ESMA’s Data Quality report (EMIR) – five critical takeaways

During April, ESMA released the latest version of its EMIR and SFTR Data Quality report.  Kaizen’s Jonathan Lee commented on the SFTR elements in an earlier blog. Below we take a deep dive into the key takeaways regarding EMIR Reporting.

1. Valuation and collateral submissions are a hot topic for ESMA

Using a simple word count, collateral and valuations are mentioned more than any other topic in this report.  Collateral and valuation reporting is a daily requirement for Financial Counterparties (FCs) and Non-Financial Counterparties that are above the clearing threshold for OTC trading (NFC+s).

ESMA stresses the ‘importance of valuation data for economic and financial risk analysis’, evidencing what is clearly a key component of EMIR Reporting and a continuing area of scrutiny for authorities.

The report highlights that ‘more than 20%’ of open derivatives do not receive an updated valuation, despite the clear reporting requirement to do so.  As mentioned in Jonathan Lee’s SFTR analysis, many of the metrics included are ‘flawed’, including this ‘20%’ figure, as the sample analysis only took into account derivatives with valuations over 15 days old, rather than those over one day old.  As part of their daily reporting requirement, firms are expected to provide collateral and valuation updates every day, and if this is truly a key focus for ESMA, future analysis would be far more accurate (and more damning), if it followed the actual reporting requirement.  For this reason, it is a fair assumption that far more than 20% of open derivatives are not receiving daily collateral or valuation updates.

Firms would be wise to note this important discrepancy and ensure that all collateral and valuation reporting reflects the daily reporting requirement ahead of future iterations of the report. More importantly, ensure all collateral and valuation reporting is accurate ahead of enhanced scrutiny by regulators for this key area of EMIR reporting.

2. Pairing remains a problem for EMIR Reporting

An important issue the report highlights is the lack of successful reconciliation.  An important and telling statistic is that only ‘60%’ of pair-able submissions do successfully pair.  This shows an upward trend from 40% to 53% and now 60%, since ESMA began tracking the yearly statistic.

The pairing phase of reconciling the two sides to each derivative relies on the reporting counterparty LEI, other counterparty LEI and the UTI to create a unique ID for that submission. These allow the trade repositories to search for the other report submission pertaining to the same derivative.  Only derivatives where both sides are required to be reported in the same jurisdiction are included in these statistics.

The whopping 40% of all reportable derivatives that fail to pair will be due to a limited range of factors, such as one counterparty having not reported the derivative successfully, one or both counterparties reporting with an incorrect LEI or UTI, disagreement on the number of trades to be reported for that derivative, and finally, general processing issues within the trade repository pairing process.

ESMA condemns this large volume of unpaired derivatives as ‘not satisfactory’, notably as the reporting of these fields has been mandatory since reporting began in 2014.

The pairing of derivatives is vital to the success and efficiency of EMIR Reporting, which is inherently focused on the level of risk and exposure in the market.  If two successful reporting submissions for the same derivative do not include the correct identifiers to enable pairing, the authorities will simply think that two unrelated single sided submissions have been completed, and that they are (incorrectly) awaiting the other side of the derivative to be reported.  Not only is this poor from a completeness and accuracy point of view, but vitally the exposure could potentially be seen as double the volume of market risk currently live for both counterparties and the economy at large.

3. Data provided to the NCAs isn’t always the same as data provided to ESMA

Generally, the data reported to the trade repository is the regulator’s view of derivative activity at each firm.  NCAs view the specific sections of EMIR data that they have been mandated to view, and ESMA has the ability to see all data, due to its regulatory oversight of EMIR Reporting for EEA firms.

However, the report highlights that data is provided to the various authorities in different ways, such as ‘TRACE’ or via sFTP.  Also highlighted was the admission that when the trade repositories allocate data to each NCA, this does not necessarily match what ESMA believes the NCA should see, resulting in both over and under reporting of data to the NCAs.

Whilst this finding does not impact the ability of counterparties to submit reports successfully, it does limit the ability of NCAs to efficiently supervise all firms to which they are mandated. And in practical terms it is extremely hard for an NCA to identify such shortcomings in the quality of data that they have been provided.

4. Non-reporting and timeliness of reports

Approximately ‘10%’ of the sample of EMIR reporting tested under the report are reported late by counterparties.  Non-reporting dropped sharply to ‘5%’ but this figure is likely to be due to Brexit splitting the two EMIR Reporting regimes across EEA and UK based firms.  Again, this is a good example of a likely ‘flawed’ metric used in this report.

Strangely the analysis does not take into account the conversion from local to UTC Coordinated Universal Time, despite UTC being a well-used reporting format under many EMIR fields, including reporting timestamp.  Further to this, the analysis does not take into account ‘public, bank or national’ holidays, even though ESMA admits in this report and other sources that they should be taken into account and adding to the flawed nature of many metrics included in this report.  As previously argued, such analysis should absolutely follow the reporting requirement to which firms are required to adhere to, instead of ‘moving the goal posts’ for the ease of data analysis.

The report also mentions the sharp decline in non-reports to less than ‘5%’, but admits that this has been dramatically impacted by Brexit (reported derivatives dropped ‘by 50%’) which split the reporting requirement into two separate EMIR jurisdictions.  For this reason, it is worth noting that it is now significantly harder to gauge an accurate view on non-reporting for the same derivatives, where counterparties are split across the EEA and UK.

5. ESMA has great expectations for all impacted bodies

The final key takeaway from the report is that a lot more is explicitly expected from all stakeholders of EMIR Reporting.

For reporting counterparties, ESMA includes strong language on the expectations of firms, namely that they are expected to have all necessary checks and balances in place ‘to ensure completeness, accuracy and timeliness’ of reported derivatives.  In addition, firms are expected to ‘actively engage’ in identifying and remediating any report rejections, reconciliation breaks, and other data quality issues for ‘already reported data’.

In short, firms are required to take ownership and ensure high quality data for both new submissions and anything previously reported.  Importantly, this will include all delegated reporting, remembering that even if firms delegate the action of reporting, the obligation of reporting remains with the counterparty to the derivative.  In addition, it will also impact firms required to perform what has informally become known as ‘mandatory delegated reporting’, where an FC has executed an OTC derivative facing an NFC- in the same reporting jurisdiction.

For the authorities, they have an explicit commitment to continue perusing improved data quality under EMIR.  ESMA and the NCAs ‘will take further action’ to improve the quality of data where ‘insufficient quality’ has been identified and prevails.Q

And finally for trade repositories, they have been identified as required to increase the quality of reports provided to the NCAs, as well as ensuring the consistency and accountability across standard ‘end of day reports’ to firms, such as the ‘trade state report’ and the ‘trade activity report’.

What’s next?

In summary, the report continues data quality themes initiated in last year’s report, but with renewed vigour, more examples of wrongdoing, and arguably significantly stronger wording from ESMA. 

Valuations and collateral reporting will be a key focus of NCA scrutiny over the next 12 months, and firms would be wise to prioritise this in their data accuracy reviews, not only of future reporting, but also of any historical submissions to the trade repository.

We welcome the focus of such reports, but are keen to see future versions encompass all reporting requirements, and importantly, we urge ESMA to ensure that all metrics at least mirror the prescribed reporting requirements, instead of being influenced by ease of calculation. 

And finally, we are very keen to see the same style of scrutiny for UK EMIR reporting from the FCA, giving UK firms ample opportunity to review any reporting shortcomings ahead of the looming EMIR Refit changes for derivatives reporting. 

Read the consultation paper on the FCA’s website.

• Do you know the true state of your EMIR reporting data quality? If you are in any doubt about how the quality of your EMIR trade and position level reports measure up, please contact us.