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IPE Views: The looming European Market Infrastructure Regulation

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  • The European Commission

Much about EMIR is still uncertain, even at this late stage of the game, warns Cordium

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 (ETDs). The industry had been expecting the regulator to stay its hand, following ESMA’s 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 for implementation of the onerous new reporting rules, which form a part of the EU’s incoming European Market Infrastructure Regulation (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 (CCP). Where central clearing of OTC contracts is not possible, strengthened risk requirements will seek to manage operational and counterparty credit risk.

It is understandable firms are concerned about the timeline for implementation, as the new requirements imply a profound shift in how they go about meeting their regulatory obligations. In particular, reporting and risk management under EMIR will force them 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 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 ETDs, 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 on the market in tandem, firms will face real difficulties in prioritising objectives and finding sufficient resources to meet all of their deadlines. The fact 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. Regulation – whether the Alternative Investment Fund Managers Directive or EMIR – 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 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.

Jonathan Mott is a managing consultant and Tom Lucey a monitoring consultant at Cordium

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