Letter to EMIR 2/3 – Some examples of challenges you may be facing as a bank

Dear Reader,

This letter is part of a series of three on the European Market Infrastructure Regulation (EMIR):

• Letter 1/3: An update on EMIR
• Letter 2/3: Recent developments in the EMIR area with EMIR Refit and the new technical reporting standards applicable from April 2024. It will provide an overview of the challenges that banks may face.
• Letter 3/3: An overview of Digital Regulatory Reporting (DRR) as a potential solution for improving the quality and convergence of reported data. In cooperation with ISDA (International Swaps and Derivatives Association).

Over the last years, the EMIR regulatory requirements have kept on evolving with the ending of the UMR phased-in approach and the ReFIT publication including the recent new reporting technical standards. For banks, the impacts of such an evolution are significant and require constant process & system changes as well as enhanced data sets. While most banks are in the implementation phase of the new EMIR reporting technical standards due 29th April 2024, we would like to share some of the challenges they are facing, and which may compromise readiness.

Considering these challenges, we observe an increased attendance of banks and market participants in working groups to exchange on and define best practices.

1. Luxembourg treatment of EMIR and market overview

Regulation (EU) No 648/2012 on OTC Derivatives, Central Counterparties and Trade Repositories dated 4 July 2012, as amended (EMIR) and Regulation (EU) 2019/834 of the European Parliament and of the Council (EMIR ReFIT) are directly applicable in Luxembourg and is complemented by the Luxembourg act dated 15 March 2016 on OTC derivatives, as amended and several CSSF Circulars.

The Financial Sector Supervisory Commission (CSSF) and the insurance sector supervisory authority (CAA) are the national authorities competent for the implementation of EMIR and have the power to sanction both FCs and NFCs for non-compliance with the requirements laid down under EMIR.

Note: “Financial counterparties”:

(a) an investment firm authorised in accordance with Directive 2014/65/EU;
(b) a credit institution authorised in accordance with Directive 2013/36/EU;
(c) an insurance undertaking or reinsurance undertaking authorised in accordance with Directive 2009/138/EC;
(d) a UCITS and, where relevant, its management company, authorised in accordance with Directive 2009/65/EC, unless that UCITS is set up exclusively for the purpose of serving one or more employee share purchase plans;
(e) an institution for occupational retirement provision (IORP), as defined in point (1) of Article 6 of Directive (EU) 2016/2341
(f) an alternative investment fund (AIF), as defined in point (a) of Article 4(1) of Directive 2011/61/EU, which is either established in the Union or managed by an alternative investment fund manager (AIFM) authorised or registered in accordance with that Directive, unless that AIF is set up exclusively for the purpose of serving one or more employee share purchase plans, or unless that AIF is a securitisation special purpose entity as referred to in point (g) of Article 2(3) of Directive 2011/61/EU, and, where relevant, its AIFM established in the Union;
(g) a central securities’ depository authorised in accordance with Regulation (EU) No 909/2014 of the European Parliament and of the Council.

2. Challenges related to the reporting under EMIR/ EMIR ReFIT

In recent years, the CSSF has, in line with the approach taken by the ESMA, been scrutinising compliance of both FC1s and NFCs with reporting requirements under EMIR, focusing on data quality.

The CSSF has conducted data quality campaigns on the reported information on derivatives trades in 2021 and 2022. These campaigns revealed that (i) consistent supervisory oversight and (ii) close tracking of the remedial actions taken by all relevant entities are required to achieve a lasting improvement in the quality of the reported data.

Regulatory assessments of data quality, including the poor level of pairing and matching of the reports, have shown that there is an unequal level of sophistication and understanding with respect to EMIR among market participants.

We observe that many participants (incl. Insurances, Investment Funds and Management Companies) have decided to delegate the EMIR reporting processing to their banks (FCs) and often entirely rely on them to the extent that they are not always aware of their ultimate responsibility for the reporting performed on their behalf.

With the entry into force of the reporting new technical standards applicable from 29 April 2024, the supervision of data quality is also required to increase. ESMA and National Competent Authorities (NCA) are required to strengthen their controls and all counterparties to derivatives, regardless of their classification, must sharpen up and be alert to their obligations under EMIR.

The challenges faced can be split in three main categories:

Data related challenges

With an increase of reporting fields from 129 to 203, counterparties will be required to populate 74 new reporting fields and modify 23 existing fields. Considering the complexity of certain fields, these changes shouldn’t be underestimated.

Related to new fields, banks need to source and retrieve specific data from external service providers. Examples for challenges related to external dependencies include:

• Clarification is still needed on the ownership of UPI (Unique Product Identifier) creation when execution occurs off venue.
• Collecting new counterparties data is also an important step requiring time and especially when counterparties are less sophisticated e.g., non-EU. or NFC-
• Collecting UTI (Unique Transaction Identifier) when special arrangements are required to ensure UTI is generated and communicated between counterparties when trade is not cleared, and execution occurs off venue (incl. the considering of the regulatory reporting requirements applicable to non-EU counterparts)

The new data requirements also increase the risk of diverging interpretations among counterparties and some participants are exploring market initiatives such as the adoption of Common Domain Model (CDM) to ensure alignment of their interpretation to market best practices and its use in applications such as Digital Regulatory Reporting (DRR).

Process related challenges

Banks are also facing challenges with the implementation of side processes to the reporting itself.

Related to the new obligation to notify the NCA(s) of any significant issue, the term “significant” has not been clearly defined by the regulator, so Banks as Report Submitting Entities (RSE) need to conduct an assessment to establish clear and measurable criteria, so as not to over-report or fail to report incidents as Entities Responsible for the Reporting (ERR). It is to be noted that banks also need to ensure they have a process in place to duly inform all other ERRs about the reporting issue, so that they can assess their overall situation and notify their NCAs if crossing the thresholds as due.

Another challenge is related to the requirement for ERRs to notify the relevant NCAs for some or all the counterparties on whose behalf it reports. This requirement would translate in significant increase of work for FCs1 with mandatory delegation and reporting on behalf of NFC-s. Overall, the operational efforts to implement the changes and update the existing processes and systems including the appropriate controls framework is significant; this not only for banks but also for all counterparties which need to report including those who choose to delegate the reporting and need to upgrade their oversight.

Note: EMIR provides for a requirement for FCs, such as credit institutions, trading with NFC-s to report transactions on behalf of both them and the NFC-. (Art. 9(1a) EMIR). In this context, FCs are solely responsible and legally liable for reporting and for ensuring the correctness of the details reported.

Business related challenges

We observe that a significant number of clients, including NFC- counterparties, are unaware of the existence of EMIR and the related obligations not limited to reporting, despite the publications of the CSSF and ESMA. In these cases, banks take an educational role with commercial teams having to explain the regulation as part of the derivatives execution offering.

This lack of knowledge quickly becomes an obstacle for the clients wishing to trade derivatives and may even lead to delays in execution given the client’s obligation to provide data before the order is placed, (e.g., their valid LEI (Legal Entity Identifier) code if applicable).

The new counterparty data requirements with the new reporting standards make the trading of derivatives more difficult which is a challenge for most banks in a time of rising rates where clients want to trade derivatives for hedging purposes in the markets and want to make one and only one transaction or where the client is non-EU.

Dear Reader, we hope you found our article stimulating and interesting.

Await our upcoming letter and our thoughts on a possible solution to tackle the EMIR Data challenge.

Contributors

Marilyn Rinck, Adviser on Financial market at the ABBL, and Natacha Dats, Chairperson of the ABBL Working group on Market Infrastructures.

Special thanks for their contribution to PWC Luxembourg and Spuerkeess.