Peter Tomlinson and Rick Watson from the Association for Financial Markets in Europe (AFME) explain the ins and outs of the Securities Financing Transactions Regulation
by Bethan Rees
SFTR is an EU reporting obligation designed to increase the transparency of the securities financing transactions (SFTs) market. Emerging from the 2008 financial crisis, international regulators revealed important regulatory gaps, and securities lending and repurchase transactions came under great scrutiny. The regulation document says that the crisis “highlighted the need to improve transparency and monitoring not only in the traditional banking sector but also in areas where bank-like credit intermediation known as shadow banking, takes place … having already been estimated to amount to close to half of the regulated banking system”.
The first wave of reporting obligations entered into force in July 2020, coinciding with phase two for financial market infrastructures
Peter Tomlinson, a manager in AFME's post-trade division, and Rick Watson, managing director and head of capital markets, events and membership at AFME, explain who the regulation applies to, what the reporting involves, and why it's of interest to capital markets and operations-based members.
What is the SFTR, and which activities does it apply to?
Rick Watson (RW): To increase the transparency of SFTs, SFTR introduces several new requirements, including rules regarding the reuse of collateral, disclosure obligations to provide transparency to investors, and of course the transaction reporting regime.
These first two pillars have been live since 2016, and the first wave of reporting obligations entered into force in July 2020. This is very much the most complex and burdensome element of SFTR, requiring counterparties to report any new SFT or any lifecycle event (such as a modification or termination of an open SFT) to a registered trade repository on a T+1 basis. An SFT is when one counterparty borrows assets (typically either securities or cash) from another counterparty, secured against existing assets that they own. The regulation buckets these into four main types of SFT:
- A repurchase transaction (repo) – selling a security and agreeing to repurchase it in the future for the original sum of money, plus a return for the use of that money.
- A securities or commodities lending/borrowing transaction – lending a security for a fee in return for a guarantee in the form of financial instruments or cash given by the borrower.
- A buy-sell back or sell-buy back transaction – similar to a repo.
- A margin lending transaction – the lending of cash by a prime broker to facilitate a client's market activity.
What does the reporting involve?
Peter Tomlinson (PT): The SFTR reporting regime is often likened to European Market Infrastructure Regulation (EMIR) reporting. This is certainly true to some extent, and in fact, some of the rules are a direct cut and paste. However, while the mechanics are similar, SFTR is far more extensive in terms of the number of fields that must be populated, which can total more than 150 depending on the product type.
"Phase three reporting obligations kick in on 11 October 2020"The reporting is split into four sections – counterparty data, loan and collateral data, margin data, and reuse data. Quite a lot of these data points have not historically been captured by firms, which has meant significant retooling of back end systems to ensure all the relevant information is recorded.
As with EMIR, reporting is two-sided, meaning both the lender and borrower are required to submit a trade report, and key data fields on both sides must match. Reports are submitted to an authorised trade repository, who then reconcile the information provided by the lender and borrower, and pass this on to the European Securities and Markets Authority (ESMA), the European regulator.
What is a unique trade identifier?
RW: The UTI is a mandatory field, and it's used by the trade repository to link the two separate reports of an SFT for them to be reconciled and matched. As the name implies, a new UTI needs to be generated for each new SFT. That means that for each transaction, the lender and borrower will need to agree who is responsible for generating the UTI and sharing this with their counterparty, to ensure both sides of the report are consistent. This UTI generation and exchange process can be a significant operational challenge for firms, and many are making use of available vendor solutions to ease this burden.
What are the deadlines CISI members need to be aware of?
PT: SFTR has a phased implementation approach, with different deadlines for different types of institution. The first phase of reporting obligations – for banks and investment firms – was due to commence in April 2020. Given the market disruption caused by Covid-19, this was sensibly delayed to July 2020, coinciding with the phase two go-live for financial market infrastructures, such as clearing houses and central securities depositories.
"The UK will not onshore SFTR reporting obligations for non-financial counterparties"
Phase three reporting obligations kick in on 11 October 2020. This will affect other types of financial counterparties, such as insurance firms, pension schemes, Undertakings for the Collective Investment in Transferable Securities and alternative investment funds, as well as third country entities. Then, in January 2021, in-scope non-financial counterparties will be required to submit reports.
Why was it thought these transactions needed a special regime of their own, rather than being governed by the same principles that apply to other transactions?
PT: As part of the post-mortem of the global financial crisis, regulators observed that SFTs were an important source of financing but identified potential financial stability risks in these markets. These included concerns over the extent to which SFTs contribute to build ups of leverage, and the level of interconnectedness in the financial system.
This is where SFTR comes in. The reporting provided under SFTR captures new information that will provide regulators with far greater visibility of securities lending markets, to assess trends in financial stability and make the appropriate policy responses.
Shadow banking has been an issue since the 2008 crisis. Why has this regulation taken so long to appear?
The genesis of SFTR is a 2013 publication by the Financial Stability Board, which set out a series of global policy standards and recommendations to address the gaps in oversight and transparency of the shadow banking system. The transposition of these recommendations into an EU legislation began in 2014 and was passed into law in 2016. Given its complexity, the design of appropriate rules for the reporting element of SFTR took significantly longer. These were finally agreed and ratified in 2018, which set the clock ticking towards the phased implementation deadline. This window between the finalisation of the reporting standards and their entry into force was to allow market participants sufficient time to prepare.
About the experts
Rick Watson is managing director and head of capital markets, events and membership at AFME.
In his capital markets role he leads staff whose member committees include all the main fixed income and equities-related cash products across Europe and AFME's growth-related initiatives, and he co-leads AFME's investor and corporate relationships.
In events and membership, he focuses on member outreach, including AFME's broad range of over 35 events, which assists members and others with capital markets education, networking and support for advocacy.
He is on AFME's senior management team.
Peter Tomlinson is a manager in AFME's post-trade division, with additional responsibility for the prime services forum.
He primarily supports AFME members with the implementation of various post-trade regulatory changes.
Prior to joining AFME, Peter worked at Deutsche Bank for seven years in various middle office roles within the Delta One business.
He holds a degree in financial economics from the University of Liverpool.
It is worth noting that Europe is leading the pack in this respect and that the highly prescriptive reporting regime is not something that has yet been widely replicated in North America or Asia.
Trade repositories have to be EU-approved. Will this still be the case once the Brexit transition period is over?
PT: During the transition period, EU law will, of course, continue to apply, and trade repositories will remain regulated by ESMA. Any trade repository wishing to provide services related to the UK's onshored version of SFTR will need to apply for registration – or recognition – with the FCA by 4 December 2020.
The FCA has not yet published any details of applications received.
After the transition period, would the UK be able to amend or even repeal the SFTR, and is there any likelihood of this?
PT: Rishi Sunak, Chancellor of the Exchequer, has confirmed in a written statement that the UK will not onshore SFTR reporting obligations for non-financial counterparties. These obligations are due to kick in in January 2021, so will not be in force by the end of the transition period, thus allowing the UK the opportunity to “exercise its discretion”.
In his announcement, Sunak also notes that “systemically important non-financial counterparties trading activity will be captured sufficiently through the other reporting obligations”, which perhaps signals that, for now at least, there is no intention to repeal those elements of SFTR that are already in force.
Will smaller players be disadvantaged by the burden of compliance?
RW: SFTR creates different sets of problems for different sized market participants. Larger firms have had to grapple with consuming and standardising data from what is often a patchwork of different systems. To some extent, many have been able to leverage existing reporting infrastructure – from both a technology and human resource standpoint – built to support Markets in Financial Instruments Directive and EMIR obligations.
For smaller firms, the ongoing operational cost of producing reports daily, not to mention reviewing and resolving any reconciliation breaks, is likely to be significant. Many firms will rely on larger counterparties to provide delegated or assisted reporting, as well as the various technology solutions offered by vendors. Small non-financial counterparties are exempt from the regulation.
What are some other challenges that CISI members might face with SFTR?
PT: From our experience, most challenges have related to data. The quantity and granularity of the data required is simply unprecedented. As well as the challenge in sourcing and storing this data internally, there are a couple of other angles to consider.
"82 of the 153 reportable fields must match on both sides of the report"
First, the quality of external static reference data. By way of example, SFTR mandates that 'legal entity identifiers' (LEIs) are included on reports, identifying which company issued the security that was loaned or borrowed. Globally, the uptake by issuers to obtain LEIs has been patchy to say the least. Where there is no issuer LEI available, it creates a significant compliance question for firms reporting under SFTR.
Second, 82 of the 153 reportable fields must match on both sides of the report, with little to no tolerance. A key area of focus for the sector has been on developing solutions to reduce the number of matching breaks at the trade repository and reduce the operational burden. This involves root-cause remediation of underlying issues and lots of dialogue between counterparties to establish common practices.
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