SECURITIES FINANCING TRANSACTION REGULATION.
Gathering the data required to complete Securities Financing Transaction Regulation (SFTR) reports could well prove a headache for firms when reporting obligations kick in next year. But, says Peter Moss, CEO of SmartStream’s Reference Data Utility (RDU), a specialist SFTR instrument reference data service can take away much of the complexity involved.
The financial services industry may still be catching its breath after the scramble to comply with MiFID II, but it must now grapple with the challenges posed by incoming Securities Financing Transaction Regulation.
January 2016 saw the publication of EU regulation 2015/2365, which introduced new measures in relation to securities financing transactions (SFTs). It followed recommendations by the Financial Stability Board and the European Systemic Risk Board, which highlighted the need for increased transparency in this area.
The new regulation affects SFTs conducted or reused by any counterparty established in the EU, irrespective of individual branch location, or by EU branches of non-EU firms. It also covers the reuse of financial instruments provided under a collateral arrangement by an EU-established counterparty, or by one from an EU branch of a third country.
The type of transactions caught by SFTR are deals where securities are lent or borrowed in return for cash, plus a financing fee, e.g. repurchase agreements (repos), securities lending, and sell/buy-back transactions.
So, what does the current securities lending landscape look like? The International Securities Lending Association (ISLA) estimates the global securities lending market (on loan) at just over Ä2 trillion and, of that, EU lenders represent one third of the global total. ISLA also calculates that there is in excess of Ä17 trillion of securities available in lending programmes globally. Of this, approximately 75% – some Ä11 trillion of supply – comes from institutional investors.
Clearly, the holders of assets wish to make their investments work as hard as possible. And securities lending can be lucrative. Its popularity – as certain industry publications have noted – is currently resurgent, making a recovery following the years after the 2008 financial crisis, when some investors withdrew from activity in this area. For some organisations, the need to meet costs and improve performance may be playing a role in driving this interest. As the Bank of England’s Securities Lending Committee observes in its May 2019 minutes, “…there has been a focus on cost dynamics within the asset management industry, as securities lending can add to fund performance or reduce cost base.”
Some elements of SFT regulation are already in force. These include rules restricting the way in which collateral can be reused, and requirements obliging investment funds to disclose details of their use of SFTs to investors. What is likely to prove the biggest headache for the industry has yet to begin, however.
From next year, firms will have to report SFTs to a trade repository registered with ESMA. Phased implementation will begin with banks and investment managers on April 14th 2020, and continue with CCPs and CSDs on 13th July 2020. Insurance and pension firms, UCITs and AIFs are scheduled to follow suit from 12th October 2020. Non-financial entities must file transaction reports from 11th January 2021. And organisations must give details not just of SFTs concluded on or following the reporting start date, but also of deals struck before then which still remain outstanding (those with a remaining maturity exceeding 180 days after reporting start date, or of open maturity and actually outstanding for 180 days after reporting commences).
Turning to the practical aspects of compliance, April 2020 – and October 2020 for the buy-side – may seem some way off but firms need to be thinking about meeting the demands of SFTR. Both sides to a transaction will need to send a trade report to a registered trade repository, on a T+1 basis, and the details of these submissions must match. Delegated reporting is, however, permitted. Firms must also store details of an SFT for at least five years after its completion, modification and termination.
Perhaps the greatest difficulty in completing SFTR reports lies in the amount and type of data firms will need to gather. There are over 140 reportable fields in total, including a significant number of reference data fields. The latter will need to be gathered from diverse sources, e.g. industry bodies, ratings agencies and index providers. This information will also need to be normalised, enriched and mapped into the form required by SFTR.
Although firms need to press on with preparations for SFTR, they are hampered somewhat by the fact that they are still waiting for ESMA’s final version of its Guidelines on Reporting under SFTR – due in Q4 of 2019. As a result of the wait, clarity is lacking in a number of areas. Take, for example, the requirement that counterparties to an SFT report on the quality of the security or collateral involved. Typically, such quality assessments are obtained via ratings agencies but this, of course, has a cost. At present, regulators appear to be suggesting that counterparties, as an alternative, could agree on the quality of a security between themselves. Some market participants, however, fear that this approach is not going to be viable.
A parallel issue relates to the reporting of security or collateral type. Where an SFT pertains to an equity firms must report on whether it belongs to a main index or not. Unfortunately, ESMA has not stated which indices constitute main ones, instead saying that it will adopt FSB standards. As the FSB has not yet clarified the situation either, the answer to this question remains unclear. It should also be noted that as the index constituents come at a cost, some in the industry have suggested that if the FSB wants this derived classification, it should publish the list constituents itself, in order to avoid burdening the sector with added reporting overheads.
Another trouble spot is the need to provide a legal entity identifier (LEI) for the issuer of a security or collateral. Where the SFT concerns a European issuer, the matter is straightforward. The global LEI system has still not been broadly adopted, however, and so an issuer from outside the EU may simply not have an LEI. But what alternative will satisfy authorities if no LEI can be produced?
In conclusion, although ESMA’s reporting guidelines have yet to be fully finalised, proactive firms will be planning carefully how best to meet SFTR reporting obligations. To assist companies to comply with these demands, the SmartStream RDU has launched an SFTR instrument reference data service.
So how does the RDU SFTR instrument reference data service work? In order to provide users with an accurate, comprehensive and easy-to-access means of obtaining the information they need, the RDU acquires instrument reference data from a broad range of industry sources, including ESMA, ANNA, GLEIF, ISO, ratings agencies and index providers. It then normalises, enriches and maps this information into the format required by SFTR and makes it available via a simple, cloud-based API. The service takes away the complexity of sourcing and deriving the reference data needed to fulfil SFTR reporting obligations, thereby freeing firms to concentrate on building their businesses and establishing an efficient SFT workflow.
©Best Execution 2019