Quality Control: Is Sampling Effective in Transaction Reporting?
Financial firms face a complex web of regulatory requirements – with transaction reporting undoubtedly taking the crown as one of the most challenging. Firms need to ensure that they fall on the right side of the regulations. Sampling might seem like an easy way to perform compliance checks on the quality of your transaction reports, but it may not be the effective solution you think it is.
Following Brexit, the Markets in Financial Instruments Directive (MiFID II) and the Markets in Financial Instruments Regulation (MIFIR) have been onshored and enshrined into UK law. The UK Financial Conduct Authority (FCA) has a robust enforcement regime, and the £34 million fine imposed on Goldman Sachs International just goes to show that no business is exempt from the need for proper compliance.
With such severe consequences for non-compliance, no firm can afford to take the wrong approach to transaction reporting. In this article, we look at whether sampling is an effective way to monitor the quality of submissions to regulators, and consider whether there’s a better approach to transaction reporting.
Compliant transaction reporting – the law
Alongside a raft of other requirements, regulations, and guidelines, firms must abide by the Regulatory Technical Standards (RTS) as set out by the European Securities and Markets Authority (ESMA). These remain relevant post Brexit, since they are part of UK law by virtue of the European Union (Withdrawal) Act 2018.
Firms should pay particular attention to Article 15 of RTS 22, which sets out requirements for the ‘methods and arrangements’ for reporting. Among other provisions, Article 15 requires trading venues and investment firms to have:
- mechanisms for identifying errors and omissions within transaction reports; and
- the means to ensure that transaction reports are complete and accurate – including through the testing of reporting processes and regular reconciliation of front-office trading records against samples provided by the authorities.
The burden presented by these requirements will naturally weigh less on firms that have robust reporting mechanisms in place. Even so, it’s still important to conduct quality assurance checks and the fact that a report can pass regulator-imposed validation checks does not mean that it’s error-free.
How can firms check the quality of transaction reports?
To avoid substantial fines and other sanctions, firms need to check the accuracy of all the data they submit to financial regulators. It’s important to ensure that all data fields are assessed against a benchmark to ensure that they are correct, and that reporting integrity is not compromised across any area of a firm’s financial activity.
Transaction reporting quality assurance can be carried out in several ways:
1. Transaction testing
Transaction testing involves the quality testing of transaction reports against source documentation. Firms typically use samples either from their own records, or provided by the regulator for use in end-to-end reconciliations. The frequency with which this testing must be performed depends on the organisation in question, and sample sizes also vary.
In simple terms, the FCA provides firms with report samples that have been validated by instrument reference data. The information held by firms in their front-office records should be brought in line with the validated reporting records, and any errors or omission must be flagged to the FCA’s Markets Reporting Team.
The process of transaction testing shows just how challenging transaction reporting can be. The FCA regularly publishes information about the failures it sees regularly, for instance in its Market Watch Newsletters which highlight common reporting errors including:
- Incorrect time reporting (particularly in respect of the UK’s transition to British Summer Time);
- The recycling of identifiers for multiple clients; and
- Failure to report price in the major currency.
2. Controls testing
Controls testing involves the evaluation of the design and operational effectiveness of the controls put in place around transaction reporting. These functions are generally carried out on a more infrequent basis, perhaps owing to the lack of regulatory scrutiny of backend transaction reporting processes.
3. Conformance testing
Conformance testing involves analysing regulatory filings and identifying nonconformance issues. As opposed to the approach taken in respect of transaction testing, conformance testing goes beyond the basic compliance burden to reconcile reporting processes with regulator instructions.
As with controls testing, conformance testing seems to be less of a priority for many firms since regulators do not pursue issues in this field quite so proactively.
Common transaction reporting compliance issues
Transaction reporting has always been a challenging affair for investment firms, but the rules shifted significantly with the implementation of MiFID II. This broadened the scope of reporting, bringing more instruments and institutions into the regulatory fold than ever before. Matters have only been complicated further by Brexit, as although the EU regime has been broadly translated into domestic law, certain dual reporting obligations have arisen where transactions have a multi-jurisdictional element.
While firms may have become comfortable with transaction testing, report sampling, and even end-to-end reconciliations, it’s clear that many businesses have deeper issues. As reporting becomes a more complex activity, business leaders should look beyond whether their reports comply with regulatory standards.
Firms should also consider whether their systems and internal governance frameworks allow for a consistently compliant approach to transaction reporting. Transaction reports and the data within them flow throughout an organisation before they reach the regulator, and so it’s essential to have proper controls in place to maintain the integrity of data while facilitating accurate report generation.
The simple approach to compliant transaction reporting
It has become increasingly clear that the FCA is not afraid to flex its regulatory muscles when it comes to sanctions for non-compliant transaction reporting. Sampling and end-to-end reconciliations of data reports are an essential part of the governance regime for all firms, but these activities are the bare minimum for compliance.
For an altogether safer and more compliant approach to transaction reporting that minimises the risk of regulator sanctions, firms should ensure that they have robust systems in place. By using eflow’s TZTR transaction reporting software, you could improve the accuracy of your transaction reports and make end-to-end reconciliations even simpler.
To improve your internal compliance regime, book a demo below or contact eflow today.
*This article is provided for informational purposes only and should not be relied upon as legal or financial advice. Its contents are current at the date of publication and do not necessarily reflect the present state of the law.