Following the launch of the Markit│CTI Tax Solutions for Section 871(m) to address compliance obligations for US equity derivatives, SRP spoke to IHS Markit's co-head of operational risk and regulatory compliance solutions, Cyrus Daftary (pictured), about the challenges of addressing section 871m and the firm's increasing focus on front-end solutions aimed at streamlining the compliance process for issuers of structured products.

"Since the acquisition of CTI by Markit in 2014, we have increased our profile through helping our clients handle due diligence, withholding and reporting by leveraging the knowledge of our tax experts," says Daftary. "Our outsourcing division offers tools for clients to address their compliance obligations which can be hosted or locally installed."

The Markit│CTI Tax Solutions for Section 871(m) resulted from the firm's collaboration with a group of early adopters to create an industry solution that would meet the needs of firms issuing products linked to US underlyings, according Daftary. "We recognised that the industry needed deeper solutions addressing the requirements of the front-office and thus have incorporated a pre-trade screening tool in our solution," he says. "We have also created a tax application that is connected to the back-office to support withholding and reporting obligations. Our section 871(m) tool is a centralised solution to simplify the compliance process to help our clients to meet their regulatory requirements."

According to Daftary, the merger in July 2016 of IHS and Markit provided further benefits for the new firm which combined IHS' multi-national corporate tax capabilities and Markit's track record in the financial services segment "which are very complementary in leveraging data to provide solutions to our clients".

"Bringing the two firms together has opened new opportunities and synergies especially around the reporting obligations of financial firms," says Daftary. "We are well positioned to capitalise on the paradigm shift we are seeing in the market. Firms are trying to do more with less, but one of the things that has not changed is the increasing regulatory burden."

IHS Markit has experienced "incredible growth" in its outsourcing business as market players move to address the changing environment. "The old philosophy of keeping operations proprietary and doing everything in-house is no longer the approach financial firms are taking," says Daftary. "We see firms increasingly using third party providers in functions where there is no competitive advantage and it can be expensive to manage internally."

IHS Markit's advantage as a firm is that its offering goes beyond that of an accounting specialists as it can operationalise the day to day compliance needs of firms, according to Daftary. "We have been approached by many firms asking us to be their Business Process Outsourcing‎ (BPO) for their tax reporting obligations," he says, adding that IHS Markit is the main consumer of its own products. "We validate over 85,000 tax forms a month and we see everything and can react to any changes in the regulatory framework."

According to Daftary, section 871(m) presents two challenges in the structured products market. "The first is that it is a very data intensive and firms are demanding tools that allow them to see what is within the scope of the new tax so that it does not create operational chaos," says Daftary. "Secondly, 871(m) has implications for firms issuing and trading equity derivative instruments from process, technology and people perspectives."

Tax used to be a function of the back-office and the trading and sales teams were focused on generating return, according to Daftary, but section 871(m) has brought that compliance function to the front office which now needs to take this into account when issuing and transacting products.

"Some firms, especially those issuing equity derivatives, have reacted to the upcoming tax requirements and have already teams dealing with how the tax will impact their activities," says Daftary. "On the buy-side, we see some firm are still grappling with how the tax will impact them so they are looking for more guidance and support."

The difference with what HIS Markit is offering goes beyond the data, "and it is more comprehensive than other offerings because it is integrates areas that might be caught by the new tax", according to Daftary. OTC and listed options, exchange-traded notes, and other equity-linked instruments such as repos and other instruments that can potentially fall within the 871(m) requirements are all covered by the new solution.

"These are all different instruments that are also traded in different venues," says Daftary. "Our tools enable institutions to see data at a contract level from different trading platforms."

According to Daftary, the response from clients has been very positive and the firm expects the Markit│CTI Tax Solutions for Section 871(m) to be deployed by financial institutions in the US and outside the US that "are active in the equity derivatives market".

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