EMIR Refit and global derivatives regulation

While some sensationalised media headlines suggest that the UK and the EU financial services regulators are constantly at loggerheads, this is not always the case. They may be competing for business, but both parties recognise the need to harmonise global standards concerning derivatives. 

We only need to look back at the 2007/8 financial crisis, which saw contagion sweeping through the markets and bringing many governments and financial institutions to their knees. It is critical that regulators can monitor not only their local derivatives markets but also global trends. By homogenising derivatives reporting regulations, the risk of noncompliance would be greatly reduced.

This article will look at harmonising derivatives regulations and EMIR REFIT, which will see global standards more closely aligned.

Fundamental changes and objectives of the EMIR Refit

There are several critical changes to the reporting system, which include:-

• Increasing the number of reportable fields from 129 to 203 to align with CPMI-IOSCO standards
• Switching from submissions in CSV to XML (using ISO 20022 standards)
• The removal of irreconcilable fields and tolerance levels in the UK system
• Unique Product Identifiers (UPIs) will reduce inconsistencies but at a cost
• Unique Trade Identifiers (UTIs) will remove a degree of discretion, creating a more formalised process
• UTIs must be provided by 10am T+1, thereby ensuring that both parties can report trades on time

It is important to note that the new regulations cover market traded and OTC derivatives, thus giving regulators information across the entire market.

EMIR Refit: What is the ultimate aim?

The objectives are simple:

“To further enhance the harmonisation and standardisation of reporting under EMIR."

The new reporting system will allow regulators to better monitor systemic risk, which has the potential to bring down not only individual entities but entire financial systems/investment markets. It is also a means of controlling regulatory and reporting costs across the whole financial services industry.

As both sides of each transaction need to match, it is asynchronous, and a sign of slight regulatory divergence post-Brexit, that Europe will go live with its version of the EMIR REFIT on 29 April 2024 while the UK is a little later, on 30 September 2024. This means that some financial counterparties will be operating two different reporting systems for a period. The overlap is due to the UK government being committed to an 18-month introductory period between the announcement of the EMIR REFIT (slightly delayed) and the switch to the new reporting system. Yes, there will be harmonisation, but at a later date.

International regulatory standards and initiatives

The G20 and, by proxy, the Financial Stability Board (FSB) are at the heart of the push to harmonise international derivatives regulations. This body promotes global financial stability by working with regulators and supervisory bodies from G20 members and non-member countries. The FSB was a successor to the Financial Stability Forum (FSF), with the need for change in light of the 2007/8 financial crisis.

The FSB was created to:

• Identify and review potential vulnerabilities of the global financial system
• Promote the exchange of information between different regulators and reporting bodies
• Assess the potential impact of regulatory changes on global markets
• Advise on best practices for regulatory standards
• Work with international standard-setting bodies to co-ordinate global regulations
• Set guidelines for establishing and supporting supervisory colleges
• Support contingency planning for cross-border crisis management
• Collaborate with the IMF to conduct early warning exercises
• Promote the harmonisation of global reporting standards

Where historically local regulators, taking in an array of different reporting systems, would be defensive of their domestic oversight, instances of contagion have brought these parties together. As we saw just recently, we were for a time staring contagion down the barrel when the US banking sector wobbled, and some banks needed additional financial backing.

The introduction of EMIR REFIT now brings the EU and the UK more in line with the US market. While the broader benefits have been detailed above, some US institutions will encounter margin calls in the future due to regulatory harmonisation. 

The benefits of global harmonisation

As the leading financial markets, such as the US, UK, EU and APAC, come together to harmonise global derivative regulations, this forces others to follow suit. EMIR REFIT has also brought together actively traded derivatives against OTC markets to provide a global picture. This allows regulators to assess ongoing and even predict systemic risk, which, as we have seen, can bring down markets and economies.

As a result of this ongoing harmonisation of derivatives regulations, there will be improved transparency and risk management. In hindsight, it was apparent before the 2007/8 financial crisis that derivatives exposure placed the US subprime mortgage market in a perilous situation. Such was the use of derivatives to slice and dice, repackage and resell mortgage obligations that a wobble and a sudden drop in confidence would bring the market crashing down. However, hindsight is a beautiful thing!

This prompted the US government to bring in new regulations to restrict the power/influence of derivatives. On the flip side, it is crucial to recognise the role that derivatives play in creating liquid markets. 

Cross border trade

Growth in cross-border derivatives trading is a significant factor which brought together G20 regulators and other non-members across the globe. While everyone from Warren Buffett to the Vatican has expressed concern about derivatives, they are an integral part of the global financial markets. Enhanced transparency and information sharing will create a more stable trade environment and, hopefully, reduce the threat of contagion as we advance.

Challenges in achieving global consistency

As investment and money markets around the world become more entwined, with cross-border transactions now as easy as dealing with your neighbour, there is a need for greater regulatory consistency. While OTC derivatives markets are primarily unregulated, there is an indirect degree of control as the financial institutions/counterparts are usually regulated. This provides an element of regulatory harmonisation, but bringing together reporting systems and formats is very different.

The main challenges in achieving global consistency in reporting standards are as follows:

Economic and political considerations

The US, UK and EU continue to battle it out to become leaders in all areas of the investment/money markets. However, each country, political party and regulator will have domestic challenges to consider in line with international pressures. While they all know they need to work together, it is often akin to a game of poker; who will blink first, who will lead and who will follow.

Different jurisdictions, different regulations 

There are three central leading bodies regarding global investment regulations; the US, UK/EU and various parties in the Far East. However, even though the UK and the EU are moving in the same direction, they are moving at different speeds. As cross-border trade continues to grow and investors/financial institutions demand greater protection and transparency, other regulators will eventually be forced to fall into line.

Technological/operational challenges

The RegTech sector, a subsector of the wider FinTech industry, has attracted massive investment over the last decade or so. This has prompted governments and regulators to be more appreciative of new technology and innovation while also looking to retain a degree of control. Then there are the operational challenges, the increase in short-term costs and challenges to profitability.

Ultimately, global regulators know they must work together to create a transparent regulatory structure. One that will help them identify potential problems, such as the systemic pressures building before the 2007 financial crisis, and take pre-emptive action.

Regulatory cooperation and the next steps

The fact that the UK and EU, according to the broader media, appear to be at loggerheads regarding their financial services industries, but working together on derivatives regulations, says everything. 

They are both well aware of the need to cooperate and add the next piece of the global regulatory jigsaw because cross-border trading is now as simple as pressing a button. 

While impossible to rule out entirely in the future, the convergence of derivatives reporting regulations makes catastrophic market events less likely or, at least, less damaging.

Even though the 2007 financial crash began in the US subprime mortgage market, an inability to identify the risk from derivatives led to contagion and a worldwide economic crash. 

We would be surprised if, despite partisanship, countries didn’t see the benefits in alignment and synchronizing of at least the important aspects of derivatives regulation. 

Conclusion

Bringing together domestically traded derivatives and OTC markets is important, but doing this worldwide is critical. This enhanced transparency allows regulators to adapt and control margin obligations to account for underlying market conditions. 

It is vital that the EU, the UK, and global partners look to harmonise EMIR REFIT and their comparative domestic regulations. 

The ongoing UK and EU EMIR REFIT regulatory changes in the derivatives market are the next stage in what some see as an eventual global regulatory system. 

At eflow, we provide various regulatory compliance solutions for the financial services industry, using continually-updated, market-leading technology to ensure accuracy and reporting speeds. 

If you would like to chat about your future obligations under the EMIR REFIT, get in touch.