Banks believe they may be able to find an answer to the perpetual system changes triggered by regulators’ frequent redrafting of derivatives reporting rules. New technology promises to cut compliance costs by axing the need for banks to undertake large implementation programs every time a rule change is made.

“It will take a fair amount of time to get to nirvana, but that nirvana will be to save money on the interpretation of the regulation,” says a reporting specialist at a European bank. “It should be standard and easily understood, [and] the actual reporting side should become a lot easier to do and to manage as well.”

Following the financial crisis, G20 governments implemented rules requiring derivatives counterparties to report details of their trades to repositories, which share the information with local regulators.

US banks have been reporting details of over-the-counter derivatives as part of the Dodd-Frank reforms since 2012, while banks in Europe having been doing the same under the European Market Infrastructure Regulation (Emir) since 2014 for both OTC and exchange-traded derivatives. The rulesets have already been subject to previous rounds of changes, and both US and EU regimes are facing further modifications within the next two years to incorporate new data fields.

Banks and regulators are now exploring the development of freely available and machine-executable code that reporting firms could copy into their internal systems, saving them from making their own interpretation of rules and developing separate codes.

“As to whether it will be regulators providing the code or if there will be a middleware provider, I’m not sure yet, but either way there is a lot of potential,” says the reporting specialist. “It really would remove a lot of the issues around individual interpretation and trying to understand the regulation.”

A head of reporting at a large US investment bank actively working on an industry-led initiative concurs, saying they feel “very positive” about it.

Open-source code can save banks money in two ways. First, they can pool the effort of designing their own interpretations and internal code for changes to requirements between them, rather than having large individual compliance teams each doing the same work. Instead, banks would work together to produce a single open-source code and implement that into their systems. Large changes to reporting rules have cost each bank millions in the past.

“It’s not inconsequential, people have spent millions of dollars to implement their trade reporting infrastructures, and now they’re spending millions more to overhaul them,” says a source with knowledge of the industry-led project.

Banks in Europe also have to constantly check the regulator’s understanding of the rules isn’t different to their own. The European Securities and Markets Authority regularly publishes Q&A documents interpreting specific parts of the EU’s rules, which means compliance costs don’t just stop once the deadline for major changes has been reached.

Lee Braine, managing director in the chief technology office at Barclays, says in an email that the industry-led initiative also has the potential to “reduce interpretation and implementation risks”. The reporting specialist at the European bank says reaching a single interpretation among banks and regulators should cut the risk of erroneous reporting, which comes with the threat of fines.

The largest fine meted out by a regulator was the £34.5 million penalty that the Financial Conduct Authority slapped on Merrill Lynch International—part of Bank of America—in 2017 for failing to report 68.5 million exchange-traded derivatives trades.

Wait and see

Both a regulatory and industry-led solution would rely on the publication of machine-executable instructions, and is described under the umbrella term ‘digital regulatory reporting’.

The International Swaps and Derivatives Association is spearheading the industry-driven initiative, consisting of banks and various vendors. The plan is for dealers to determine a single interpretation of each reporting field of each jurisdiction’s rules. Isda will then provide a code that would link the information needed to satisfy the regulation with standardized terms used in its common domain model (CDM)—a digital blueprint that provides a representation of derivatives products and trade events. Banks that haven’t implemented CDM as part of their business will map terminology used in their businesses to CDM.

Isda’s first code will interpret changes that the Commodity Futures Trading Commission has made to its reporting rules, which will take effect from December 5 this year. Following implementation in the US, Isda also plans to release another code that will be used for changes to Emir that are anticipated to take effect next year. Both rule changes will incorporate internationally agreed critical data elements released by the International Organization of Securities Commissions in April 2018, in an effort to harmonize reporting fields between jurisdictions.

Regulators are also exploring how to provide regulation in machine-executable code. These initiatives appear further behind than Isda’s project.

In the UK, both the Bank of England and Financial Conduct Authority have undertaken two pilots that assessed how technology could improve regulatory reporting, and whether it was worth it. Results of the last pilot were published in January 2020 and the assessment concluded more work was needed to understand the costs and benefits.

Meanwhile, the European Commission released a paper in December last year stating that it was looking to provide regulations in machine-readable format alongside the standard text format.

Despite the progress Isda’s project has made, dealers have varying degrees of appetite for the code right now. Some are using it to validate their own implementations.

“They can take [the code] and use it internally instead of developing their own code, or they can use it as a validation layer,” says the source with knowledge of the industry-led project. “For instance, if they’ve already built their code for CFTC [reporting], they can take the code and run it through [their trade data] to see whether they get the same results.”

Others—including the reporting specialist at the European investment bank—aren’t convinced it can be used and relied upon just yet, but might adopt it in the future.