Dealing with the ever-growing regulatory burden in capital markets


Dealing with the ever-growing regulatory burden in capital markets

By Michael Dorval

A pragmatic approach for banks facing Basel III, the Dodd-Frank Act, the European Market Infrastructure Regulation and other new regulatory frameworks

Over the past 30 years, there has been a radical change in the environment for financial institutions. Where banks once had a clear view of the key financial regulations that applied to their businesses and how they affected their operations, now they face a whole raft of new rules that impact their activities across a number of different dimensions.

And the process is definitely not over yet. On the buy-side, hedge and private equity funds must deal not only with MiFID II, but also with the European Market Infrastructure Regulation (EMIR) and the Alternative Investment Fund Managers Directive (AIFMD).

The requirements from the regulators are becoming more complex and challenging. Some are appearing in the form of principles, such as the Basel Committee on Banking Supervision’s influential principles for effective risk data aggregation and reporting, first published in 2013. Others are of a highly detailed and technical nature, such as the requirements of MiFID II.

This vast web of new rules has major implications for banks’ IT systems, customer processes, risk management, reporting and many other areas. Considerable expert resources are required to analyze and interpret the ramifications for business operations. Tackling the various regulatory frameworks, such as Basel III, EMIR, IFRS and MiFID II, in isolation and piecemeal is inefficient. A portfolio-based approach will enable firms to systematically establish commonalities and potential synergies between sets of rules, as well as identify differences, which will lead to more effective implementation and compliance.

Regulation becomes more multifaceted

Global banks face onerous compliance responsibilities in the coming years. For a start, there is the demanding but inconsistent schedule for the implementation of new rules.

Some of the deadlines are global and fixed, such as for IFRS 9, but in other cases local regulators have set different implementation dates for their jurisdictions. There are also variations across regions in implementation programmes. Regulators are phasing the introduction of Basel III rules for elements such as capital, liquidity, systemic buffers and LCR, in different sequences.

Although Europe has tried to prevent local divergences in the rule books within its boundaries, it has proved more difficult to achieve harmonization globally. For example, there is significant divergence in the interpretation by Europe and the US of Basel III’s liquidity coverage ratio (LCR). Also, EMIR and Dodd-Frank OTC derivatives reporting requirements differ in terms of frequency, series of reports and type of counterparty.

A synchronized regulatory response

Taking a regulation-by-regulation approach to the compliance challenge is no longer feasible. The requirements are simply too many and too detailed. MIFID II documentation alone is more than 2,000 pages of text. A separate response for each new set of rules means a multiplicity of separate teams, budgets, processes and technology solutions. The cost and complexity of managing such a programme can be significant. A more efficient response is to take an integrated view across regulatory initiatives.

In practice, this means linking the regulations to the business of the bank – looking at how rules such as MIFID II, Dodd-Frank, the Capital Requirements Directive IV and the Financial Transaction Tax affect risk management, finance and treasury, and compliance. It means rating the impact (as high, medium or low) of each set of rules on the various components of each function like risk management and finance and treasury.

Regulatory overlap and differences

The Basel Committee/International Organization of Securities Commissions (IOSCO) rules on margining for uncleared OTC derivatives is just one area where banks have to deal with overlaps and differences. First proposed in 2013, the margining framework was refined in 2014 to produce Regulatory Technical Standards that require transposition into law by national and regional authorities. An analysis across jurisdictions shows a number of regional differences in approach to issues such as the phase-in approach, the minimum transfer amount and the initial margin maximum threshold.

Some examples of where it makes sense to examine overlaps and difference are:

  • The interpretation of trading platforms like Swap Execution Facility (SEF) versus Organized Trading Facility (OTF) versus Multilateral Trading Facility (MTF)
  • Implied changes to post-trade reporting in MIFID II compared with Dodd-Frank
  • The relationship between Basel III and EMIR capital requirements for central counterparties (CCPs)

Breaking down the barriers between business lines

A key step in achieving an efficient integrated approach to regulatory compliance is overcoming the barriers between business lines. The operation of different business lines as separate silos is a common obstacle to achieving enterprise goals and can hamper regulatory implementation. At first glance, the data requirements of Dodd-Frank, EMIR, MIFID II and the Fourth Anti-Money Laundering Directive (AMLD IV) cover a diverse range of definitions and collection methods that require considerable interpretation, and where it can be hard to see how it would be possible to take a holistic approach. However, closer analysis reveals they all require some sort of entity or client classification or categorization.

Dodd-Frank specifies the need for Legal Entity Identifiers (LEIs) for swaps reporting, and there is a similar requirement in trade reporting under EMIR. When the LEIs are defined once, they can be re-used across regulatory frameworks – for example, to help identifying beneficial ownership under AMLD IV. In addition, the requirement under MIFID II to classify clients into retail, professional and eligible counterparty could also benefit from an LEI like identifier.

Linking regulation to the trade lifecycle

By connecting regulation with the different steps of the trade lifecycle, business processes can better be visualized and analyzed. For example, that the Basel Committee’s Fundamental Review of the Trading Book has a clear impact on trade strategy and risk management through its new definition of the boundary between the trading and banking books and the imposition of new measures for market risk management (moving away from Value-at- Risk [VaR] to expected shortfall). In contrast, MIFID II has more effect on the trade initiation and execution stages through its definition of trading platforms, such OTFs, MTFs and traditional exchanges, and rules on where trades can be routed.

IT systems: search for the right ingredients

One way to tackle the regulatory challenge is to take a best fit approach in terms of IT – where the individual tasks required to comply with a new set of rules are delegated to the systems best equipped to handle them. Take the example of the margin requirements for uncleared OTC derivatives. These rules will have a significant impact on front and middle office systems. The requirements can be delegated to the best-fit systems as follows:

  • Risk systems are best equipped to tackle the sophisticated calculations for initial margin – one-tailed VaR with a 99% confidence level, at least 10 days margin period of risk, with historical or Monte-Carlo scenarios.
  • Front office systems are best suited to do the calculations related to variation margin, such as mark-to-market calculations using Overnight Index Swap (OIS) and Credit Support Annex (CSA) discounting.
  • Enterprise collateral management systems have the enterprise view that enables them to monitor exposures, perform collateral optimization, make margin calls and handle dispute workflow. The collateral management system should also be the central repository of agreement definitions.

Flexibility of IT is a further essential requirement for achieving compliance.

A key challenge in meeting the requirements of the new OTC derivatives clearing regulation is achieving more rigorous and frequent portfolio reconciliation. Automating these activities by linking to external solutions, such as the TriOptima post-trade service, will be crucial to ensure smooth workflow. There are many other examples in the new regimes where integration tools are essential to link into the emerging landscape of new trading platforms (SEFs, OTFs, and MTFs), central counterparties and various trade repositories.


Regulation is clearly high on the agenda of banks. Although the challenges of compliance will differ from bank to bank, the traditional industry approach of handling each regulation separately is no longer feasible due to cost and complexity.

An integrated approach across regulatory initiatives, such as Basel III, Dodd-Frank, EMIR and MIFID II, is essential for effective implementation. Such an approach enables potential overlaps and synergies between regulations to be exploited. It entails breaking down the barriers between different business lines to find common solutions, and linking regulatory requirements with the various steps of the trade lifecycle to help visualize and analyze how the regulations impact individual business processes.

The new regulations should be viewed in the context of the cross-business IT architecture of the bank. Demanding new rules, such as margin requirements for uncleared OTC derivatives and the Fundamental Review of the Trading Book, should be tackled by delegating tasks to the most appropriate systems and through overall IT flexibility.

This article was first published in edition 4 of Rocket, our magazine. Download available Rocket editions here, and save your up to date address in your profile to receive the latest hard copy editions as they become available.

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