Inaccurate trade reporting can cost millions – yet regulators may reject correctly reported trades from investment firms because a trading venue is at fault. Oliver Bishop of Elixirr explains.
Transaction reporting is currently as prominent as ever at the UK’s Financial Conduct Authority (FCA), which issued two large fines recently for reporting breaches under MiFID I. Most of the problems in reporting – such as transactions that pass validation but are fundamentally wrong because the names of the buyer and seller are the wrong way round – are established and ongoing.
The regulator has given further insight into reporting errors in the latest issue of its ‘Market Watch’ publication.
However, it was FCA comments on ‘reference data’ – which includes identification of counterparties and securities – that led us to do some analysis on the Financial Instruments Reference Data System, known as Firds.
Firds is the data collection infrastructure established by the European Securities and Markets Authority (Esma), in cooperation with regulators in the EU. Firds is intended to give rise to efficient and harmonised collection of instrument reference data across market participants, such as trading venues and national regulators.
The results or our analysis were interesting. But first a little more detail on the problems the FCA is highlighting.
Whilst already familiar to many market participants, the FCA clearly stated that there is a high incidence rate of what are called CON-412 rejections, those where the “instrument is not valid in the instrument reference data on the trade date”, and CON-472 errors, where an underlying instrument is not valid on the trade date. Of interest here is that (at least) two parties can be at fault for this: investment firms (both buy and sell-side) and trading venues.
Investment firm errors were not the focus of this analysis, since these errors are likely to be easily explained. Typically, these errors will occur in the case of an accuracy error (e.g. incorrect instrument identifier, MIC code – which identifies the trading venue - or trade date) or over-reporting. In the case of accuracy, resolution is simply down to the firm to correct its report. While this may not be simple, these issues are conceptually easy to understand, and the requirements are clear.
Many firms have a collection of issues that they are working to resolve, and an associated requirement to back-report/replay a population of trades to ensure the correctness of the records submitted to the regulator.
In the case of over-reporting, we suspect given the heavy enforcement of under-reporting under MiFID I (see most FCA MiFID fines to date), some firms may have made a risk-based decision to tolerate some over-reporting.
In both cases, it is important to be open and honest with your regulator and take reasonable steps to investigate, resolve and replay all observed issues.
Venues, however, is where it gets more interesting. If a firm correctly reports transactions, it may still get one of the rejections above, but this can be due to an error in the data being submitted by the trading venue. This issue may also be familiar to participants and likely comes down to trading venues creating a gap in Firds attributable to completeness, accuracy or both.
In the case that data reported to Firds by the venue was not complete, it is possible that venues, including ‘systematic internalisers’ (SIs) and ‘multi-lateral trading facilities’ (MTFs), may not submit reference data despite being required to do so.
Here, rejections will occur which are the fault of the trading venue because transaction reporting validations will test whether the instrument was traded on the venue being reported. The trusted source for what was traded on a venue is the venue itself, and if they do not report the instrument being traded on that day, then any transaction reports will be rejected.
We suspect the issue may be mostly with SIs and potentially a limited number of MTFs and ‘organised trading facilities’ (OTFs). According to our analysis, the number of venues that have never submitted reference data (or have never submitted it under the correct MIC) consists of over 150 SIs and a single-digit number of MTFs/OTFs.
There are potentially legitimate reasons to explain both of these results. For example, it is possible to register an MTF/OTF but not yet be trading. But it is likely that some of these firms should be reporting, particularly the SIs. Firms which may fall into this category should review their obligations under RTS 23 (regulatory technical standards to do with the supply of reference data) and ensure that they are correctly submitting. This includes correctly identifying when they are trading as an SI and passing this information to the RTS 23 reporting system.
If a trading venue submits incorrect data to Firds then it can cause rejections but will not always do so, since some errors will not lead to a rejection during transaction reporting validations.
Incorrect venue identification codes, or MIC codes, are an important accuracy error which can lead to rejections. If a trading venue submits data with an incorrect MIC code (for example, giving the wrong segment of an operator’s venue), the instrument is not perceived to have been traded on the venue which was identified by the firm. The report will be rejected back to the firm at the fault of the trading venue.
Another error which can lead to rejections is when a venue submits data that suggests the instrument is not valid on the trade date. Venues are required to submit numerous date fields to Firds.
These issues are currently sitting ‘under the radar’ and, while we believe many participants are aware of them, it is not clear to many how to fix them. Ultimately, the situation is simple: when these errors are encountered, either the firm itself or the trading venue/SI has got something wrong. If it is the trading venue, firms have reason to escalate as it inhibits their ability to report correctly. However, before doing that, you should have complete confidence in your own reporting – after all, there is another party who can be at fault…
Given that the FCA is now applying a greater focus on issues with reference data and Firds, we believe these could well be the next aspect of MiFID reporting to be penalised.
Oliver Bishop is a principal at Elixirr
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