Updated EMIR Refit and SAP Trade repository reporting: are you ready?
SAP Treasury’s Strategy for Seamless Compliance worldwide
In the first half of 2024, European treasurers are confronted with a new item on their agenda: the updated EMIR Refit. The new EMIR reporting rules will be implemented in the EU on the 29th of April 2024, and in the UK on the 30th of September 2024.
The Updated EMIR Refit introduces the following main changes:
- Harmonizing the reporting formats to ISO 20022 XML
- Increasing the number of reporting fields from 129 to 203 (204 in the UK)
- Introducing new fields: UPI (Unique product identifier) and RTN (Report Tracking Number)
For more details about these changes, refer to this article on the implications of the EMIR Refit.
Trade repository reporting in SAP Treasury and Risk management
SAP Treasury users inquire on how to deal with the changes in their solution, what comes out of the box, what adjustments are necessary,and where the challenges are.
Since the introduction of the original EMIR reporting in 2012, SAP has covered the requirements for EMIR reporting in the component Trade repository reporting. It is a robust functionality fully integrated into the SAP Transaction manager environment. Due to varying requirements among the various trade repositories, SAP has ceased to enhance the solution and referred clients to the partner solution of Virtusa. However, the SAP Trade repository solution (“TARO”) is still supported on all current releases in the existing functional extend and can be used and adopted by in-house developments and consulting partners (SAP Note 2384289). Using the Virtusa solution or a custom solution, with EMIR Refit, a number of new required fields needed to be incorporated into the deal management data model.
The following changes have been provided by individual SAPNotes over the course of the past months:
- Unique Product Identifier (ISO 4914 UPI) and Report Tracking Number (RTN) have been introduced. They are available under the tab “Administration” in the deal data.
- These fields have been introduced to the relevant BAPIs, mirror deal functionality, as well as to the SAP TPI interface.
New reporting fields
The EMIR Refit solution utilizes fields, which have already been made available earlier, over the course of the original EMIR Refit in 2018 (Switch FIN_TRM_FX_HMGMT_3), and are present also under the tab “Administration” for the relevant product categories:
- CFI Code (Classification of Financial Instruments, ISO 10692 Classification)
- ISIN on the deal level for OTC deals
- Market Identification Code (MIC)
The recently introduced field is the UPI, which is a classification assigned by ANNA Derivatives Service Bureau. It consists of 12 characters and reflects both the Asset class, Instrument type, Product and the CFI. The CFI itself is an instrument classification which is 6 characters long.
The next consideration is how to populate these fields. In case of external trades, the CFI and UPI can be delivered by the trading platform. SAP Trade platform integration (TPI) covers the transfer of these fields from the trading platforms.
Since 2019, in case of OTC deals, EMIR Refit made financial counterparties (FC) solely responsible and legally liable for reporting on behalf of both counterparties, provided the non-financial counterparty is below the clearing threshold (NFC-). Therefore, this option would be necessary only for large financial entities, as smaller corporates are not obliged to report external OTC deals, as the counterparty reports on their behalf.
Corporates are obligated to report their intercompany deals, under the condition that they cannot apply for an opt out with their regulator. In that case, the CFI and UPI need to be derived in-house.
For that purpose, there are enhancements (BAdIs) available, to implement one's own derivation logic.
The reporting format has been standardized with ISO 20022 based XML. XML output can be easily generated based on a DMEE structure. Unlike the original version from 2012, SAP does not deliver the new report structures needed for the EMIR Refit. This part needs to be set up in a project.
The impact of the EMIR Refit in the trade repository reporting of your organisation can bring up many specific questions. We are happy to help you answer them from both the advisory as well as the technical implementation point of view. Examples on how Zanders can assist is:
- Implementing the new Emir Refit requirements in SAP Treasury
- Assisting in applying for the exemption of reporting internal trades with the various regulators
Reach out to Michal Šárnik to receive assistance on this topic.
The implications of the EMIR Refit
SAP Treasury’s Strategy for Seamless Compliance worldwide
The EMIR Refit was originally introduced with the goal of simplifying regulations, and these new requirements took effect in 2019. Following the EMIR Refit, there has been a subsequent round of amendments and updated technical guidelines. In this article, we highlight the key changes.
ESMA has published the final reporting guidelines for the updated EMIR refit to take effect on 29 April 2024 (Europe) and 30 September 2024 (UK). These changes, while strivinging to streamline and standardise the reporting across Trade repositories, will add some initial challenges in setting up the new report and reporting format.
Although a significant number of corporates rely on the financial counterparty to report on their behalf, these changes can still cause a major headache for corporates that continue reporting by themselves or need to report internal trades.
Key changes
The first major change concerns the number of fields that can be reported on. Currently there are 129 reportable fields, under the updated legislation there is a withdrawal of 15 and 89 new fields. This brings the new report to a hefty 203 reportable fields.
There will be an introduction of more counterparty-specific fields. These fields will require a deeper understanding of and communication with all counterparties. New counterparty data that will be required includes a Clearing Threshold and Corporate Sector.
The way that these fields will be reported is under huge review. The updated legislation will remove the CSV file, a business staple due to its ease of creation and flexibility, and replace the file with an XML submission using ISO 20022 standards. This move to XML will give corporates the headache of building the necessary XML file. One benefit of the XML format is that it will make moving between Trade Repositories easier as there will be a uniform file specification.
Introducing UPI
Another major change concerns the introduction of a Unique Product Identifier (UPI). The UPI is aimed at reducing the misreporting of products, ISINs, CFI codes, and other classifications. The UPI will be controlled and issued by the Derivatives Service Bureau (DSB). With a central database of identifiers, this should reduce misreporting. It is also hoped that the use of a centrally managed UPI will lead to a reduction in the number of reportable fields in the future . A downside to this change is that companies will need to sign up with the DSB and a fee will be charged for each UPI. There is a general consensus that with the introduction of the UPI, the UTI is likely to be phased out and removed in the future.
One easily missed detail on the new requirements is the necessity to update all outstanding trades to the new reporting format and level of detail, within 6 months of the go-live. This can be problematic for firms that don’t have the necessary data points for the historic trades and will require a review to bring these trades up to the required reporting standard.
In summary, there are large changes in the number of fields needing to be reported, much more granularity required from dealing counterparties, and a change of file type to XML.
Reporting validations and final report can be found on the ESMA website.
With our experience in EMIR and EMIR Refit legislation we can help with the transition to the new reporting requirements.
Please contact Keith Tolfrey or Wilco Noteboom for further insights.
Setting up an Effective Counterparty Risk Management Framework
Compared with only a few years ago, today’s corporate treasurers are exposed to a much greater variety of counterparty risks within both their supply chains and financial institutions. This article provides guidance on how these counterparty risks can be effectively monitored and managed.
In recent years, the counterparty risks that corporates are exposed to have dramatically changed. Besides the traditional default risk that corporates hold on their customers, there has been an increase in counterparty risk regarding the exposures to financial institutions (FIs), the total supply chain, and also to sovereign risk. Market volatility remains high and counterparty risk is one of the top risks that need to be managed. Any failure in managing counterparty risk effectively can result in a direct adverse cash flow effect.
There are two important factors that have resulted in greater attention being paid to counterparty risk related to FIs in treasury. Firstly, FIs are no longer considered ‘immune’ to default. Secondly, the larger and better-rated corporates are now hoarding a day’s more cash compared to their pre-2008 crisis practice, due to restricted investment opportunities in the current economic environment, limited debt redemption and share buy-back possibilities and the desire to have financial flexibility.
Several trends can be identified regarding counterparty risk in the corporate landscape. In a corporate-to-bank relationship, counterparty risk is being increasingly assessed bilaterally. For example, the days are over when counterparty risk mitigating arrangements, such as the credit support annex (CSA) of an International Swaps and Derivative Association (ISDA) agreement, were only in favor of FIs. Nowadays, CSAs are more based on equivalence between the corporate and FI.
Measuring and Quantifying of Counterparty Risks
The magnitude of counterparty risk can be estimated according to the expected loss (EL), which is a combination of the following elements:
- Probability of default (PD): The probability that the counterparty will default.
- Exposure at default (EAD): The total amount of exposure on the counterparty at default. Besides the actual exposure the potential future exposure can also be taken into account. This is the maximum exposure expected to occur in the future at a certain confidence level, based on a credit-at-risk model.
- Loss given default (LGD): Magnitude of actual loss on the exposure at default.
This methodology is also typically applied by FIs to assess counterparty risk and associated EL. The probability of default is an indicator of the credit standing of the counterparty, whereas the latter two are an indicator of the actual size of the exposure. Maximum exposure limits on the combination of the two will have to be defined in a counterparty risk management policy.
Another form of counterparty risk is settlement risk, or the risk that one party of the agreement does not deliver a security, or its value in cash, as per the agreement after the other party has already delivered the security or cash value. Whereas EAD and LGD are calculated on a net market value for derivatives, settlement risk entails risk to the entire face value of the exposure. Settlement risk can be mitigated, for example by the joining multicurrency cash settlement system Continuous Link Settlement (CLS), which settles gross transactions of both legs of trades simultaneously with immediate finality.
Counterparty Exposures
In order to be able to manage and mitigate counterparty risk effectively, treasurers require visibility over the counterparty risk. They must ensure that they measure and manage the full counterparty exposure, which means not only managing the risk on cash balances and bank deposits but also the effect of lending (the failure to lend), actual market values on outstanding derivatives and also indirect exposures.
Any counterparty risk mitigation via collateralisation of exposures, such as that negotiated in a CSA as part of the ISDA agreement and also legally enforceable netting arrangements, also has to be taken into account. Such arrangements will not change the EAD, but can reduce the LGD (note that collateralisation can reduce credit risk, but it can also give rise to an increased exposure to liquidity risk).
Also, clearing of derivative transactions through a clearing house – as is imposed for certain counterparties by the European Market Infrastructure Regulation (EMIR) – will alter counterparty risk exposure. Those cleared transactions are also typically margined. Most corporates will be exempted from central clearing because they will stay below the EMIR-defined thresholds.
It will be important to take a holistic view on counterparty risk exposures and assess the exposures on an aggregated basis across a company’s subsidiaries and treasury activities.
Assessing Probability of Default
A good starting point for monitoring the financial stability of a counterparty has traditionally been to assess the credit rating of the institutions as published by ratings agencies. Recent history has proved however that such ratings lag somewhat behind other indicators and that they do not move quickly enough in periods of significant market volatility. Since the credit rating is perceived to be somewhat more reactive they will have to be treated carefully. Market driven indicators, such as credit default swap (CDS)* spreads, are more sensitive to changes in the markets. Any changes in the perceived credit worthiness are instantly reflected in the CDS pricing. Tracking CDS spreads on FIs can give a good proxy of their credit standing.
How to use CDS spreads effectively and incorporate them into a counterparty risk management policy is, however, sometimes still unclear. Setting fixed limits on CDS values is not flexible enough when the market changes as a whole. Instead, a more dynamic approach that is based on the relative standing of an FI in the form of a ranking compared to its peers will add more value, or the trend in the CDS of a FI compared against that of its peers can give a good indication.
A combination of the credit rating and ‘normalised’ CDS spreads will give a proxy of the FI’s financial stability and the probability of default.
Counterparty Risk Management Policy
It is important to implement a clear policy to manage and monitor counterparty risk and it should, at the very least, address the following items:
- Eligible counterparties for treasury transactions, plus acceptance criteria for new counterparties – for example, to ensure consistent ISDA and credit support agreements are in place. This will also be linked to the credit commitment. Banks which provide credit support to the company will probably also demand ancillary business, so there should be a balanced relationship. While the pre-crisis trend was to rationalise the number of bank relationships, since 2008 it has moved to one of diversification. This is a trade-off between cost optimisation and risk mitigation that corporates should make.
- Eligible instruments and transactions (which can be credit standing dependent).
- Term and duration of transactions (which can be credit standing dependent).
- Variable maximum credit exposure limits based on credit standing.
- Exposure measurement – how is counterparty risk identified and quantified?
- Responsibility and accountability – at what level/who should have ultimate responsibility for managing the counterparty risk.
- Decision making to provide an overall framework for decision making by staff, including treatment of breaches etc.
- Key Performance Indicators (KPIs) – Selection of KPIs to measure and monitor performance.
- Reporting – Definition of reporting requirements and format.
- Continuous improvement – What procedures are required to keep the policy up to date?
Conclusion
To set up an effective counterparty risk management process, there are five steps to be taken as shown below; from identifying, quantifying, setting a policy to process and execute the set policy regarding counterparty risk.
Treasurers should avoid this becoming an administrative process; instead it should really be a risk management process. It will be important that counterparty risk can be monitored and reported on a continuous basis. Having real-time access to exposure and market data will be a prerequisite in order to be able to recalculate the exposures on a frequent basis. Market volatility can change exposure values rapidly.
* A credit default swap protects against default. In the event of a default the buyer will receive compensation. The spread (CDS spread) is the (insurance) premium paid for the swap.