THE HIGH PRICE OF NON-STANDARD COMMUNICATION: firms reduce costs, errors and risk for OTC cleared derivatives reporting and communications by adopting new clearing connectivity standard
Now that some of the dust has settled following the implementation of several regulatory initiatives, such as Dodd-Frank, MiFID II/MiFIR, and European Market Infrastructure Regulation (EMIR), many financial institutions are grappling with how to deal with the impact these initiatives have had on their derivatives business. In this article, Phil Matricardi and Adam Kott discuss why firms are adopting the new ISDA Clearing Connectivity Standard (CCS), introduced two years ago, for derivatives reporting and communication and why an industry utility for data transformation is a necessary next step.
New regulatory requirements, combined with the increasing volume of cleared derivative trades, number of new players, and expansion of new offerings from existing players have added more complexity and expense to managing derivatives. As a result, firms—those interested in remaining competitive and protecting revenues— have begun to critically evaluate their operating models, processes and technology and look for ways to be more efficient and cut unnecessary costs.
One area ripe for improvement is derivatives reporting and communication. Particularly as the industry comes to terms with mandatory clearing, the lack of a formal standard for formatting and transmitting margin and position data is a significant hurdle to achieving efficient and cost-effective connectivity between market participants. Currently, data between asset managers, clearing brokers, custodians and service providers is transmitted in a variety of formats. Custodians, for example, routinely receive a wide range of account-related information, such as fees, trade positions, netted positions, terminated trades and collateral from clearing brokers. Due to a lack of formal standards for formatting this type of data, most clearing brokers supply information to their customers in different electronic formats; these formats have been developed over time to suit their own operational needs and based on their own proprietary software or heavily modified commercial software.
THE NEW REALITY OF NON-STANDARD DATA FORMATS
Up until new regulations went into effect and firms began to look for ways to decrease costs, use of proprietary data formats was considered a competitive advantage. Clearing brokers are often required to comply with their clients’ proprietary file formats. If a client wants to work with a new clearing broker, that broker may have to build a new set of reports—a process that can be expensive and time consuming to the broker. In fact, brokers have related that their clients negotiate format with them in the same way that they negotiate fees, and that compliance with custom formats is a constant and expensive burden. Pushing back on clients by insisting that they use the International Swaps and Derivatives Association (ISDA) standard set of CCS reports is a key reason why clearing brokers support the initiative.
On the other side, such propriety data formats cause custodians to spend considerable time and effort manipulating the data into a consistent format that their systems and operations teams can consume. As the volume of cleared derivatives trading multiplies and custodians are forced to spend more resources reformatting non-standardized data, costs are increasing along with instances of manual errors and, subsequently, operational risk.
In fact, according to the ISDA 2011 operations benchmarking survey, roughly 10% of trade records contain errors across interest rate, credit, equity, currency and commodity derivatives. The survey also attributes 50% of trade capture errors to the front office.1 These errors range from counterparty name to legal agreement date, and plague all the commonly traded derivatives. Such errors can only be caught and corrected by reconciling positions and trading activity across counterparties, which is a very expensive process if each position at each broker has to be translated manually to match the client’s preferred format.
The reality is that the use of proprietary data formats is a costly and inefficient business practice, and clearly an area of competitive disadvantage.
FIRMS EMBRACE THE USE OF A STANDARD FORMAT FOR CLEARING REPORTS
In 2012, the ISDA Clearing Connectivity Standard (CCS), a standardized connectivity format, was introduced to the clearing broker community for transmitting cleared over-the-counter (OTC) derivative-related information. Specifically, CCS standardizes all of the message elements that should be universally present in margin statements, such as fields, headers and descriptions.
The standard currently covers cleared IRS, CDS, and NDF trade, position, margin and collateral data for LCH, CME and ICE products. The CCS format can also be applied to varying timing and/or frequencies for complete or partial feeds based on the needs of the various parties. The format is currently specified as a series of CSV files, and made available as a free, downloadable Excel document from the ISDA website. When the ISDA CCS Steering Committee deems it appropriate, the CCS format will transition from CSV to FpML.
Figure 1. High-Level Overview of Sections Covered by the Clearing Connectivity Standard
Today, CCS is recognized as the industry standard by ISDA and many of the largest OTC derivatives clearing brokers including Bank of America Merrill Lynch, Barclays, J.P. Morgan, and UBS. In addition to CCS being a significant step towards achieving efficient and cost-effective connectivity between market participants, members of the Futures Commission Merchant (FCM) community are embracing its use to:
- Reduce errors and risk. By moving to a standard format, firms greatly reduce the need to spend time interpreting and reconciling data from different formats, or having to manually enter data from reports into their own systems, putting the data at risk for human error.
- Improve communication. Currently, when counterparties, or clearing brokers, service providers and custodian banks call to report or resolve an issue, they spend a considerable amount of time describing the content and defining the data. This process of break identification is streamlined by adhering to CCS.
- Meet client demands. Derivatives customers, notably large asset managers, have already begun approaching their clearing brokers to request compliance with CCS.
- Reallocate resources. As margin reconciliation becomes standardized and automated, operations staff can be reallocated to more capital-efficient processes.
- Pass along savings. The automation of margin standardization and reconciliation may allow clearing brokers, custodians and service providers to pass savings on to their clients, who in turn can use this newly freed capital to engage in more swap transactions.
- Improve client onboarding. End users who wish to receive CCS reports can do so quickly and efficiently, eliminating the need to negotiate numerous custom reports required by their clearing brokers, custodians and service providers.
- Gain a holistic view of client swap information. By using a standard format, custodians and service providers can see a complete view of their clients’ swap data across all clearing brokers, including margin balances and requirements, collateral holdings, and upcoming cash flows. Likewise, end users can easily view their information across clearing brokers, custodians and service providers.
Furthermore, as more firms adopt CCS, its use will strengthen an industry mandate, creating added pressure for those firms that delay complying with the standard. It is highly likely that, in the future, clearing brokers who do not adopt CCS may have increased costs passed on to their clients from custodians who are no longer willing to absorb the high cost of translating non-standardized data.
MARKET ASKING FOR MORE CCS COVERAGE AND AUTOMATION
Today, 26 firms have joined the ISDA CCS Steering Committee to continue defining the standard, and 17 firms are testing or producing one or more standardized CCS reports. Committee members are already asking to expand CCS’s scope beyond cleared OTC into listed futures and options to facilitate cross-product margining and netting. CCS currently allows for this at the account level, and discussions are underway to make enhancements to existing reports to include more granular futures and options information. Additionally, members have asked for the creation of a parallel set of standardized reports focused exclusively on futures and options products.
With industry-wide adoption of the new standard a future reality, the creation of a market utility that automates the translation and normalization of cleared product data is a clear next step for the industry. Such a utility would remove the burden of having to modify existing systems and reports for firms that do not have (or do not wish to spend) the resources to do so.
Additionally, despite regulatory needs and the industry’s cry for standardization, some firms may continue to use their proprietary formats. An industry utility would relieve custodians and service providers of the time-consuming and costly task of translating these reports. Non-standard data would be passed through the utility, which would translate and transform it into a CCS report and deliver it to the report recipient. Such a utility would also support data transparency requirements and enable straight-through processing.
Figure 2. How a Market Utility Could Streamline Derivatives Reporting and Communication
The derivatives market has already undergone major changes in the last few years—and more changes are likely to come if they can help firms dramatically reduce costs or increase profits. Identifying areas where efficiencies can be gained and expenses can be cut is now a necessity for market participants that wish to remain competitive and protect revenues. The industry has begun to address the issues of nonstandardized data formats for derivatives reporting and communication with the development of the CCS. With the market-wide need to remove the cost and burden of complying with non-standardized reports and bring speed and efficiency to derivatives reporting and communication, the creation of an industry utility only seems like a matter of time.
- ISDA, “ISDA Operations Benchmarking Survey 2011,” http://www2.isda.org/functional-areas/research/surveys/operations-benchmarkingsurveys/ (July 2014)