Early Testing Will Be Key to Derivatives Reporting Compliance

DTCC’s Chris Childs and Priya Kundamal say there is no replacement for early testing to ensure data and reporting systems are fit for purpose.

As regulators seek to sharpen their toolkits for detecting risks lurking in the USD 20 trillion OTC derivatives market, swap dealers and corporates are bracing themselves for a tumultuous year of operational change in 2024.

This year will usher in new trade reporting requirements across several major jurisdictions – including the UPI (Unique Product Identifier) to provide a globally consistent product taxonomy, the UTI (Unique Transaction identifier) which requires common transaction identifiers across reporting regimes, the CDE (Critical Data Elements) to provide internationally harmonised data fields and definitions, and ISO 20022 XML messaging standards for reporting to trade repositories.

The US CFTC (Commodity Futures Trading Commission) implemented the first phase of its new rules, dubbed the “CFTC Rewrite”, in December 2022. It is due to implement the second phase of the rules on 29 January 2024, making it the first to implement the UPI and the requirement to use the ISO 20022 XML format in reporting.

Japan and the EU will be next to implement their versions of the new rules in April 2024, though Japan will not be implementing the UPI until a year later. The UK will follow suit in September 2024, then Singapore and Australia in October 2024, and Hong Kong sometime later in 2025.

Data Harmonisation

The idea behind the reporting changes was to address the lack of harmonisation in the OTC derivatives data that has been reported to date, which hinders regulators’ ability to monitor for emerging vulnerabilities in the global financial system and pockets of systemic risk.

In 2017, CPMI (BIS Committee on Payments and Market Infrastructures) and IOSCO (International Organization of Securities Commissions) came up with 110 critical data elements that they recommended should be reported with OTC derivatives trades.

According to Chris Childs, Managing Director and Head of Repository & Derivatives Services at DTCC, fewer than 50 of these data elements have been universally adopted by regulators. But this has still been “a step in the right direction”, as the harmonised data fields represent “most of the data that regulators would need to amalgamate to identify economic and systemic impacts”.

However, the variation between the data elements each jurisdiction requires has brought about significant operational challenges for firms, Childs says, adding that these become even more onerous for those required to report in multiple jurisdictions where the requirements differ.

“The immediate challenge for firms is the lack of a single source of data. They will have to figure out which systems they want to use to capture the data, and how to structure the data for reporting purposes,” Childs said. He added that the use of ISO 20022 XML for reporting further complicates matters as it means many firms will have to completely retool their systems.

 The Devil is in the Details

DTCC has been working to help firms cope with the operational challenges they will face to meet the upcoming compliance deadlines, streamline data management and reporting processes, and reduce the likelihood of errors in derivatives trade reporting.

DTCC is currently in testing with the industry to meet the CFTC’s January deadline, and has already launched UAT environments for Japan and Europe, allowing more than six months for testing before their April 2024 go-live dates. For Singapore and Australia, UAT environments are expected to be spun up by April, also allowing at least six months for testing.

But even before the UAT phase, firms should be leveraging project documentation and simulator tools to help them get an early sense of how messages will appear on the testing platform and in live reporting, says Priya Kundamal, Head of DTCC Data Repository Singapore.

“This is important because of the scale of change. Besides having to figure out how to capture the data required for the different fields, firms need to get a handle on the UPI as this is something completely new, not to mention the significant changes to the reporting format that come with the introduction of ISO 20022 messaging.”

Kundamal says firms will need to think about whether they will be building out their systems in-house or using vendor technology. They also need to consider how they are resourced to support the transition, i.e. whether they will be hiring expertise to work in-house, establishing dedicated teams, or using external expertise.

According to Childs, it is often only the tier 1 firms that are able to justify the cost of setting up in-house systems, while tier 2 and smaller firms tend to be more likely to look to vendor solutions to help them with reporting.

Whether firms are using in-house or vendor systems, however, the ones that will fare best are those that start testing early, as it allows them to gain a much more detailed view of the operational issues they will face under the new reporting regimes, says Childs. “The devil is in the details. The earlier and the more you test, the more likely you are to have a successful transition,” he added.

Scale of Change

Childs says the first steps for in-scope firms is to develop an understanding of the rules, and perform a thorough evaluation of their existing infrastructure and reporting processes to identify the scale of change. This will help firms assess whether they would benefit more from building in-house systems or outsourcing to vendors, he says.

To assist with this process, DTCC houses within its Learning Center portal sets of project documentation, functional change documents, and message submission templates – which are designed to help firms understand the scale, breadth, and depth of the reporting changes, specific to each jurisdiction.

DTCC has also set up a consulting services arm, which leverages decades of experience operating a global trade repository business to help firms understand the new rules and assess whether they have the right systems and controls over their data in place, and what changes might be needed.

“Firms will have to make sure they can actually capture the data that’s required for reporting, figure out which systems are capturing the data, and then find a way to stitch that data together in the format regulators require in submissions,” says Childs.

“You’ve also got to think about how to correct errors when they are identified. That is, how do you book corrections on your own systems, and whether this matches up with how the regulator wants to view the data and how they expect corrections on historical trades to be made.”

Taking Ownership

According to Childs, there are a number of upstream issues that firms have to solve for to come into compliance with the new reporting regimes. In particular, regulators are increasingly focusing on the quality of data, so there’s an expectation that firms are “looking very carefully at what’s being reported and checking that it’s accurate,” he says.

This means the firms will need to ensure their data governance, data lineage and control frameworks allow for high quality data to be reported. Childs says there is no replacement for early testing, as firms will need to make sure their systems and technology are fit for purpose, whether they are in-house or not.

“You can’t delegate away the responsibility, so taking ownership is really important,” Kundamal says. “But, on the plus side, the firms that successfully transition to the new reporting requirements will ultimately end up with a lot more automation, more streamlined processes, more robust controls, and more robust reporting.”

“There are a lot of changes all happening over the next one year, and some of them are quite complex. We are working to support the industry and give firms a lot of runway for testing before the upcoming go-live dates. I think there are a lot of opportunities, but ultimately it’s a matter of reporting entities taking that step forward.”

This article was produced by Regulation Asia in partnership with DTCC.

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