The more challenging aspects of implementation involve jurisdiction-specific data fields, the UTI waterfall, UTI generation, and ISO 20022.
Industry preparations are underway in Singapore and Australia to meet complex new requirements for reporting OTC derivatives transactions.
Later this month, we will see the CFTC (Commodity Futures Trading Commission) implement the second phase of its own rule rewrite, for the first time introducing the UPI (Unique Product Identifier) in derivatives reporting for all asset classes apart from commodities.
The first phase of the CFTC Rewrite was implemented in December 2022, introducing new and updated data fields to drive the submission of more standardised trade data, largely based on the CDE (critical data elements) developed by CPMI and IOSCO.
New reporting requirements will be coming into force in Japan on 1 April (initially without the UPI); the EU on 29 April; the UK on 30 September; and Australia and Singapore on 21 October. Hong Kong will be next, once it finalises the requirements under its new regime.
Ahead of the second phase of the CFTC Rewrite taking effect, there is hope that the implementation will help to inform how market participants address the new requirements in other jurisdictions, particularly in relation to the UPI.
In some jurisdictions, such as Australia and Singapore, regulators have managed to closely align their implementation timetables and data requirements. Yet, there are still concerns that regulatory fragmentation will present significant implementation challenges across jurisdictions.
Globally, the new reporting regimes have converged on similar data standards and message formats, however this convergence has not been without limitations. While the reporting format is standardised, jurisdiction-specific data fields are expected to create challenges for firms, particularly those that will be reporting under multiple regimes.
For example, the CFTC already requires 47 data fields which are jurisdiction specific. Yet last month, additional revisions were proposed that would add even more CFTC-specific data elements which are not required by other jurisdictions, making almost 40 percent of data fields US-specific.
According to one commissioner, this creates “further obstacles and uncertainty for meaningful global aggregation and analysis of trade repository data”, unnecessarily increases compliance costs, and moves the CFTC further away from the opportunity to meaningfully aggregate data across-borders.
But inconsistencies in the data requirements are not just a CFTC problem. For example, the EU and UK require FX swaps to be reported as one transaction whereas other jurisdictions require these to be reported as two transactions with two UTIs (Unique Transaction Identifiers).
Further challenges are expected to arise from part of the rules that specify how derivatives should be valued. For cleared trades, market participants are required to use clearing house valuations, except under Australia’s regime, which calls for firms to use their own valuations.
Plenty of nuances
There are plenty of other nuances under the various local regimes that are expected to present challenges during implementation, particularly for global and regional firms that may trade in several (or all) of the jurisdictions where new rules are coming into force in the year ahead and beyond.
Larger firms expect that the experience gained from the US and EU implementations will make the required changes in Australia, Singapore and eventually Hong Kong easier to implement.
In Singapore, the regulator asked the industry in November to start preparing for the new regime on the basis of the ‘close to final’ guidelines issued in May 2023.
Certain new data elements, and requirements to reconcile positions and validate the reported data are seen as some of the key challenges, particularly for smaller buy-side firms, who have never before had to report derivatives transactions in the way that is now specified.
The ISO 20022 messaging format, while a necessary enhancement to improve data quality and standardisation, is also seen as a top challenge for smaller firms who have historically reported via CSV upload.
Across jurisdictions, the new rules also introduce requirements to report a UTI. Under each regime, a waterfall approach is applied to determine which counterparty would need to generate this identifier.
However, due to differences at the jurisdictional level, it is not yet entirely clear which party would be responsible for generating the UTI in certain cross-border trades, such as off-venue trades and those that are not centrally cleared.
There is a view that the sell side should be generating UTIs rather than the buy side, but this may not necessarily be the case if the rules as currently written are followed prescriptively.
Meanwhile, some APAC bankers have expressed concerns that the rules are designed in a way that could result in US and European counterparties generating the majority of UTIs.
Generally, it is significantly simpler to be the UTI generator as it allows firms to report straight away and with confidence. Firms that do not generate the UTI would have to either wait for the counterparty to share the UTI or report an interim UTI which then needs to be remediated later.
While groups like ISDA are working to develop best practices to resolve these and other UTI-related issues, the industry is simultaneously working out what the UPIs will be for their products. In this regard, APAC jurisdictions will indeed have the benefit of learning from implementation in the US and EU.
However, while the UPI concept was actually designed to provide a consistent way of describing products across regimes, the industry is observing instances where the same product may be described by two different UPIs.
This can occur when different counterparties submit different attributes to ANNA DSB (Derivatives Service Bureau) for the same trade type. For example, is a standard FRA a physical settlement or a cash settlement? If two banks have different interpretations they will get two different UPIs.
It could also occur with total return swaps, which could be labelled as either equity or credit products, or in certain edge cases involving structured products.
Expectations are that from day one, UPI in certain products may not be quite as unique as anticipated. There will likely be a period after go-live where the industry works through these issues to converge on a true best practice. For APAC firms, the hope is that this occurs before their own local go-live dates.
Other unresolved issues
Market participants can expect regulators to be much more focused on data quality. However, each regime has its own methodology for how and when to report significant errors to regulators. Firms with multi-regime reporting will need to build their control frameworks to accommodate this lack of harmonisation.
Still, further challenges are expected around delegated reporting, collateral valuation, validation of reporting, and reconciliation, among other areas. While some of this might be resolved through best practice standards developed by industry bodies and trade repositories, others may only be resolved after a process of refinement which could involve further regulatory change.
In effect, this means a third phase of implementation is indeed expected in the US, EU and other jurisdictions. For market participants, this would mean further investment in systems development, which might present additional challenges for firms that rely on systems built in-house.
As the industry prepares for implementation, the first step is to understand the requirements that will apply to them, and how data moves through their systems. Budgets and project management teams would need to be put in place, and system and process changes would need to be implemented, properly tested, and documented.
Some firms will be better prepared for the changes than others. In most cases, a lead time of at least 6-8 months is considered necessary to ensure a smooth implementation that can adapt to hiccups and teething issues along the way.
To learn more about navigating the upcoming changes rule changes, join this webinar on Thursday, 25 January 2024.