Over twenty years ago when I started my finance career as a trader at a Wall Street firm, I was quickly introduced to the idea of RGE’s vs NRGE’s. What are these? RGE’s are ‘revenue generating employees’ vs the ‘non-revenue generating employee’ NRGE’s.
More or less, the front office represents the RGE’s and the middle and back office are the NRGE’s. You can’t have one without the other, but in every firm I’ve worked for, there were always the RGEs that tried to pull rank of importance on everyone else because they could point to detailed revenue figures they brought. On the other hand, once an RGE stopped performing well, there were the NRGE’s that were more than happy to tell the RGE how useless they were to the firm.
Transaction reporting – the NRGE of compliance
Since entering the world of RegTech in 2016 and first supporting EMIR, I often think about the RGE vs NRGE dynamic. Firms need to comply with transaction reporting, but never see any benefits from it. When I speak with the clients, I often hear questions of what’s the point of the regulation, it doesn’t apply to me and its strictly a cost basis that needs to be handled as cheaply and efficiently as possible. Not much different than having to pay for mandatory renter’s insurance on one’s office, EMIR and other transaction reporting felt like the NRGE of NRGE.
What’s the point?
Since the go-live of CFTC Dodd-Frank reporting in 2013, derivative reporting of FX transactions has existed in one form or another. At present, along with the US, similar reporting regulation exists in Canada, Singapore, EU, UK, Australia, Japan and Hong Kong.
The premise of all the different regimes is more or less the same; capture key details about derivative transaction to allow regulators to monitor counterparty exposure, size of the market, trading trends and systemic risk. Data submitted includes LEIs of counterparties, product descriptions, quantities, notional amounts and identifying the buyer and seller.
Since the start of these regulations, a big question being asked is “what do regulators even do with this data?”. It can be argued that until the last few years, the answer has been more or less nothing. The only sizable fine related to derivative transaction reporting occurred in EMIR and was due to non-reporting of listed derivatives. As exchange traded products, their systemic risk is mitigated by central clearing obligations, and most regimes exclude them from being required to be reported.
Therefore, when it comes to fulfilling to premise of using derivative transaction reporting data for monitoring the market against risks, the evidence is that many regulators haven’t supervised appropriately. In their Peer Review of EMIR governance in October 2019, ESMA published their findings that many NCAs were lagging in their monitoring of data and improvement was needed. In addition, when introducing the update to Part 43 and Part 45 of Dodd-Frank reporting, the CFTC cited requirements for receiving improved data quality as the impetus for the regulatory updates.
Data quality focus
That all being said, after years of neglect, there is no doubt now that regulators are actively looking at derivatives report submissions and reviewing data quality. In the EU, following ESMA’s concerns and preparation for Brexit, NCAs have been and continue to conduct data reviews.
Common problems they have found are late reporting, anomalies in notional amount values and mismatches of trades with data from counterparty submissions. In addition, regulators in regions where many buyside funds are domiciled such as Ireland and Luxembourg have questioned fund companies how delegated submissions are being monitored for accuracy.
With the added scrutiny, it has put more pressure on investment firms and FX brokers to have systems in place to report efficiently and monitor for breaks and incorrect reporting.
This answers the above question of ‘What’s the point?’. The fact that we are finally seeing regulators focus on the reports, means firms need to take the regulation more seriously as it is more likely than ever to trigger fines and warnings from NCAs. However, as its still a cost burden, the NRGE approach still exists and complying with the regulation as cheaply and efficiently as possible while maintaining accurate and complete results is the optimal goal for investment firms.
To assist firms in achieving accurate reporting, a growing group of technology firms have been producing products to assist firms with their reporting. Spun out of the larger fintech sector, regtech focuses on creating solutions that merge technology with compliance. More than just technology, many regtech firms also employ regulatory subject matter experts to assist clients with answering question about how to report as well as preparing best practices to share with customers.
These are some of the main features regtech solutions provide to support transaction reporting:
- Data transformation – A big part of reporting is mapping trade data to that of the report formats required by the regulation. Regtech firms provides services to map an investment firm’s data and transform it to the submission formats. This saves time for companies as they don’t need to develop data transformation tools in-house.
- Reference Data Merging – As mentioned above, counterparty and instrument details are a key part of the reports. Regtech solutions may include the ability for firms to store static reference data files such as mapping of product and client short codes to their LEI, underlying currency, price multiplier and ISIN. The regtech solution then automatically merges this static data into the daily transaction data to create the final report.
- LEI Management – Some systems allow firms to received feedback from the GLEIF database of the status of counterparty LEIs to know if they are about to expire or inactive. This is important in the post MIFID II world where firms have a ‘no LEI, no trade’ mandate with their counterparties.
- Exception management – Just reporting isn’t enough. Having data on what’s incorrect and how to fix it is a key feature of status emails and dashboards that regtech firms provide. A proper system should be able to provide enough details for firms to be able to fix errors at source the reduce further incorrect reporting in the future.
- Reconciliation – Regulators are now more likely to be asking firms how they are checking that report submissions are complete. Reconciliation features allow firms to compare their submissions to front office transactions and identify report breaks as well as better understand why certain trades that are captured aren’t being reported. Reconciliation data can also compare to submissions being sent to trade repositories and NCAs to ensure that both sides are reporting the same number of trades and positions.
- Automation – To achieve efficient reporting, automating the process is key. Most regtech solutions include features to pull or receive investment firm data, create the report and submit it to trade repositories. Some solutions also automate the capture of messages back from the repository to provide a full end-to-end reporting with exception management.
- Future Proofing – With updates to transaction reporting regulation occurring often, regtech may be able to support these changes. This reduces the need for investment firms to build new processes in-house to support the changes.
FX specific solutions
For investment firms involved with FX, there are a number of asset class specific cases that regtech firms can assist with. The include:
- Swap submissions – Under EMIR and other OTC derivative reporting regimes, FX swaps have a number of challenges when reporting them. As a FX swap is composed of two legs, typically a spot and a forward leg, the two parts need to be reported together in the unified swap. A common industry challenge is where an OMS system is capturing each leg separately. A regtech solution can be used to identify common trade ID’s of the two swap components to combine them into a single submission.
- Counterparty side – Another question applicable to FX swaps and also forwards is who is the buyer and seller of the trade. Regtech subject matter experts can assist firms with feedback on this information while the technology solution should be able to apply logic to automatically format a swap or forward transaction with the correct buyer and seller format.
- Position compression – Very relevant to FX CFD brokers is the need to report end of day netted positions of trades. Regtech solutions include features to automatically compress daily transactions and then report them on a netted end of day position by counterparty level. This can decrease substantially the overall number of open trades a firm has and potentially decrease their trade repository costs.
The final frontier - Deriving actionable data
Helping answer the question of “How do I gain any benefit from my reporting?” many regtech firms are working on big data solutions to provide investment firms with tools to extract useful information from their regulatory submissions.
While not a revenue producing feature, advanced reporting solutions are providing ‘Insights’ modules. These tools allow investment firms to gather information on their reporting quality and performance over historical periods. Calculations may include lists of top error reasons, how often submissions are late and percentage of inaccurate reports.
Using the findings, the top errors allow firms to apply the 80/20 rule where they can concentrate on the 20% are issues that are creating 80% of their rejected submissions. This can greatly improve reporting quality by fixing the biggest issues first.
The historical percentages of rejected and late submissions allow firms to set KPIs to track their performance. By comparing month to month or quarter to quarter statistics, companies can determine whether their reporting quality is improving or not. During the Covid epidemic and early days of work at home, these types of analysis allowed many firms to easily identify spikes in report quality which were usually a result of out of date reference data being used.
Whether one works at a regtech vendor or any other fintech company servicing the finance industry, a popular question from client is intel in what the rest of the industry is doing. To support this answer, a number of regtech firms are creating opt-in anonymized peer review stats. The figures aggregate figures from clients opting in to share their information with it compared to a firms reporting data. The result are high level figures of trends that show top products traded compared to their peers, volume figures and may also spread capture.
When focusing on the FX asset class, firms can review how their top traded currencies compare to other brokers. This can help them determine if there are certain products their peers are doing well with that a FX firm might want to promote more as well. Overall, anonymized peer data provides actionable trends to help boost their performance.
Where things could get even more interesting is the convergence of artificial intelligence (AI) and regtech. Holding investment firm transaction data, regtech firms are in a position where they can assist their clients to provide tools to review trades to provide insight on investment results.
To support this use case, a number of regtech firms are developing AI solutions to review for trends such as best times to trade, optimal counterparties and most profitable traded products. AI feedback can then be used by investment firm front offices improve their trading performance. Such results offer the potential of finally providing companies the ability to squeeze out revenue benefits from the NRGE regulation.