Beware of valid but wrong SFTR reports
26 May 2020
Kaizen Reporting warns firms preparing for SFTR reporting that valid data doesn’t necessarily mean accurate data
Image: hvostik/Shutterstock.com
Many services have come to the fore ahead of the Securities Financing Transactions Regulation (SFTR) go-live, offering everything from trade matching, reference data enrichment to assisted reporting services. Securities financing businesses have historically been subject to very few regulatory reporting obligations, rarely abide by standards and are often quite firm-specific operations with a focus on collateral management and settlement efficiency rather than the finer details of individual transactions necessary for reporting.
The regulation has certainly inspired a desire to implement standards and bring industry participants closer together in areas such as user acceptance testing (UAT). A consortium has sought to help firms capture the complete scope of their businesses and the UAT testing necessary to try to ensure completeness of SFTR reporting. Furthermore, in an attempt to give comfort around progress with SFTR project plans, operating models have been reviewed and benchmarking put in place. This has provided something of a jump-start for firms that were struggling to get their SFTR plans firmly off the ground.
Look out for valid but wrong reports
Completeness of reporting and ensuring that reports are compliant with validation rules are both vital but it’s far from the whole story. Unfortunately, validation rules are very far from foolproof, with some significant holes. They also do not ensure that valid data (field populations that meet the conditionality and syntax rules) is correct data. Standardised test packs and a consortium approach to UAT testing is a very useful SFTR implementation tool but it simply doesn’t go far enough to ensure that data quality has been established or maintained once SFTR is a live reporting regime.
Our wealth of experience in testing existing G20 position and transaction-based reporting regimes such as the second Markets in Financial Instruments Directive’s transaction Reporting, the European Market Infrastructure Regulation or the US Dodd-Frank Act indicates that many reporting counterparties routinely submit reports that are valid but wrong. Indeed, the vast majority of fully validated transaction reports we test exhibit multiple errors, what we call the “valid but wrong problem”.
Why SFTR, why now?
EU regulators have built SFTR to meet a dual-purpose mandate. Firstly, to provide an aggregated macro view of SFT market system, counterparty and collateral risks to share with both European and global regulators. Secondly, the reports are required to support investigations regarding market abuse and any market or credit events involving a reporting entity. They have chosen not to use golden sources of reference data themselves, instead reliant upon the pricing, interest rates, party to a transaction and security classification data provided by reporting parties. Two-sided reporting is required to prevent double-counting but also to try to ensure that risks are classified correctly.
Trade matching, assisted reporting and delegated reporting that attempt to make two-sided reporting function more like single-sided reporting will often mask issues with data quality, as the old saying goes “two wrongs do not make a right”. Under SFTR, national competent authorities (NCAs) are required to enact penalties for reporting infringements that are effective, proportionate and dissuasive. They will not hesitate to do so if poor quality data is thwarting their macro or micro surveillance efforts.
Getting it right
Adopting frequent, periodic accuracy testing, pre-go-live and on an ongoing basis is really the only sure-fire way of obtaining quality assurance around your SFTR reporting at the point of implementation and into the future for this fast-evolving business. Deploying accuracy testing will also give operations teams greater confidence in responding to trade repository reconciliation feedback, without the need to conduct detailed investigations into their own reports in many cases both saving time and money.
Kaizen’s approach to regulatory testing for SFTR is very different. We take a holistic perspective to a firm’s reported data with an initial focus on the primary source of reporting errors - the accuracy of data contained within the reports submitted to a trade repository. This universal testing approach involves applying tests across every record and every one of the 155 fields and four reporting tables, every SFT transaction type and all 10 action types.
Our methodology has been designed to provide full coverage, giving greater confidence to senior management and regulators alike that the reporting issues have been surfaced. With regular testing, firms can know that the testing that is applied is consistent with the business practices and products and any new regulatory requirements published by the European Securities and Markets Authority as well as industry practice.
The regulation has certainly inspired a desire to implement standards and bring industry participants closer together in areas such as user acceptance testing (UAT). A consortium has sought to help firms capture the complete scope of their businesses and the UAT testing necessary to try to ensure completeness of SFTR reporting. Furthermore, in an attempt to give comfort around progress with SFTR project plans, operating models have been reviewed and benchmarking put in place. This has provided something of a jump-start for firms that were struggling to get their SFTR plans firmly off the ground.
Look out for valid but wrong reports
Completeness of reporting and ensuring that reports are compliant with validation rules are both vital but it’s far from the whole story. Unfortunately, validation rules are very far from foolproof, with some significant holes. They also do not ensure that valid data (field populations that meet the conditionality and syntax rules) is correct data. Standardised test packs and a consortium approach to UAT testing is a very useful SFTR implementation tool but it simply doesn’t go far enough to ensure that data quality has been established or maintained once SFTR is a live reporting regime.
Our wealth of experience in testing existing G20 position and transaction-based reporting regimes such as the second Markets in Financial Instruments Directive’s transaction Reporting, the European Market Infrastructure Regulation or the US Dodd-Frank Act indicates that many reporting counterparties routinely submit reports that are valid but wrong. Indeed, the vast majority of fully validated transaction reports we test exhibit multiple errors, what we call the “valid but wrong problem”.
Why SFTR, why now?
EU regulators have built SFTR to meet a dual-purpose mandate. Firstly, to provide an aggregated macro view of SFT market system, counterparty and collateral risks to share with both European and global regulators. Secondly, the reports are required to support investigations regarding market abuse and any market or credit events involving a reporting entity. They have chosen not to use golden sources of reference data themselves, instead reliant upon the pricing, interest rates, party to a transaction and security classification data provided by reporting parties. Two-sided reporting is required to prevent double-counting but also to try to ensure that risks are classified correctly.
Trade matching, assisted reporting and delegated reporting that attempt to make two-sided reporting function more like single-sided reporting will often mask issues with data quality, as the old saying goes “two wrongs do not make a right”. Under SFTR, national competent authorities (NCAs) are required to enact penalties for reporting infringements that are effective, proportionate and dissuasive. They will not hesitate to do so if poor quality data is thwarting their macro or micro surveillance efforts.
Getting it right
Adopting frequent, periodic accuracy testing, pre-go-live and on an ongoing basis is really the only sure-fire way of obtaining quality assurance around your SFTR reporting at the point of implementation and into the future for this fast-evolving business. Deploying accuracy testing will also give operations teams greater confidence in responding to trade repository reconciliation feedback, without the need to conduct detailed investigations into their own reports in many cases both saving time and money.
Kaizen’s approach to regulatory testing for SFTR is very different. We take a holistic perspective to a firm’s reported data with an initial focus on the primary source of reporting errors - the accuracy of data contained within the reports submitted to a trade repository. This universal testing approach involves applying tests across every record and every one of the 155 fields and four reporting tables, every SFT transaction type and all 10 action types.
Our methodology has been designed to provide full coverage, giving greater confidence to senior management and regulators alike that the reporting issues have been surfaced. With regular testing, firms can know that the testing that is applied is consistent with the business practices and products and any new regulatory requirements published by the European Securities and Markets Authority as well as industry practice.
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