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What Does "Best Efforts" for Compliance Really Mean?

As European Market Infrastructure Regulation (EMIR) requirements have gradually come into force this year (with limited success), regulators have stressed that firms' compliance will be judged on a "best efforts" basis. But what does this really mean, and more importantly, how will it impact financial penalties?

Last week, regulators from the U.K.'s Financial Conduct Authority (FCA), the Prudential Regulation Authority (PRA), and the European Commission took the stage at the Enterprise Collateral conference in London to address their concerns about a potential shortage of high-quality assets (the challenge of sovereign debt crises), the process of trading in counterparty risk for systemic risk (from bilateral arrangements to central clearing), and the topic of "best efforts"—albeit in a rather roundabout manner. On the latter note, the regulators suggested that firms need to prove they have "clearly defined" policies in place around key operational requirements for trade reporting under EMIR—even if the data being collected remains patchy and irreconcilable (only around 1% of the data regulators collect is actually able to be reconciled in order to meet systemic risk-monitoring needs).

The FCA noted that it is hopeful that over time the data will get to a point where it will be "of real use," but there is a way to go yet due to a chronic lack of consistency in formats and standards (a common complaint in the data management world). Much was made of fostering "open dialogue" with the industry about the need for standards within the trade repository arena to make this data useful, but—surprisingly—the regulators indicated that they consider it the industry's job to impose these standards on the repositories. How industry participants are expected to compel trade repositories to adopt standards is anyone's guess. Moreover, what is the incentive for firms if improving standardization could mean they will be more easily caught and fined for data quality issues? Isn't that like turkeys voting for Christmas and Thanksgiving?

Regardless, the U.K. regulators are keen to rein in their provision of industry guidelines for fear of "muddying the waters" in terms of implementation. Though the FCA has been a veritable guideline factory over the last 24 months, tackling everything from retail investors to investment banks, one can presumably expect less of these guidelines in future, with more reliance on industry feedback and engagement.

The fact that European regulators do not have "no action" letters at their disposal also means that the industry will have to continue to work on the "best efforts" basis. It will likely only be when a firm gets slapped with the first fine that the industry will get a definite read on the level of effort required to stay off the naughty list.

Given that trade reporting is coming into play in the realm of securities financing, expect much more of these concerns to crop up in the coming months and years in various segments of the market. "The dog ate my trade report" isn't going to cut it in the long term.