There are a number of other interrelated regulations in the United States and Europe which significantly affect the trading, reporting and IT infrastructure investments of firms active in the derivatives markets.
REMIT (Regulation on Wholesale Energy Markets Integrity and Transparency). REMIT is a European regulation requiring the reporting of derivatives trades on physical commodities. REMIT is a highly transformative regulation for commodity producers, hedgers and traders which interacts with EMIR and MiFID.
Reg NMS (SEC). As mentioned in Part 3, Reg NMS is a U.S. market transparency regulation for equity securities which requires a significant amount of data all the way from pre-trade bid/ask prices through to post-trade reporting and reconciliation. The counterparty identification requirements are significant for broker-dealers and other major equity market participants. Reg NMS overlaps with CFTC / Dodd-Frank and SEC rules related to derivatives.
T2S (TARGET2 Securities). T2S is a European regulation which is intended to integrate and harmonize the highly fragmented securities settlement infrastructure in Europe where there are 35+ CSDs. T2S is being driven by the need to reduce costs of settlement and to optimize liquidity and capital management across the EU. T2S effectively forces asset servicers, custodians, clearing houses and payment processors to adopt common trade and counterparty standards. T2S is therefore highly interrelated with EMIR and MiFID as all three regulations cover shared derivatives data.
Volcker Rule (U.S.)
Under the Dodd-Frank Act’s Volcker Rule, granular hedging is now required by Tier 1 and 2 banks to eliminate proprietary risk taking. The Volcker Rule first affected Sell Side banks and brokers by forcing the divestment or closure of proprietary trading desks. However, the Volcker Rule has been expanded further to cover non-hedged position risk taken by the bank’s Treasury and/or accumulated across business lines or trading desks.
Under these new sell side rules, banks must utilize derivatives predominantly for hedging purposes, and must prove derivatives hedges are effective at the position level. This is similar to FAS 133 / IAS 39 in many respects, although the concept of hedge effectiveness differs. To comply with the Volcker hedging rules, banks must tightly integrate their trade and counterparty identifiers to enable detailed reporting on an intraday basis. The same IT and data infrastructure used for CFTC, EMIR, Reg NMS and MiFID is involved.
These hedging regulations also affect banks’ Capital Requirements like RWA. Traders must adjust their derivatives hedges vs. underlying positions to meet Volcker. As a result the bank may have less available liquid capital to meet Basel, U.S. Fed and other capital regulations.
Recently the Volcker Rule has been expanded to the buy side by covering Asset Managers who are Major Swap Participants.
Basel II, 2.5 and III and BCBS 239 Risk Aggregation.
Basel regulations and best practices governance require increased data granularity, quality and completeness for risk, capital, trading, etc. Firms building their data and IT infrastructures to meet multiple derivatives reporting regulations must take into account the interaction with investments made to meet Basel requirements. Most regulations require increased data granularity, reconciliation and reporting flexibility. Derivatives compliance IT and data investments made by financial firms are reusable, as long as the increased complexity is rationalized and modern, flexible technologies are adopted.