Is your glass half-full or half-empty?
31 December 2014
New regulations are coming thick and fast, but there is room to manoeuvre. Jeremy Taylor of Rule Financial reports
Image: Shutterstock
Firms could be forgiven for admitting a sense of ‘regulatory fatigue’ as they approach the end of 2014. This would be understandable, as regulatory demands continue to increase rapidly as a consequence of the now ‘distant’ financial crisis of 2008.
The reality is that we are now living in a new era of enhanced scrutiny and regulation. Some may view it as a temporary state, while others will see it simply as a cyclical phenomenon, and one that the global financial sector has experienced before, with cycles of regulation and liberalisation taking place ever since the Great Depression of the 1930s.
Firms might complain about the burden of compliance, but there is a general recognition that there was, and there remains, a need for change. Rebuilding trust and confidence in the financial industry is a fundamental principle going forward.
The US Dodd-Frank Act, European Market Infrastructure Regulation (EMIR), Markets in Financial Instruments Directive (MiFID) II and BCBS239 are just some of the most significant regulations that were designed and enacted to help restore this confidence. The challenge for many firms has been in dealing with the pace and relentless nature of regulatory change.
More resources and budgets are being allocated to support compliance. The implementation of more complex restructuring programmes to help comply with the new legislation continues to increase, adding to the growing pressure of the simpler forms of previous regulatory compliance. This will only continue in 2015 and beyond.
Firms may feel that their resources are being pulled in many different directions as they attempt to withstand this regulatory avalanche, however, some have come to realise that some regulation does present them with opportunities. The challenge in 2015 is whether firms have the vision, expertise and capability to take advantage of the opportunities on offer.
This year saw the EMIR trade reporting mandate come into effect, on 12 February.
The drive to reduce risk and improve transparency within the over-the-counter (OTC) derivatives market has continued to prove a challenge for market participants and the regulator. Achieving EMIR’s reporting requirements for collateral reporting, delegated reporting, clearing and product standardisation has produced mixed results.
It suggests that further clarification on reporting standards is needed, while some firms may appear to be experiencing a lack of confidence in their reporting.
Both buy-side and sell-side firms have experienced varying degrees of difficulties in terms of compliance. Most large sell-side firms invested a lot of time and resources, as well as millions of dollars, to ensure that they had in place robust reporting mechanisms before the deadline passed. Unfortunately, the same could not be said of the buy side, which has struggled to catch up.
Buy-side firms have suffered from a lack of reporting experience in comparison to their sell-side counterparts. This lack of experience has proved particularly challenging as EMIR has increased the level of reporting obligations for buy-side firms in covering OTC derivatives and exchange-traded derivatives.
Criticism was levelled at the regulator, the European Íø±¬³Ô¹Ï and Markets Authority (ESMA), which was accused of not providing enough guidance to firms before the mandate was implemented. The view remains that a number of important questions were left unanswered before the deadline passed.
ESMA denied many of these claims, and argued that it has provided sufficient guidance, especially on how to implement standards for reporting to trade repositories. ESMA’s stance has been one whereby firms should look to apply the existing guidance that is already in place.
However, the view persists that there has been a lack of guidance and no clear consensus on reporting requirements around trade representation, on how unique trade identifiers should work, the standards required for legal entity identifiers, or clarity on collateral reporting.
This will need to be urgently addressed if firms are to have confidence in the system and in their efforts to comply with trade reporting requirements. ESMA is currently conducting a further consultation, focusing on reporting standards. This should be completed in February 2015 and will hopefully lead to better clarification and standardisation around reporting. If this does not happen, it may be left to individual firms to take up the regulatory initiative themselves and make best efforts to solve individual issues.
A further consequence of EMIR is that the regulation has come with a high financial cost. The price of doing business in OTC derivative trading has increased and this raises some difficult questions firms. Cleared and non-cleared OTC derivative transactions have become more expensive. In this changed environment, how do businesses continue to make a profit?
We are likely to see readjustments within the OTC market over the next few years. The cost for non-centrally cleared transactions is substantially higher than centrally cleared OTC derivatives. As such, there will be winners and losers between those firms that can afford to invest in new systems and processes, thereby remaining profitable in this market, and those that cannot. Others may decide to look for cheaper and more standardised alternatives to non-cleared products, or withdraw completely from those markets in which they can no longer make a sensible profit.
The increased cost of doing business will mean that firms will be forced to undertake major reviews of their product lines and restructure their offerings as required.
Continuing the theme of derivative trading reform, MiFId II and the Markets in Financial Instruments Directive (MiFIR) have also continued to generate sizeable discussion and consultation in 2014.
Although the objective of greater transparency and fairer competition in capital markets is a welcome move, MiFID II faces a number of challenges from EU member states protecting their own interests.
The European Parliament’s adoption of MiFID II and MiFIR in April 2014 was a significant landmark. On 22 May 2014, ESMA published its discussion and consultation papers on proposals for regulatory technical standards and implementing technical standards that should be adopted.
MiFiD II contains more than 100 requirements for ESMA to draft these standards. ESMA also has to provide technical advice to the European Commission that will allow it to adopt these delegated acts.
The consultation and final report was a significant undertaking for ESMA. With this in mind, we are still playing a waiting game in terms of reaching the finalised standards. The consultation period ended on 1 August and its findings will be provided in the form of technical advice to the European Commission by the end of 2014.
The first quarter of 2015 should see ESMA’s publication of the technical standards report. It is anticipated that the final technical standards will be delivered to the European Commission by July 2015. The objective for firms in 2015 should be to remain up-to-date and engage with the policy-making process. Secondly, firms should not hold back in continuing to develop their strategies and implementation plans for MiFID II ahead of the 2017 deadline.
A review of regulation in 2014 would not be complete without discussing the impact of BCBS239. The fallout from the 2008 financial crisis uncovered shocking levels of institutional risk management. This included the widespread absence of consolidated views of risk across organisations and the inability of firms to produce the required aggregation and reports quickly enough.
The 14 principles mandated by BCBS239 broadly cover governance and structure, risk data aggregation capabilities, risk reporting practices, and supervision. Firms seeking to comply with BCBS239 need to enforce common risk data standards and policies supported by strong governance structures.
The ongoing criticism of BCBS239 is that it is not prescriptive in its requirements. The onus has been left with the firms to decide whether to implement the minimum requirements for compliance, or to go further by undertaking significant and long-lasting changes in the operational management of risk data aggregation.
Many firms are at different stages on the road to compliance. Next year will prove to be an intense and pressurised year for those who know they will struggle to meet the January 2016 deadline.
Following hard on the heels of BCBS239, we also have BCBS261. This relates to non-centrally cleared derivatives and will see many firms having to divert investment and resources to build new front-to-back processes and settlement mechanisms for initial margin on uncleared derivatives. Firms that embrace the principles fully will be able to enjoy a considerable advantage over competitors that aspire to simply comply.
This era of financial regulation may feel like an endless onslaught for some, but the difference between success and failure in this new environment will depend largely on the attitudes and strategies adopted by individual firms. Some may view the onslaught of regulation as a bad thing, while others see it as redefining the market and presenting new opportunities for growth.
It is understandable that many firms may feel like guinea pigs in a series of ongoing tests. However, rather than view regulation as a form of punishment for the sins committed in the past, regulation should be embraced and accepted as the ‘new normal’. In doing so, new opportunities will ultimately begin to present themselves.
In 2015, those firms that embrace the new reality will be those that are open minded, flexible and agile about the future. Firms should seek to collaborate more with colleagues, both internally and externally, to find workable solutions. A new way of thinking and operating may be required for some, but it is important to remember that not every firm will do this effectively. For those that do, the coming year presents a number of opportunities.
The reality is that we are now living in a new era of enhanced scrutiny and regulation. Some may view it as a temporary state, while others will see it simply as a cyclical phenomenon, and one that the global financial sector has experienced before, with cycles of regulation and liberalisation taking place ever since the Great Depression of the 1930s.
Firms might complain about the burden of compliance, but there is a general recognition that there was, and there remains, a need for change. Rebuilding trust and confidence in the financial industry is a fundamental principle going forward.
The US Dodd-Frank Act, European Market Infrastructure Regulation (EMIR), Markets in Financial Instruments Directive (MiFID) II and BCBS239 are just some of the most significant regulations that were designed and enacted to help restore this confidence. The challenge for many firms has been in dealing with the pace and relentless nature of regulatory change.
More resources and budgets are being allocated to support compliance. The implementation of more complex restructuring programmes to help comply with the new legislation continues to increase, adding to the growing pressure of the simpler forms of previous regulatory compliance. This will only continue in 2015 and beyond.
Firms may feel that their resources are being pulled in many different directions as they attempt to withstand this regulatory avalanche, however, some have come to realise that some regulation does present them with opportunities. The challenge in 2015 is whether firms have the vision, expertise and capability to take advantage of the opportunities on offer.
This year saw the EMIR trade reporting mandate come into effect, on 12 February.
The drive to reduce risk and improve transparency within the over-the-counter (OTC) derivatives market has continued to prove a challenge for market participants and the regulator. Achieving EMIR’s reporting requirements for collateral reporting, delegated reporting, clearing and product standardisation has produced mixed results.
It suggests that further clarification on reporting standards is needed, while some firms may appear to be experiencing a lack of confidence in their reporting.
Both buy-side and sell-side firms have experienced varying degrees of difficulties in terms of compliance. Most large sell-side firms invested a lot of time and resources, as well as millions of dollars, to ensure that they had in place robust reporting mechanisms before the deadline passed. Unfortunately, the same could not be said of the buy side, which has struggled to catch up.
Buy-side firms have suffered from a lack of reporting experience in comparison to their sell-side counterparts. This lack of experience has proved particularly challenging as EMIR has increased the level of reporting obligations for buy-side firms in covering OTC derivatives and exchange-traded derivatives.
Criticism was levelled at the regulator, the European Íø±¬³Ô¹Ï and Markets Authority (ESMA), which was accused of not providing enough guidance to firms before the mandate was implemented. The view remains that a number of important questions were left unanswered before the deadline passed.
ESMA denied many of these claims, and argued that it has provided sufficient guidance, especially on how to implement standards for reporting to trade repositories. ESMA’s stance has been one whereby firms should look to apply the existing guidance that is already in place.
However, the view persists that there has been a lack of guidance and no clear consensus on reporting requirements around trade representation, on how unique trade identifiers should work, the standards required for legal entity identifiers, or clarity on collateral reporting.
This will need to be urgently addressed if firms are to have confidence in the system and in their efforts to comply with trade reporting requirements. ESMA is currently conducting a further consultation, focusing on reporting standards. This should be completed in February 2015 and will hopefully lead to better clarification and standardisation around reporting. If this does not happen, it may be left to individual firms to take up the regulatory initiative themselves and make best efforts to solve individual issues.
A further consequence of EMIR is that the regulation has come with a high financial cost. The price of doing business in OTC derivative trading has increased and this raises some difficult questions firms. Cleared and non-cleared OTC derivative transactions have become more expensive. In this changed environment, how do businesses continue to make a profit?
We are likely to see readjustments within the OTC market over the next few years. The cost for non-centrally cleared transactions is substantially higher than centrally cleared OTC derivatives. As such, there will be winners and losers between those firms that can afford to invest in new systems and processes, thereby remaining profitable in this market, and those that cannot. Others may decide to look for cheaper and more standardised alternatives to non-cleared products, or withdraw completely from those markets in which they can no longer make a sensible profit.
The increased cost of doing business will mean that firms will be forced to undertake major reviews of their product lines and restructure their offerings as required.
Continuing the theme of derivative trading reform, MiFId II and the Markets in Financial Instruments Directive (MiFIR) have also continued to generate sizeable discussion and consultation in 2014.
Although the objective of greater transparency and fairer competition in capital markets is a welcome move, MiFID II faces a number of challenges from EU member states protecting their own interests.
The European Parliament’s adoption of MiFID II and MiFIR in April 2014 was a significant landmark. On 22 May 2014, ESMA published its discussion and consultation papers on proposals for regulatory technical standards and implementing technical standards that should be adopted.
MiFiD II contains more than 100 requirements for ESMA to draft these standards. ESMA also has to provide technical advice to the European Commission that will allow it to adopt these delegated acts.
The consultation and final report was a significant undertaking for ESMA. With this in mind, we are still playing a waiting game in terms of reaching the finalised standards. The consultation period ended on 1 August and its findings will be provided in the form of technical advice to the European Commission by the end of 2014.
The first quarter of 2015 should see ESMA’s publication of the technical standards report. It is anticipated that the final technical standards will be delivered to the European Commission by July 2015. The objective for firms in 2015 should be to remain up-to-date and engage with the policy-making process. Secondly, firms should not hold back in continuing to develop their strategies and implementation plans for MiFID II ahead of the 2017 deadline.
A review of regulation in 2014 would not be complete without discussing the impact of BCBS239. The fallout from the 2008 financial crisis uncovered shocking levels of institutional risk management. This included the widespread absence of consolidated views of risk across organisations and the inability of firms to produce the required aggregation and reports quickly enough.
The 14 principles mandated by BCBS239 broadly cover governance and structure, risk data aggregation capabilities, risk reporting practices, and supervision. Firms seeking to comply with BCBS239 need to enforce common risk data standards and policies supported by strong governance structures.
The ongoing criticism of BCBS239 is that it is not prescriptive in its requirements. The onus has been left with the firms to decide whether to implement the minimum requirements for compliance, or to go further by undertaking significant and long-lasting changes in the operational management of risk data aggregation.
Many firms are at different stages on the road to compliance. Next year will prove to be an intense and pressurised year for those who know they will struggle to meet the January 2016 deadline.
Following hard on the heels of BCBS239, we also have BCBS261. This relates to non-centrally cleared derivatives and will see many firms having to divert investment and resources to build new front-to-back processes and settlement mechanisms for initial margin on uncleared derivatives. Firms that embrace the principles fully will be able to enjoy a considerable advantage over competitors that aspire to simply comply.
This era of financial regulation may feel like an endless onslaught for some, but the difference between success and failure in this new environment will depend largely on the attitudes and strategies adopted by individual firms. Some may view the onslaught of regulation as a bad thing, while others see it as redefining the market and presenting new opportunities for growth.
It is understandable that many firms may feel like guinea pigs in a series of ongoing tests. However, rather than view regulation as a form of punishment for the sins committed in the past, regulation should be embraced and accepted as the ‘new normal’. In doing so, new opportunities will ultimately begin to present themselves.
In 2015, those firms that embrace the new reality will be those that are open minded, flexible and agile about the future. Firms should seek to collaborate more with colleagues, both internally and externally, to find workable solutions. A new way of thinking and operating may be required for some, but it is important to remember that not every firm will do this effectively. For those that do, the coming year presents a number of opportunities.
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