EMIR vs SFTR
When comparing the goals of the four regulations mentioned above, it becomes clear that EMIR and SFTR are very closely related in their aim to bring transparency to the risk exposure in the derivatives and securities financing markets, respectively. Both regulations require market participants to report on relevant contracts, life cycle events, exposures, and the collateral posted/received against the derivatives to a trade repository (TR). The ESMA-authorized TRs are required to provide the consolidated information to ESMA and the national competent authorities (NCAs) for further analysis.
Despite their similar goals, SFTR is by many market participants regarded as more complex than EMIR due to the nature of SFTs and the prevailing workflows in the market. The volume and frequency of life cycle events related to SFTs will require firms who lack consolidated data sources to look for scalable yet transparent solution architectures that will allow them to consolidate their reporting data for submission or at least reconciliation. Furthermore, as many firms will also be challenged by the manual nature of their processes for SFT trading and settlement, we expect more automation and electronification of SFT trading to satisfy regulators’ expectations regarding reporting data quality. Based on our experience with EMIR as well as MiFID II, such fundamental changes to operating models are easier to implement for firms that have a solid IBOR architecture as a framework for all operational processes.
The volume and frequency of life cycle events related to SFTs will require firms who lack consolidated data sources to look for scalable yet transparent solution architectures that will allow them to consolidate their reporting data for submission or at least reconciliation
When it comes to EMIR, market participants have for a long time questioned whether the NCAs would be able to process the data they received. While this was a valid question for the first years under EMIR, the Luxembourgish regulator CSSF issued a press release mid-July 20181 reminding regulated entities to be mindful of the data they submit (or that is being submitted on their behalf). This reminder should make it clear to all market participants that the NCAs, actually, can manage the data they receive and are set to take actions upon misreporting.
European lawmakers have designed MiFID II/MiFIR to achieve a different set of goals compared to EMIR and SFTR, and hence these two regulations come with a slightly different set of transparency requirements. While EMIR and SFTR are looking to increase the transparency for regulators, MiFID II/MiFIR are looking to ensure a well-functioning market as well as increased transparency for investors. One of the key requirements of MiFID II/MiFIR is ‘order record keeping’.2 Under this requirement, market participants must demonstrate that they register the entire life cycle of an order, including all changes, amendments, and executions in the market down to the allocation of aggregated orders to single client portfolios. Firms must have full data lineage available throughout their entire trading and portfolio management solution architecture in order to comply with this requirement.
One of the key requirements of MiFID II/MiFIR is ‘order record keeping’… Firms must have full data lineage available throughout their entire trading and portfolio management solution architecture in order to comply with this requirement.
From a disclosure perspective, MiFIR Art 26 imposes a transaction reporting requirement onto investment firms. Under Art 26, firms must report all orders, related market executions, and detailed information about investment decision-makers to an authorized reporting mechanism (ARM) or directly to their NCA. The NCAs use this information to monitor market abuse and maintain the well-functioning of the markets, which was the goal that MiFID II was intended to accomplish within the European Union. As opposed to EMIR or SFTR, MiFIR Art 26 does not require any reporting on open positions, but only on orders that have been placed in the market. The FCA recently reported on their experiences regarding MiFID II reporting data quality, clearly demonstrating that they can reconcile reports from different sides of the trade. MiFID II raises the bar for firms as they are expected to continuously monitor and improve their reporting, including actively requesting reported data from their NCAs to reconcile against.
Whereas all the above-mentioned regulations, EMIR, SFTR, and MiFID II/MiFIR, focus on daily orders, transactions, and exposures in the market, Solvency II takes another angle. The aim of Solvency II is to achieve transparency into the long-term stability of insurance companies in Europe. This is important as policy holders often have a long-term view on their contracts and the reason why the European Commission aims to give them better transparency into how well their insurance providers are doing on the long term. To ensure the long-term stability of insurance companies, Solvency II requires firms to fulfil a certain Solvency Capital Requirement (SCR), i.e. they need to have enough solvency capital available to cover the risks stemming from their insurance and investment operations.
When it comes to investment operations, Solvency II also aims to provide a higher level of transparency. Insurance companies are required to supply a full look-through to the underlying assets of their derivatives, funds, participations, structured products, or securitized products like ABS, which poses new challenges for these firms and their IT solutions. First, their system architecture must be able to provide and maintain all the necessary data for all assets involved, and, second, their IT systems need to be able to incorporate this additional information into the SCR calculation.
Solvency II … poses new challenges for these firms and their IT solutions … their system architecture must be able to provide and maintain all the necessary data … and, second, their IT systems need to be able to incorporate this additional information into the SCR calculation.
Investment management system requirements and challenges
The above high-level comparison of the four regulations shows that they all pose new data transparency and data management requirements on the firms impacted. The ability to access, consolidate, and report all relevant data has become more important than ever. However, for many firms who, due to short-term tactical solutions, find themselves operating a patchwork of disparate systems, this is a big challenge.
When looking at stand-alone reporting solutions that are built to consolidate data from disparate operational systems before providing these to the regulators, you quickly realize that one of the key challenges for these solutions is to compensate for the lack of transparency of the operational upstream systems. To overcome this problem, the reporting solution needs to introduce information to the firm’s data model at a very late point in the value chain. To do this in a reliable way, reporting solutions often mimic functionalities that are in general part of investment management platforms and hence come at an increased complexity and cost.
When looking at stand-alone reporting solutions that are built to consolidate data from disparate operational systems before providing these to the regulators … one of the key challenges … is to compensate for the lack of transparency of the operational upstream systems.
Consolidated data adds value across the investment management value chain
As opposed to choosing a short-term stand-alone reporting solution to meet increasing regulatory requirements, choosing a long-term consolidated investment management system with multi-asset class support gives investment managers the ability to manage all asset classes on a unified platform based on an investment book of record (IBOR). Besides fulfilling regulatory transparency demands, a consolidated system based on a single source of data enables automated workflows that remove the need for error-prone manual workarounds and equip investment managers with the real-time data they need to make optimal trading decisions, assess where they are under-investing, and detect investment breaches. Research from the consultancy Forward Look, Inc. suggests that the improved timeliness and quality of data delivered by integrated solutions can translate into anywhere between 51-242 basis points (bps) of inherent alpha.3
While the transparency brought by an IBOR in the front office can directly correlate to a firm’s bottom line, it can also bring much needed clarity to other crucial areas of the business. For instance, compliance and risk functions can better calculate exposure during market events. Using real-time, and not last night’s, data, they can also account for corporate actions and cash flows enabling more accurate forecasting. Further, an IBOR greatly helps making relevant information, normally only residing in middle and back office, available to the front office. In this capacity, it can for instance enable a portfolio manager to assess how a certain trading scenario impacts portfolio risk, or what the margin requirements are for an OTC trade with broker X versus broker Y.
At the same time, IBOR functionality can alleviate the regulatory demands placed on a firm’s back office. Vital resources no longer need to spend time on reconciliating data from disparate systems to create reports and best execution evidence. Instead, they can add value to more sophisticated tasks, such as auditing readiness for new regulations, and respond to the increasing number of ad-hoc reports frequently requested by investors.
Data transparency is a must-have not a nice-to-have
The operational benefits of IBOR technology are clear, but the path towards it is muddied with misconception. Many asset managers working with a tangled web of IT systems underestimate the possibility of IBOR technology, often brushing it off as an idealistic goal. In fact, it can be embedded in a variety of different infrastructures. For instance, we currently see many firms initiating system consolidation projects in the order and execution management space. It’s a natural first step to introduce the IBOR as part of this, to solve many needs across the front office. To harness true automation, using an architecture that brings you as close as possible to ‘live’ data, firms should look to an integrated system to deliver the quickest, most reliable, and correct information across the business.
The transparency that firms once perceived to be a luxury will become a necessity.
In the future, as global investment management continues to be bombarded by market complexity, including further regulatory requirements, the transparency that firms once perceived to be a luxury will become a necessity. Investment managers will begin to see the urgency in accessing up-to-the-minute data, and the need for a holistic data approach, not just to sustain, but to empower themselves with the competitive edge required to truly grow.
2. COMMISSION DELEGATED REGULATION (EU) 2017/565 re organizational requirements and operating conditions for investment firms and defined terms
3. Chito Jovellanos: ‘The Impact of Investment Operations on Portfolio Performance’, The Journal of Investing, Fall 2011, Vol. 20, No. 3, pp. 40-52.