (EMIR) and the Markets in Financial Instruments Regulation (MiFIR).
Delta Capita believes that banks have a short window of opportunity to validate and affirm their compliance and regulatory reporting capabilities before falling under the lens of the regulator.
NCA fines risk
To date, the FCA has fined 13 or so firms for MiFID transaction reporting breaches.
Mark Steward, FCA executive director of enforcement and market oversight, said:
“Firms must have proper systems and controls to identify what transactions they have carried out, on what markets, at what price, in what quantity and with whom. If firms cannot report their transactions accurately, fundamental risks arise, including the risk that market abuse may be hidden.
“Effective market oversight relies on the complete, accurate and timely reporting of transactions. This information helps the FCA to effectively supervise firms and markets. In particular, transaction reports help the FCA identify potential instances of market abuse and combat financial crime.
“The problems identified include banks failing to ensure they provided complete and accurate information in relation to reportable transactions. It also erroneously reporting transactions to the FCA, which were not, in fact, reportable.
“The FCA also found that there were failures to take reasonable care to organise and control its affairs responsibly and effectively in respect of its transaction reporting. These failings may relate to aspects of change management processes, its maintenance of the reference data used in its reporting and how it tested whether all the transactions it reported to the FCA were accurate and complete.Â
“The FCA has identified failures over an extended period to manage and test controls that are vitally important to the integrity of the markets. These were deemed serious and prolonged failures. With the FCA stating “we expect all firms will take this opportunity to ensure they can fully detail their activity and are regularly checking their systems, so any problems are detected and remedied promptly.â€
Clearly the importance and value of accurate and complete transaction reporting data are recognised by the NCAs and action will be taken to incentivise high-quality reporting.
Lessons learned from existing transaction reporting regulations
Prior to EMIR go-live there was limited industry alignment, incomplete best practice definition and non-standard data all creating challenges to regulatory interpretation and effective transaction reporting.
The most recent ESMA supervision annual report 2019 reflects EMIR trade state report pairing and matching at 59 percent and 29 percent respectively.
Post-go-live the poor pairing and matching performance has required ongoing remediation and management. Root Cause Analysis activity was required to understand the trade repositoires (TR) exceptions, identifying the responsible party to repair the fail which all contributes to a high cost of on-going compliance, poor key performance indicators and sub-par tracking and audit reports.
Many banks have relied on offshore low-cost resources to perform these tasks, further increasing operational costs and delivering a tactical solution to transaction reporting compliance. While trade confirmation matching services catch most of the economic trade breaks there remain high risks of material exceptions passing through to the trade repository. Prioritising these exceptions requires improved business and data knowledge. Further increasing the longer-term costs of compliance.
By promoting ISO standards for SFTR reporting ESMA has addressed some of the transaction reporting data format challenges experienced under EMIR but the rules may still lead to some interpretation inconsistency. To submit the trade reports to the TR message validation needs to pass. It is likely there will be a high volume of trades that fail validation and do not proceed to the trade pairing process. Understanding the acknowledged/negative acknowledgement (ACK/NAK) error message is an art in its own right.
While the securities finance industry has a good contract compare process for key economic terms there are many data items that open to error. For example, legal entity identifiers/International Íø±¬³Ô¹Ï Identification Number (LEI/ISIN) references are frequently stored in a bank database but are not reconciled to Global Legal Entity Identifier Foundation/Association of National Numbering Agencies (GLEIF/ANNA). There are examples where LEIs are incorrectly mapped to counterparty legal entities. Collateral identifiers are missing as the collateral is out of the scope of the registry. UTIs can be misreported where two counterparties are reporting to different TRs.
Industry best practice seeks to align and normalise processes but there remain variations in business processes across banks such as the booking models for partials. Huge strides have been made in alignment across the sector, but further strategic transformation is needed to harmonise further across the industry.
Call to action
The proliferation of regulations has led some banks to adopt a historical strategy of ‘cheapest to comply’ which may provide tactical cost benefits but client experience may be compromised and a more strategic approach to high quality, industrialised ongoing transaction reporting will help reduce reputational risk and regulatory fine risk. In addition, the lower cost compliance approach may contribute to future technical debt as the platform may not scale or provide the flexibility to support future regs or changes.
Based upon the experience of previous transaction reporting regulations some banks have identified a need to perform a compliance validation and due diligence review. This has the goal of validating and benchmarking the compliance implementation against best practice and identify any compliance gaps, risks or issues. The health check approach will provide a review of the compliance architecture and identify any priority remediation steps needed to de-risk future reporting.
Delta Capita has captured and modelled the SFTR EU law, the regulatory technical standards and technical standards, ISLA and ICMA best practice in modus our award-winning RegTech 2020 Best Regulatory Reporting Solution. This approach provides the benefit of a packaged, modelled alignment with industry best practice that supports regulatory traceability at the clause level for both data and business processes.
The result is that banks gain increased confidence in the report population and consistency of trade reporting – a standardised approach for the industry.
Delta Capita recommendations
As a trusted partner for SFTR to 11 global sell-side banks including prime services and agent lending, Delta Capita has a wealth of experience and expertise to leverage the Modus tooling to deliver services of either a high level or deep-dive review of the SFTR implementation – to benchmark and analyse against industry best practice. This approach will help reduce the risk of regulatory fines, decrease work effort and resources needed to perform continuous compliance and to manage the exceptions.
The International Íø±¬³Ô¹Ï Lending Association (ISLA) and the International Captial Market Association’s (ICMA) European Repo and Collateral Council have made significant contributions to aligning data and process through the publication of their industry best practice models. However, it is unclear how many banks have a consistent interpretation of these best practices and have been able to implement them in the time window available.
The regulatory obligation requires accuracy, timeliness and completeness in SFTR transaction reporting. The additional three-months extension effectively provided by the European Íø±¬³Ô¹Ï and Markets Authority (ESMA) to finalise reporting may now reasonably require all SFTR reporting to fully meet the criteria. It is likely ESMA and the national competent authorities (NCAs) will have little sympathy for any incorrect SFTR reporting – the UK’s Financial Conduct Authority (FCA) has a clear record of fines for enforcement of transaction reporting obligations under the European Market Infrastructure Regulation (EMIR) and the Markets in Financial Instruments Regulation (MiFIR).
Delta Capita believes that banks have a short window of opportunity to validate and affirm their compliance and regulatory reporting capabilities before falling under the lens of the regulator.
NCA fines risk
To date, the FCA has fined 13 or so firms for MiFID transaction reporting breaches.
Mark Steward, FCA executive director of enforcement and market oversight, said:
“Firms must have proper systems and controls to identify what transactions they have carried out, on what markets, at what price, in what quantity and with whom. If firms cannot report their transactions accurately, fundamental risks arise, including the risk that market abuse may be hidden.
“Effective market oversight relies on the complete, accurate and timely reporting of transactions. This information helps the FCA to effectively supervise firms and markets. In particular, transaction reports help the FCA identify potential instances of market abuse and combat financial crime.
“The problems identified include banks failing to ensure they provided complete and accurate information in relation to reportable transactions. It also erroneously reporting transactions to the FCA, which were not, in fact, reportable.
“The FCA also found that there were failures to take reasonable care to organise and control its affairs responsibly and effectively in respect of its transaction reporting. These failings may relate to aspects of change management processes, its maintenance of the reference data used in its reporting and how it tested whether all the transactions it reported to the FCA were accurate and complete.Â
“The FCA has identified failures over an extended period to manage and test controls that are vitally important to the integrity of the markets. These were deemed serious and prolonged failures. With the FCA stating “we expect all firms will take this opportunity to ensure they can fully detail their activity and are regularly checking their systems, so any problems are detected and remedied promptly.â€
Clearly the importance and value of accurate and complete transaction reporting data are recognised by the NCAs and action will be taken to incentivise high-quality reporting.
Lessons learned from existing transaction reporting regulations
Prior to EMIR go-live there was limited industry alignment, incomplete best practice definition and non-standard data all creating challenges to regulatory interpretation and effective transaction reporting.
The most recent ESMA supervision annual report 2019 reflects EMIR trade state report pairing and matching at 59 percent and 29 percent respectively.
Post-go-live the poor pairing and matching performance has required ongoing remediation and management. Root Cause Analysis activity was required to understand the trade repositoires (TR) exceptions, identifying the responsible party to repair the fail which all contributes to a high cost of on-going compliance, poor key performance indicators and sub-par tracking and audit reports.
Many banks have relied on offshore low-cost resources to perform these tasks, further increasing operational costs and delivering a tactical solution to transaction reporting compliance. While trade confirmation matching services catch most of the economic trade breaks there remain high risks of material exceptions passing through to the trade repository. Prioritising these exceptions requires improved business and data knowledge. Further increasing the longer-term costs of compliance.
By promoting ISO standards for SFTR reporting ESMA has addressed some of the transaction reporting data format challenges experienced under EMIR but the rules may still lead to some interpretation inconsistency. To submit the trade reports to the TR message validation needs to pass. It is likely there will be a high volume of trades that fail validation and do not proceed to the trade pairing process. Understanding the acknowledged/negative acknowledgement (ACK/NAK) error message is an art in its own right.
While the securities finance industry has a good contract compare process for key economic terms there are many data items that open to error. For example, legal entity identifiers/International Íø±¬³Ô¹Ï Identification Number (LEI/ISIN) references are frequently stored in a bank database but are not reconciled to Global Legal Entity Identifier Foundation/Association of National Numbering Agencies (GLEIF/ANNA). There are examples where LEIs are incorrectly mapped to counterparty legal entities. Collateral identifiers are missing as the collateral is out of the scope of the registry. UTIs can be misreported where two counterparties are reporting to different TRs.
Industry best practice seeks to align and normalise processes but there remain variations in business processes across banks such as the booking models for partials. Huge strides have been made in alignment across the sector, but further strategic transformation is needed to harmonise further across the industry.
Call to action
The proliferation of regulations has led some banks to adopt a historical strategy of ‘cheapest to comply’ which may provide tactical cost benefits but client experience may be compromised and a more strategic approach to high quality, industrialised ongoing transaction reporting will help reduce reputational risk and regulatory fine risk. In addition, the lower cost compliance approach may contribute to future technical debt as the platform may not scale or provide the flexibility to support future regs or changes.
Based upon the experience of previous transaction reporting regulations some banks have identified a need to perform a compliance validation and due diligence review. This has the goal of validating and benchmarking the compliance implementation against best practice and identify any compliance gaps, risks or issues. The health check approach will provide a review of the compliance architecture and identify any priority remediation steps needed to de-risk future reporting.
Delta Capita has captured and modelled the SFTR EU law, the regulatory technical standards and technical standards, ISLA and ICMA best practice in modus our award-winning RegTech 2020 Best Regulatory Reporting Solution. This approach provides the benefit of a packaged, modelled alignment with industry best practice that supports regulatory traceability at the clause level for both data and business processes.
The result is that banks gain increased confidence in the report population and consistency of trade reporting – a standardised approach for the industry.
Delta Capita recommendations
As a trusted partner for SFTR to 11 global sell-side banks including prime services and agent lending, Delta Capita has a wealth of experience and expertise to leverage the Modus tooling to deliver services of either a high level or deep-dive review of the SFTR implementation – to benchmark and analyse against industry best practice. This approach will help reduce the risk of regulatory fines, decrease work effort and resources needed to perform continuous compliance and to manage the exceptions.
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