Feb 27, 2014

Trend Analysis on EMIR Reporting Regulation

Trade reporting under EMIR began on February 12, and over the past several weeks it's been widely reported that market participants in Europe were not prepared to start reporting derivatives trades as mandated. In this video blog, Udi Sela, Vice President of the Numerix Clients Solutions Group sits down with CMO, Jim Jockle to discuss the scope of the reporting, including the general preparedness of larger banks and financial institutions, and concerns expressed thus far by both regulators and market participants. Udi elaborates on some of the challenges faced, and near-terms winners and losers.

Weigh in and continue the conversation on Twitter @nxanalyticsLinkedIn, or in the comments section.


Video Transcript:

Jim Jockle (Host): Hi welcome to Numerix Video Blog, I'm your host Jim Jockle. Trade reporting under EMIR began on February 12th and over the past two weeks it's been widely reported that market participants in Europe have been inadequately prepared to start the reporting derivatives trades as mandated. Today with us is Udi Sela from the Financial Services Group here at Numerix. And we're going to discuss some of the scope of the reporting including general preparedness of larger banks for financial institutions as well as some concerns thus far by regulators and market participants. Udi welcome.    

Udi Sela (Guest):  Thank you. Nice to be here.

Jockle: So Udi, in the Client Solutions Team, just give us a very high level – EMIR. What is it? What was the February 12th deadline, and just a quick overview would be great.     

Sela: Sure so EMIR in essence is about OTC Derivatives. Now it's about first of all, centrally reporting all the open OTC trades. And then when possible clear them, have them cleared centrally. Now of course it stems back from the subprime crisis, but basically the regulator needs to know how many time bombs are actually out there, what is the magnitude, what are the risks and so forth. It's really about more information, and control.

Jockle: So what are some of the challenges that we're facing right now? Now that we're still just two weeks into this?

Sela: It's pretty much, it's about the data. So first of all is about collecting data and then how do we cleanse it. Just think about firms that don't have heavy treasury systems in place. And the firm has different departments each of them, holds many trades in excel spreadsheets so you really need to collect trades, see which are still "live", which trades  offset each other and figure the collaterals required and so forth. Not everyone has derivatives as the core business and therefore people argue that this reporting effort could mean for non-professional players, it could be a tedious effort to really collate the data imported import it properly without making mistakes.

That's one thing. Second thing is what falls under derivatives. So for instance one of the debates is about FX forward-trades fall short within one week. Should we report them, shouldn't we have the infrastructure in place and so forth?

Third thing is about, setting thresholds. What is the size of an open book of which you need to start reporting? Now, say we always stay below threshold. So now how do you prepare to cross the threshold because it's not like one day there is a turnkey solution and then you can start reporting. It can cause significant investments. So these are pretty much the challenges.

Jockle: So let's talk about some of the goals of reporting right. So there's one thing to have information. We've seen different elements of information whether it is from the BIS, whether it's from ISDA, and it's one thing to get an understanding of notional amount of trades, and trades that are cleared. But it's another element to really understand the risk in the market whether just because my positions are X and Y, they might be perfectly off-setted, it's just the reality of the OTC and the derivatives markets. What are some of the advancements that the regulators are looking to do with this data to get a better understanding and find those outliers to prevent future collapses?

Sela: So I think that is a very good question. I think it is very similar to what we see now with clients. That they are looking basically for shortfalls of the overall exposure. So basically the regulator would like to do some stress test, but an overall exposure basis. Think of what happens if S&P falls by 30 percent. What would be the impact on the books. Think of VaR now. What is the overall exposure of what would be the loss confidence level of 99% if all prices go up by 100 percent. These are things that have happened. So now, the regulator having all the information now outside would be able to quantify the overall risks. So if something happens in the market, then you know information is power they would be able to take the necessary steps to mitigate that risk.

Jockle: So even though we're two weeks out who's happy who's unhappy? Who are the near term winners and losers as it relates to compliance?

Sela: So I think pretty much, the winners are first of all the regulators that push it through because it's what they were after. Second it seems that the winners are the providers. Providers could be like global banks, we have something like eight, eight different banks that provide delegated services. So people that don't have to go into the hassle of building all those systems; you can now send all their trades and have those banks provide the reporting services for these derivatives players. Of course to a large extent it means that the banks would need to know the positions of the client more likely win the business. And therefore generate additional revenues. And of course providers should be pretty happy because people are now looking to buy adequate solutions as we (at Numerix) see too. And probably the losers are those that have to make all those investments and things that are not necessary key to their respective business.  

Jockle: It's interesting that you say that because one of the things that we've talked about is regulation as a changer as it relates to infrastructure and reporting. But it's also clearly having an impact on revenue opportunities and a focus on services from some of these large banks themselves. Do you see this as a continued trend to some of these larger institutions?

Sela: Yes pretty much so I think that we always see the denominator in the market when where services generally begin with higher margins and then everyone goes into the space margins become normal. Pretty much like prime brokerage becomes almost a commodity. So typically the larger institutions are always looking for the new business spaces where they could generate the margins which are above normal. obviously as an outcome, the new regulatory requirements new opportunities now occur and could be around clearing, could be around reporting and initial margining. And as oppose for instance valuation which is being commoditized.

Jockle: So one final question for you and then we'll wrap this up. Thinking back to the G20 meeting and really where the birth place of the derivatives reform in the modern error came out of, where would you say in the continuum we are in terms of completeness? Are we ten percent there, fifty percent there, eighty percent there? Or how badly is this roll out going to be continuing in this distant future.

Sela: Wow that's a difficult question. I think that we, first of all it depends where we want to go right. What is the end goal which I don't know myself. But I think that we're probably 30 to 40 percent of the way. Because now we have more transparency in terms of bilateral OTC trades. Given the trade repositories. We already mentioned that there are five or six. And we've seen that the overall open exposures are smaller because risk is now being mitigated in terms of counterparty risk but I think the one thing that is a big flaw in my opinion is the fact that the cleared trades are typically the most simple exotics.

So I don't think that if we had the structure in place it would have made much difference because maybe we would've known about the trades but the risk was not quantified. There were no ways of mitigating the risk. In terms of Bearn Sterns or Lehman Brothers probably would have encountered similar events and defaults.

Jockle: Well we can certainly argue that thirty percent is greater than zero percent. So especially as we're getting more rules and definitive frameworks in place, hopefully we'll start to see that thirty percent accelerate and everyone will continue to move forward in a more level playing field. Udi I want to thank you so much. And of course we want to talk to you and talk about the topics that you want to talk about.

ISDA released a great tool, if you haven't seen it you can get it on Numerix on the LinkedIn site. It's a updated regulatory calendar. They're going to be doing regular updates that certain benchmarks in times and dates that will be hid across the globe and across regulations. So with that, I'd like to thank you again Udi. And we'll talk to you next time. 

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