The addition of trading on Swap Execution Facilities (SEFs), possible central clearing for some instruments, and reporting of all trades to the newly established trade repositories means that not only the connectivity requirements to trade FX have become more complex, but also that the workflows will need to be re-evaluated for any possible impact.
While the new connectivity is fairly straight-forward and can either be built in-house or outsourced to a third party middleware provider, dealing with the added complexity to the workflow is quite a challenge. It requires sourcing the correct trade data, at the right time, managing the new reporting codes and identifiers and dealing with the status and messages coming back from the CCPs and trade repositories. Banks will need new exception management workflows to handle incoming messages from trade repositories and CCPs and in some cases a new internal workflow will be needed to receive automatic updates of reported trades, which is likely to impact existing trading systems.
Trading on SEFs in the US, which for the FX market means non-deliverable forwards, went live in October. ESMA has announced and approved the first four trade repositories under EMEA – DTCC, Regis-TR, UnaVista (the London Stock Exchange) and KDPW in Poland, and it is understood at least another two are to come. So far, there are just five CCPs on the horizon for FX – the CME Group, LCH.Clearnet, Hong Kong Exchange and Singapore Exchange, with Nasdaq expected to unveil its offering in the near future, but this too could increase.
The DTCC Derivatives Repository Limited (DDRL) applied for approval as a trade repository under ESMA in March 2013, on the first day on which an application could be made. Stewart Macbeth, Chief Product Development Officer of DTCC Deriv/SERV and CEO of DDRL, says that the introduction of an FX trade repository will have a significant impact on FX workflow processes for some time as the firms work on enriching trade messages with the information needed to fulfil the reporting requirements.
The main requirements are the need to attach a common trade identifier to trades and agreeing the details of the trade to be reported. Furthermore, there are some detailed fields that are quite difficult for counterparties to populate in an identical way because they are not pure economic fields as such. These include execution time and confirmation time. In terms of the product description field, Macbeth says the lack of codified standards means that currently participants are using different descriptions.
While trade associations are still talking to ESMA about including existing product standards and product taxonomy as part of the reporting requirements nothing has been approved yet. Macbeth adds that the sooner these standards are agreed, the sooner market participants can adopt them. Testing has begun in Europe and reporting across a broad group of fields and jurisdictions will go live on 12 February 2014, but there is still a level of ambiguity around reporting. In the US, Macbeth says there is a greater level of codified reporting for FX products. Reporting for FX has begun in Japan and Australia, and Singapore is expected to go live in 2014 for FX.
Macbeth says: “Reporting is adding to the operational challenges faced by firms because it is a new requirement. There are third party vendors that are offering delegated reporting, however, that still means the information will need to be retrieved from the systems, enriched and transformed before it is submitted to the trade repository.”
He adds that for firms that connect directly to the trade repository, submitting the data to the trade repository with a common identifier will be key. “Firms have to think about slightly different workflows to establish these trade identifiers and communicate the trade details ahead of reporting to a trade repository,” he says. For those connecting indirectly, Macbeth says that there are potentially going to be different services offered by banks to their customers, so understanding those and how they can prepare to overcome the technical challenges will be crucial.
Macbeth also says that some of the larger funds and large corporates have made moves to connect directly to the repository. He believes the recent approval of trade repositories created a new flurry of activity and he also expects more buy-side firms to connect directly to DTCC.
The FX industry will have at least four trade repositories to choose from. Firms need to understand the business models of each and choose the trade repository that offers economies of scale, provides choice when it comes to reporting and connectivity options, taking into account the volume of derivatives traded, and has no hidden costs.
Macbeth is confident that DTCC has future-proofed its trade repository and can easily expand the data coverage it has and tweak the processes further down the line as the learning curve develops. He says: “We will most likely understand more, over time, about how we can extend our software to hold more reference data so customers will not need to report every data item on every change. Once we understand which data they have most trouble with that model will optimise.”
“I think we will find ourselves optimising what we do alongside the delegated reporting offerings from banks and I am sure we will work out how best we change our processes to align with those.”
In Europe, firms will always have the choice of trade repository. In the US, where the customer does not have connectivity to a trade repository, the SEF will select a repository and report the trades. In Europe, as both parties have to report the trade, to a certain extent the trade repository will have to compare and match the trades. Macbeth also adds that where the two counterparties go to two different trade repositories there will be a reconciliation process between the two repositories. He says that this is why there is so much focus on trying to agree trades before reporting takes place, if not, reports will start to diverge. “Some of the more complex fields, such as confirmation time, execution time and the product descriptions, which are text-based, have the potential to show up as different.”
Steve French, Director, Product Marketing at Traiana says that the new regulations will bring client clearing, as opposed to interdealer clearing, to the FX market for the first time and will prompt a need to classify clients as there will be more types of participants connecting to clearing in different ways. As there are many banks that will not become direct members of a clearing house, they will need to become clients of a clearing member creating a new clearing client type alongside the pure buy-side clients. French says: “This adds a new layer of complexity as some banks will have to change their flows to connect to clearing members and they will effectively look like clients. This connectivity for a non-clearing bank will look very like our existing clients for FX prime brokerage.”
He says the workflows will vary depending of whether it is an interdealer trade, either between two clearers, a clearing bank with a third party clearing member, or two third party clearing members.
As a result, it is not just the buy-side that will have to change their workflows in the light of the new regulations affecting FX. Some banks are set-up to do ‘give-up’ trades only, and executing banks, that face clients, have also added complexity to deal with in allocations as well as the receipt and processing of split shakes.
According to French, the new regulatory requirements bring with them complexity of client types, or participants, and their interaction with clearing members as well as the need to connect to CCPs, either in multiple jurisdictions or which have differing workflows, matching capabilities and APIs. Furthermore, for reporting, French says participants do not want to have to send the same trade multiple times for clearing, credit checks, and reporting in different jurisdictions.
French stresses that SEFs are highly involved in reporting as well as clearing. SEFs need to look at how they will fulfil their clearing and reporting connectivity and, more importantly, once a SEF is up and running certain reporting mandates have got to be fulfilled. He says: “SEFs have got a crucial role in passing the appropriate trade identifiers to enable the counterparties to the trade to fulfil their own reporting obligations.”
Traiana has tried to make the changes needed as painless as possible for existing participants. He says clients connected to the Traiana infrastructure will see a minimal impact in order to fulfil their clearing and reporting requirements through the ability to enrich trades with both static data, and the generation of the appropriate identifiers, and through the dynamic routing to the appropriate clearing houses.
For the banks, French says Traiana is trying to leverage existing Harmony connectivity, which has been there for a number of ‘give-up’ banks for many years, and offers the option to re-use that existing connectivity and for Traiana to change the look of the trades, to make them look like client trades, for the non-clearing banks.
He says: “Many banks looked at reporting even though there was a wide belief that a clearing mandate would come in before reporting. Under both Dodd-Frank and EMIR, reporting is actually coming in before the clearing mandate.”
The EMIR deadline for reporting of February 2014 made many banks revisit what they did in order to comply with the Dodd-Frank reporting requirements and take a fresh look at how they could invest in more flexible system connectivity as there are other jurisdictions on the horizon as well.
Using Harmony, Traiana is enhancing on-boarding capabilities with a ‘self-service’ solution so Traiana can on-board clients on behalf of reporting parties or clients contracted directly with Traiana. He says: “We do a one-time static data on-boarding where we hold that data within Harmony and then any subsequent trade can be enriched with that static data before submission to the specific trade repository.”
As Traiana supports all FX products, French says there would be no additional workflow or additional connectivity needed to turn any of these trades into cleared trades in the future, if further regulation is made. Going forward, he believes clients are now looking for diversification, better use of margin and better offsetting and are looking to use more prime brokers. For this reason, he predicts, the industry may see less trades across a greater number of prime brokers in order to get this diversification.
He says: “Clients should be able to reach as many clearing houses and as many FCMs as possible through a single point – they should have the freedom of choice of clearers, clearing houses and trade repositories and flexibility of integration to the platform. They should not be forced down a single protocol for that connectivity across the different jurisdictions.”
Economies of scale
Middleware specialist, MarkitSERV has worked with the major clearing market participants for three years to build functionality that can be leveraged to support the clearing requirements of Dodd-Frank and EMIR and the firm is monitoring developments carefully to see if there are any further modifications required. For reporting, MarkitSERV will assist clients in complying with the new requirements and where it makes sense, bringing the clearing and reporting functionality closer together.
Keith Tippell, Managing Director of MarkitSERV FX, says “It’s a story of ongoing changes and an ever increasing number of end points (CCPs and repositories) along with a greater number of participants who either need to take part in the workflow or see the results. With four FX CCPs live and more to launch, five to ten repositories at steady state and up to eight entities involved in a SEF executed clearing FX transaction, there is a lot of connectivity required which can be very expensive if you build it all yourself. And this is exactly what our clients are asking us to focus on – building middleware to bring all this together, gaining economies of scale, by building once and managing the ongoing change of each piece of end point connectivity in one place. As part of this work we also drive standardisation, based on industry design/consensus, to the workflows.”
MarkitSERV has invested heavily in building a future-proofed FX clearing connectivity and workflow platform. This platform has been live since 2011 and now connects most of the major dealers with up to four FX CCPs, supports client clearing and manages clearing broker / FCM ‘take-up’ workflow.
Tippell adds: “We have partnered with SWIFT and Misys to give market participants more choice in how they connect into the workflows. We have leveraged three years’ worth of work on clearing to help build out our SEF connectivity product, FXWEB, which offers regulatory reporting and clearing solutions to SEFs, along with voice affirmation for voice brokers. This service has been live since early October with a significant number of FX SEFs. MarkitSERV is also heavily focused on SEF confirmations and all the challenges around regulatory reporting including UTI pairing and exchange.”
DealHub provides connectivity, trading, trade processing and business intelligence solutions to global financial markets, including all of the world’s largest FX banks. Patrick Philpott, President, DealHub US says that the introduction of SEFs for trading of required products and the introduction of CCPs for mandatory clearing will impact both the reporting workflow and the end-to-end trading workflow. “Where the SEF is part of a pre-existing trading venue, as is primarily the case in FX, physical connectivity for STP remains the same, however, the message payload varies depending on whether the trade is SEF eligible or not – this creates complexity and requires updates to existing systems by market participants.”
“Specifically, the SEF is responsible for generation of the USI and for the initial trade reporting for SEF executed trades – this is a change to currently implemented reporting workflows at SD/MSP banks. The USI must now be consumed rather than generated and the initial reporting needs to be suppressed by the SD/MSP (although continuation data reporting is still done by the SD/MSP).”
In terms of trading workflow, the need for trade certainty prior to execution means a new pre-trade credit check is required for SEF executed trades. For prime brokers this means new requests from SEFs for credit checks. When a prime brokerage client wants to trade on the platform, the prime broker needs to respond in real-time before the trade is executed on the SEF platform. Philpott says that trades executed on the SEF are also legally confirmed once done so this also impacts the FX confirmation workflow process.
Furthermore, according to Philpott, a recent advisory from the CFTC regarding the provision of open access to all SEF participants also has a significant impact on trading platforms and their enablement functionality. He says: “If a liquidity provider provides liquidity to a SEF then they must enable all participants on the platform to trade with them – in effect this means the dealer to client relationship cannot be maintained on a SEF - the only trading protocol allowed is an all to all protocol.”
Another significant workflow impacted by SEF rules is the treatment of trades that fail to clear for any reason other than operational issues – the void ‘ab initio’ rule means that such trades can be done again on the same terms or one of the counterparties may choose to walk away from the trade if they are no longer in the money based on the original trade terms.
In terms of connectivity, Philpott says that firms need to have pre-trade credit checking connectivity in place as well as SEF, CCP and TR connectivity. While this physical connectivity needs to be set up and maintained, the real challenge is managing the routing rules, monitoring trade lifecycle status, responding to client and regulator queries and dealing with exceptions.
“To keep on top of this challenge, banks need to implement flexible, easy to manage routing rules and create dashboards that provide a homogenous view, in real-time, of all client and firm trading activity. The status of each trade across multiple venues, CCPs and TRs must be clearly shown so that any exceptions or issues are immediately addressed to ensure continued compliance with all execution, clearing and reporting rules,” he adds.
To this end, DealHub’s approach from the outset has been to provide a local repository along with a flexible script driven rules engine and API interfaces to TRs and CCPs. This way, as the rules continue to evolve or are clarified, the flexible rule set can be easily configured to implement changes. Philpott says: “We also built a comprehensive dashboard that gives a real-time overview of all activity in real-time along with a 10 year archive that helps firms to manage the complete workflow in real-time and to comply with record keeping requirements including the ability to reconstruct the trade lifecycle of individual deals by maintaining linkage between the pre-trade price negotiation, the execution and the post-trade activity for the trade.”
The requirement for both parties to report to the TR without duplication presents challenges for FX since there is no central clearing in place for FX instruments. At some point in the workflow, the parties need to agree and/or exchange the UTI for the trade prior to reporting to the TR. This could occur during the trade recap, via an allege message from the TR or at confirmation.
Says Philpott: “Delegated reporting requires the reporting party to maintain counterparty static for its clients as some of the information required on the trade report is not available at the point of execution.”
He adds that collateral information will also need to be reported under EMIR and is generally held in separate systems at firms so this needs to be gathered and integrated into the reporting suite, and for banks that opt to use a counterparty or third party for delegated reporting, the bank is under the obligation to reconcile their trades against the TR or possibly multiple TRs.
Unlike Dodd Frank reporting, there is no concept of a reporting party where one party generates the USI and communicates it to the other party, according to Philpott. “Where parties have an obligation to report in the US, the USI could be used as the UTI. In terms of generating the UTI, firms could use the FX Cash Rule or the Option Seller Rule to determine which party generates the UTI. Alternatively firms will agree bilaterally on which party always generates the UTI.” For delegated reporting, additional static data is held for each counterparty and used in combination with rules to complete the counterparty part of EMIR reporting.
“While this physical connectivity needs to be set up and maintained, the real challenge is managing the routing rules, monitoring trade lifecycle status, responding to client and regulator queries and dealing with exceptions.”
DealHub is currently working on data transformation and routing changes for integration to multiple CCPs and TRs, changes to credit management systems for pre-trade credit checking, new dashboard monitoring systems and changes to reconciliation systems. Work is also being done for generation and exchange of UTIs and counterparty static data for EMIR reporting.
Philpott summarises by commenting that “In this environment, with challenging deadlines, fast evolving rules and flexible interpretations, banks need a partner with three key assets: flexible technology, comprehensive regulatory knowledge and deep integration expertise. It is this combination that will ensure banks are able to build the connectivity and workflows they need to be certain of meeting regulatory obligations on time, while minimising the impact on their core systems and processes.”